PART I
As used in this Annual Report,
“
we
,” “
us
,” “
our
,” “
ImageWare
,” “
ImageWare
Systems
,”
“
Company
” or “
our Company
” refers to ImageWare Systems, Inc. and all
of its subsidiaries.
Overview
The Company is a pioneer and leader in the
emerging market for biometrically enabled software-based identity
management solutions. Using those human characteristics that are
unique to us all, we create software that provides a highly
reliable indication of a person’s identity. Our
“flagship” product is our patented IWS Biometric
Engine
®
.
Scalable for small city business or worldwide deployment, our IWS
Biometric Engine is a multi-biometric software platform that is
hardware and algorithm independent, enabling the enrollment and
management of unlimited population sizes. It allows a user to
utilize one or more biometrics on a seamlessly integrated platform.
Our products are used to manage and issue secure credentials,
including national IDs, passports, driver licenses and access
control credentials. Our products also provide law enforcement with
integrated mug shot, LiveScan fingerprint and investigative
capabilities. We also provide comprehensive authentication security
software using biometrics to secure physical and logical access to
facilities or computer networks or Internet sites. Biometric
technology is now an integral part of all markets we address and
all of our products are integrated into the IWS Biometric
Engine.
Historically,
we have marketed our products to government entities at the
federal, state and local levels, however, through the emergence of
cloud based computing, a mobile market that demands increased
security and interoperable systems, and the proven success of our
products in the government markets, has enabled us to enlarge our
target market focus to include the emerging consumer and
non-government enterprise marketplace.
Our
biometric technology is a core software component of an
organization’s security infrastructure and includes a
multi-biometric identity management solution for enrolling,
managing, identifying and verifying the identities of people by the
physical characteristics of the human body. We develop, sell and
support various identity management capabilities within government
(federal, state and local), law enforcement, commercial
enterprises, and transportation and aviation markets for
identification and verification purposes. Our IWS Biometric Engine
is a patented biometric identity management software platform for
multi-biometric enrollment, management and authentication, managing
population databases of virtually unlimited sizes. It is hardware
agnostic and can utilize different types of biometric algorithms.
It allows different types of biometrics to be operated at the same
time on a seamlessly integrated platform. It is also offered as a
Software Development Kit based search engine, enabling developers
and system integrators to implement a biometric solution or
integrate biometric capabilities into existing applications without
having to derive biometric functionality from pre-existing
applications. The IWS Biometric Engine combined with our secure
credential platform, IWS EPI Builder, provides a comprehensive,
integrated biometric and secure credential solution that can be
leveraged for high-end applications such as passports, driver
licenses, national IDs, and other secure documents.
Our
law enforcement solutions enable agencies to quickly capture,
archive, search, retrieve, and share digital images, fingerprints
and other biometrics as well as criminal history records on a
stand-alone, networked, wireless or Web-based platform. We develop,
sell and support a suite of modular software products used by law
enforcement and public safety agencies to create and manage
criminal history records and to investigate crime. Our IWS Law
Enforcement solution consists of five software modules: Capture and
Investigative modules, which provide a criminal booking system with
related databases as well as the ability to create and print mug
photo/SMT image lineups and electronic mugbooks; a Facial
Recognition module, which uses biometric facial recognition to
identify suspects; a Web module, which provides access to centrally
stored records over the Internet in a connected or wireless
fashion; and a LiveScan module, which incorporates LiveScan
capabilities into IWS Law Enforcement providing integrated
fingerprint and palm print biometric management for civil and law
enforcement use. The IWS Biometric Engine is also available to our
law enforcement clients and allows them to capture and search using
other biometrics such as iris or DNA.
Our secure credential solutions empower customers
to create secure and smart digital identification documents with
complete ID systems. We develop, sell and support software and
design systems which utilize digital imaging and biometrics in the
production of photo identification cards, credentials and
identification systems. Our products in this market consist of IWS
EPI Suite and IWS EPI Builder (“
SDK
”). These products allow for the production
of digital identification cards and related databases and records
and can be used by, among others, schools, airports, hospitals,
corporations or governments. We have added the ability to
incorporate multiple biometrics into the ID systems with the
integration of IWS Biometric Engine to our secure credential
product line.
Our enterprise authentication software includes
the IWS Desktop Security product which is a comprehensive
authentication management infrastructure solution providing added
layers of security to workstations, networks and systems through
advanced encryption and authentication technologies. IWS Desktop
Security is optimized to enhance network security and usability,
and uses multi-factor authentication methods to protect access,
verify identity and help secure the computing environment without
sacrificing ease-of-use features such as quick login. Additionally,
IWS Desktop Security provides an easy integration with various
smart card-based credentials including the Common Access Card
(“
CAC
”), Homeland Security Presidential Directive
12 (“
HSPD-12
”), Personal Identity Verification
(“
PIV
”) credential, and Transportation Worker
Identification Credential (“
TWIC
”) with an organization’s access
control process. IWS Desktop Security provides the crucial
end-point component of a Logical Access Control System
(“
LACS
”), and when combined with a Physical Access
Control System (“
PACS
”), organizations benefit from a complete
door to desktop access control and security
model.
Recent Developments
Creation of Series G Convertible Redeemable Preferred Stock and
Series G Financing
On December 27, 2016, the Company filed the
Certificate of Designations, Preferences, and Rights of the Series
G Convertible Preferred Stock with the Delaware Division of
Corporations, designating 6,120 shares of the Company’s
preferred stock, par value $0.01 per share, as Series G Convertible
Redeemable Preferred Stock (“
Series G
Preferred
”). Shares of
Series G Preferred rank junior to the Company’s Series B
Convertible Redeemable Preferred Stock, Series E Convertible
Redeemable Preferred Stock, Series F Convertible Redeemable
Preferred Stock as well as the Company’s existing
indebtedness, and accrue dividends at a rate of 10% per annum,
payable on a quarterly basis in shares of the Company’s
common stock, par value $0.01 per share (“
Common
Stock
”). Each share of
Series G Preferred has a liquidation preference of $1,000 per share
(“
Series G Liquidation
Preferenc
e”), and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Series G
Liquidation Preference, divided by $1.50.
On December 29, 2016, the Company accepted
subscription forms from certain accredited investors (the
“
Investors
”) to purchase a total of 1,625 shares of
Series G Preferred for $1,000 per share (the
“
Series G
Financing
”). In addition,
the Company also received executed exchange agreements from the
Investors pursuant to which the Company exchanged an aggregate
total of approximately 3.4 million shares of Common Stock held by
the Investors for an aggregate total of approximately 4,400 shares
of Series G Preferred.
Creation of Series F Convertible Redeemable Preferred Stock and
Series F Financing
On September 2, 2016, the Company filed the
Certificate of Designations, Preferences, and Rights of the Series
F Convertible Preferred Stock with the Delaware Division of
Corporations, designating 2,000 shares of its preferred stock as
Series F Convertible Redeemable Preferred Stock
(“
Series F
Preferred
”). Shares of
Series F Preferred rank junior to the Company’s Series B
Convertible Redeemable Preferred Stock, Series E Convertible
Redeemable Preferred Stock and existing indebtedness, and accrue
dividends at a rate of 10% per annum, payable on a quarterly basis
in shares of the Company’s Common Stock. Each share of Series
F Preferred has a liquidation preference of $1,000 per share
(“
Series F Liquidation
Preference
”), and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Series F
Liquidation Preference, divided by $1.50.
On September 7, 2016, the Company and Cap 1 LLC
(the “
Investor
”), entered into a securities purchase
agreement, wherein the Investor agreed to purchase 2,000 shares of
Series F Preferred for $1,000 per share (the
“
Series F
Financing
”), resulting in
gross proceeds to the Company of $2.0 million net of issuance costs
of approximately $21,000.
Amendments to Lines of Credit
On
December 27, 2016, in connection with the consummation of the
Series G Financing, the Company and Neal Goldman, a member of the
Company’s Board of Directors (the “
Holder
”), agreed to enter
into the
fifth amendment (the “
Line
of Credit Amendment
”) to the
convertible promissory note previously issued by the Company to the
Holder on March 27, 2013 (the “
Goldman
Line of Credit
”), to provide
the Company with the ability to borrow up to $5.5 million under the
terms of the Goldman Line of Credit, bringing the total amount the
Company may borrow under its existing lines of credit to $6.0
million. In addition, the Maturity Date, as defined in the Goldman
Line of Credit, was amended to be December 31, 2017. The Line of
Credit Amendment was executed on January 23,
2017.
In
addition, on January 23, 2017, the Company and Charles Crocker,
also a member of the Board of Directors of the Company, amended the
line of credit and promissory note, dated March 9, 2016 (the
“
Crocker
LOC
”), to extend the
maturity date thereof to December 31, 2017. No other amendments
were made to the Crocker LOC.
Key Product Introduction
On
November 14, 2016, the Company introduced GoVerifyID®
Enterprise Suite, a multi-modal, multi-factor biometric
authentication solution for the enterprise market. An
algorithm-agnostic solution, GoVerify ID Enterprise Suite is an
end-to-end biometric platform that seamlessly integrates with an
enterprise’s existing Microsoft infrastructure, offering
businesses a turnkey biometric solution for quick deployment. The
Company feels that this product has the potential to dramatically
accelerate adoption of its biometric solution due to the worldwide
prevalence of enterprise use of the Microsoft
infrastructure.
Working
across the entire enterprise ecosystem, GoVerifyID Enterprise Suite
offers a consistent user experience and centralized administration
with the highest level of security, flexibility, and usability.
Specific benefits include:
●
Mobile-workforce
friendly—With GoVerifyID Enterprise Suite user authentication
logins are possible for a tablet or laptop even when disconnected
from the corporate network. Additionally, GoVerifyID Enterprise
offers a consistent user authentication experience across all login
environments.
●
Hybrid
cloud—GoVerifyID Enterprise Suite is linked from the cloud to
an enterprise’s Microsoft infrastructure and is backward
compatible with Windows 7, 8 and 10. Additionally, because the
solution is SaaS-based it can easily scale to process hundreds of
millions of transactions and store just as many
biometrics.
●
Seamless
integration—GoVerifyID Enterprise Suite is a snap-in to the
Microsoft Management console and can be centrally managed at the
server. Additionally, the solution allows for seamless movement as
it integrates with Active Directory using an organization’s
existing Microsoft security infrastructure.
Industry Background
Biometrics and Secure Credential Markets
We
believe the biometric identity management market will continue to
grow as the role of biometrics becomes more widely adopted for
enhancing security and complying with government regulations and
initiatives and as biometric capture devices become increasingly
mobile, robust and cost effective. Our biometric and secure
credentialing solutions are meeting the requirements and standards
for true multi-modal biometric identity management systems, as well
as providing scalability to support evolving
functionality.
As
a result of HSPD-12, government organizations are required to adopt
new processes for verifying the identity of employees and
contractors as well as controlling access to secure facilities and
information systems. In response to the strict requirements set
forth by the Federal government, ImageWare enhanced its IWS
Biometric Engine and secure credentialing product suite by adding
card management and card printing modules which enable the offering
of end-to-end support for PIV-I and PIV-II business processes,
technical requirements, as well as the ability to partner with
leading physical and logical access control vendors for logistics
and deployment considerations. We believe that the
HSPD-12 standards as well as the product enhancements created to
meet those standards will, in large part, be adopted by the
commercial market and that the Company’s products will
transition into those market spaces without significant
customization.
Organizations
concerned with security can use our technology to create secure
“smart” identification cards that can be instantly
checked against a database of applicable biometrics to prevent
unauthorized access to secure facilities or computer networks. We
believe potential customers in these markets include, among others,
large corporations, border crossings (land, air and sea), airports,
hospitals, universities and government agencies.
Identification
systems have historically been sold based upon the cost-savings
digital systems offer over traditional non-digital systems. We
believe that the ability to easily capture images and data in a
digital database and to enable immediate and widespread access to
that database for remote identification/verification will be a
functionality that both public and private sector customers will
require in the future and that such functionality will be one of
the primary drivers for future growth within this market. We are
able to provide field-proven identification products with high
quality reference accounts across the board in terms of size and
complexity of systems and user requirements. When combined with our
proven biometric, cloud and interactive mobile messaging
capabilities, we believe we can provide a leading product offering
into the biometrically enabled secure identity management
market.
Law Enforcement and Public Safety Markets
The
United States law enforcement and public safety markets are
composed of federal, state and local law enforcement
agencies. Our target customers include local police and
sheriff’s departments, primary state law enforcement
agencies, prisons, special police agencies, county constable
offices, and federal agencies such as the Department of Homeland
Security, FBI, DEA and ICE. In addition, police agencies
in foreign countries have shown interest in using the full range of
IWS Law Enforcement products to meet the growing need for a
flexible yet robust booking/investigative solution that includes
the routine use of IWS Facial Recognition as well as the ability to
use other biometrics. We continue to target agencies in foreign
countries for our biometric and law enforcement
solutions.
Law
enforcement customers require demanding end-to-end solutions that
incorporate robust features and functionalities such as biometric
and secure credentialing capabilities, as well as instant access to
centrally maintained records for real time verification of identity
and privileges. Law enforcement has long used the multiple
biometrics of fingerprint and face in establishing an
individual’s identity record. More recently, law enforcement
is seeking capability to utilize additional biometrics such as iris
and DNA. The Company’s multi-biometric platform
product, the IWS Biometric Engine, allows company customers to use
as many and different biometrics as desired all on a single,
integrated platform.
Agencies
are also moving toward a more shared experience where specific
pieces of suspect/arrest data may be viewed by outside agencies
allowing a suspect’s identity to be quickly defined with the
end goal being the swift apprehension of the subject.
Products and Services
Our
identity management solutions are primarily focused around
biometrics and secure credentials providing complete,
cross-functional and interoperable systems. Our biometric and
secure credentialing products provide complete and interoperable
solutions with features and functions required throughout the
entire identity management life cycle, enabling users the
flexibility to make use of any desired options, such as identity
proofing and enrollment, card issuance, maintenance and access
control. Our solutions offer a significant benefit that one
vendor’s solution is used throughout the various stages, from
establishing an applicant’s verified identity, to issuance of
smart card based credentials, to the usage and integration to
physical and logical access control systems.
These
solutions improve global communication, the integrity and
authenticity of access control to facilities and information
systems, as well as enhance security, increase efficiency, reduce
identity fraud, and protect personal privacy.
We
categorize our identity management products and services into three
basic markets: (i) Biometrics, (ii) Secure Credential, and (iii)
Law Enforcement and Public Safety. We offer a series of
modular products that can be seamlessly integrated into an
end-to-end solution or licensed as individual
components.
Biometrics
Our
biometric product line consists of the following:
GoMobile InteractiveTM
In July 2013, the Company introduced its mobile
biometric identity management platform, GoMobile InteractiveTM
(“
GMI
”). Based upon acquired patented
messaging platform technology combined with the Company’s
patented IWS Biometric Engine®, GMI allows global business,
service and content providers to offer users biometric security for
their products, services and content on the Android or iPhone
operating systems. GMI includes a standalone application that can
be used as a turnkey solution, as well as a software development
kit, enabling integration with existing mobile applications for
Android and iPhone. Targeted verticals for the
product include mobile banking and value transfer, retail,
healthcare and entertainment services. By supporting multi-modal
biometrics on a mobile device, the Company is able to offer an
out-of-band security solution that is far superior to traditional
password or PIN protection, which are now failing and costing
businesses billions of dollars. In addition, the GMI
service supports dynamic information gathering, allowing clients to
learn about their users through the use of interactive surveys that
can be secured using biometrics.
IWS Biometric Engine
This
is a biometric identity management platform for multi-biometric
enrollment, management and authentication, managing population
databases of unlimited sizes without regard to hardware or
algorithm. Searches can be 1:1 (verification), 1:N
(identification), X:N (investigative) and N:N (database integrity).
IWS Biometric Engine is technology and biometric agnostic, enabling
the use of biometric devices and algorithms from any vendor, and
the support of the following biometric types: finger, face, iris,
hand geometry, palm, signature, DNA, voice, 3D face and retina. IWS
Biometric Engine is a second-generation solution from the Company
that is based on field-proven ImageWare technology solutions that
have been used to manage millions of biometric records since 1997
and is ideal for a variety of applications including: criminal
booking, background checks (civil and criminal), watch list,
visa/passport and border control (air, land and sea), physical and
logical access control, and other highly-secure identity management
environments. The Company believes that this product
will be very attractive to the emerging commercial and consumer
markets as they deploy biometric identity management
systems.
Our
IWS Biometric Engine is scalable, and biometric images and
templates can be enrolled either live or
offline. Because it stores the enrolled images, a
new algorithm can be quickly converted to support new or alternate
algorithms and capture devices. The IWS Biometric Engine is built
to be hardware “agnostic,” and currently supports over
100 hardware capture devices and over 70 biometric
algorithms.
The
IWS Biometric Engine is available as a Software Development Kit, as
well as a platform for custom configurations to meet specific
customer requirements. The added suite of products provides
government, law enforcement, border management and enterprise
businesses, a wide variety of application-specific solutions that
address specific government mandates and technology standards. It
also provides the ability to integrate into existing legacy systems
and expand based upon specific customer requirements. This enables
users to integrate a complete solution or components as needed. The
application suite of products includes packaged solutions
for:
●
HSPD-12 Personal Identity Verification
●
Applicant Identity Vetting
●
Physical Access Control
●
Single-Sign-On and Logical Access Control
IWS PIV Management
Application.
The
Company provides a set of Enterprise Server products within our
complete PIV solution, and these software products supply
server-based features and functions, while the use case for PIV
requires client-based presentation of PIV data and
workflow. The IWS PIV Management Application supplies
the web-based graphical user interface that presents the user or
client interface to the various server functions. Since
the server-based applications perform specific functions for
specific phases of the PIV life cycle, these server-based
applications need to be bound together with additional workflow
processes. The IWS PIV Management Application meets this
need with software modules that interface and interconnect the
server-based applications.
IWS PIV
Middleware.
The IWS
PIV Middleware product, which is NIST certified and listed on the
GSA approved product list, is a library of functions that connect a
card reader & PIV card on the hardware side with a software
application. The library implements the specified PIV Middleware
API functions that support interoperability of PIV
Cards. This software has been developed in conformance
with the FIPS-201 specification, and the software has been
certified by the NIST Personal Identification Verification Program
(“
NPIVP
”) Validation Authority as being
compliant.
IWS Background
Server.
The IWS
Background Server is a software application designed specifically
for government and law enforcement organizations to support the
first stage of biometric identity management functions such as
identity proofing and vetting. IWS Background Check
Server automatically processes the submission of an
applicant’s demographic and biographic data to investigative
bureaus for background checks prior to issuing a
credential.
IWS Desktop
Security.
IWS
Desktop Security is a highly flexible, scalable and modular
authentication management platform that is optimized to enhance
network security and usability. This architecture provides an
additional layer of security to workstations, networks and systems
through advanced encryption and authentication technologies.
Biometric technologies (face, fingerprint, iris, voice or
signature), can be seamlessly coupled with TPM chips to further
enhance corporate security. USB tokens, smart cards and RFID
technologies can also be readily integrated.
Additional features include:
●
Support for multiple authentication tools
including Public Key Infrastructure (“
PKI
”) within a uniformed platform and
Privilege Management Infrastructure (“
PMI
”) technology to provide more advanced
access control services and assure authentication and data
integrity;
●
Integration with IWS Biometric Engine for searching and match
capabilities (1:1, 1:N and X:N);
●
Integration with IWS EPI Builder for the production and management
of secure credentials;
●
Support for both BioAPI and BAPI standards;
●
Supports a single sign-on feature that securely manages Internet
Explorer and Windows application ID and password
information;
●
Supports file and folder encryption features; and
●
Supports various operating systems, including Microsoft Windows
2000, Windows XP, and Windows Server 2003.
IWS Biometric Quality
Assessment & Enhancement (“IWS Biometric
IQA&E”).
The IWS
Biometric IQA&E is a biometric image enhancement and assessment
solution that assists government organizations with the ability to
evaluate and enrich millions of biometric images automatically,
saving time and costs associated with biometric enrollment while
maintaining image and database integrity.
The IWS Biometric IQA&E improves the accuracy
and effectiveness of biometric template enrollments. The software
may be used stand-alone or in conjunction with the IWS Biometric
Engine. IWS Biometric IQA&E provides automated image quality
assessment with respect to relevant image quality standards from
organizations such as International Civil Aviation Organization,
National Institute of Standards and Technology
(“
NIST
”), International Organization for Standards
(“
ISO
”) and American Association of Motor Vehicle
Association (“
AAMVA
”). IWS Biometric IQA&E also enables
organizations to conduct multi-dimensional facial recognition,
which further enhances accuracy for numerous applications including
driver licenses, passports and watch lists.
IWS
Biometric IQA&E automatically provides real-time biometric
image quality analysis and feedback to improve the overall
effectiveness of biometric images thus increasing the biometric
verification performance, and maintaining database and image data
integrity. IWS Biometric IQA&E provides a complete platform
that includes an image enhancement library for biometric types
including face, finger and iris.
Secure Credential
Our
secure credential products consist of the following:
GoVerifyID
®
On
November 14, 2016, the Company introduced
GoVerifyID
®
Enterprise Suite, a multi-modal,
multi-factor biometric authentication solution for the enterprise
market. An algorithm-agnostic solution, GoVerify ID Enterprise
Suite is an end-to-end biometric platform that seamlessly
integrates with an enterprise’s existing Microsoft
infrastructure, offering businesses a turnkey biometric solution
for quick deployment. The Company feels that this product has the
potential to dramatically accelerate adoption of its biometric
solution due to the worldwide prevalence of enterprise use of the
Microsoft infrastructure.
Working
across the entire enterprise ecosystem, GoVerifyID Enterprise Suite
offers a consistent user experience and centralized administration
with the highest level of security, flexibility, and
usability.
●
Mobile-workforce
friendly—With GoVerifyID Enterprise Suite user authentication
logins are possible for a tablet or laptop even when disconnected
from the corporate network. Additionally, GoVerifyID Enterprise
offers a consistent user authentication experience across all login
environments.
●
Hybrid
cloud—GoVerifyID Enterprise Suite is linked from the cloud to
an enterprise’s Microsoft infrastructure and is backward
compatible with Windows 7, 8 and 10. Additionally, because the
solution is SaaS-based it can easily scale to process hundreds of
millions of transactions and store just as many
biometrics.
●
Seamless
integration—GoVerifyID Enterprise Suite is a snap-in to the
Microsoft Management console and can be centrally managed at the
server. Additionally, the solution allows for seamless movement as
it integrates with Active Directory using an organization’s
existing Microsoft security infrastructure.
IWS Card
Management.
The IWS
Card Management System (“
CMS
”) is a comprehensive solution to support
and manage the issuance of smart cards complete with the following
capabilities:
●
Biometric enrollment and identity proofing with Smart Card encoding
of biometrics;
●
Flexible models of central or distributed issuance of
credentials;
●
Customizable card life-cycle workflow managed by the CMS;
and
●
Integration of the CMS data with other enterprise solutions, such
as physical access control and logical access control (i.e.
Single-Sign-On, or SSO).
IWS EPI
Suite.
This is an ID
software solution for producing, issuing, and managing secure
credentials and personal identification cards. Users can
efficiently manage large amounts of data, images and card designs,
as well as track and issue multiple cards per person, automatically
populate multiple cards and eliminate redundant data entry. IWS EPI
Suite was designed to integrate with our customers’ existing
security and computing infrastructure. We believe that this
compatibility may be an appealing feature to corporations,
government agencies, transportation departments, school boards, and
other public institutions.
IWS EPI
Builder.
This is a
software developer’s kit and a leading secure credential
component of identity management and security solutions, providing
all aspects of ID functionality from image and biometric capture to
the enrollment, issuance and management of secure documents. It
contains components which developers or systems integrators can use
to support and produce secure credentials including national IDs,
passports, International Civil Aviation Office -compliant travel
documents, smart cards and driver licenses. IWS EPI Builder enables
organizations to develop custom identification solutions or
incorporate sophisticated identification capabilities into existing
applications including the ability to capture images, biometric and
demographic data; enable biometric identification and verification
(1:1 and 1:X) as well as support numerous biometric hardware and
software vendors. It also enables users to add electronic
identification functionality for other applications, including
access control, tracking of time and attendance, point of sale
transactions, human resource systems, school photography systems,
asset management, inventory control, warehouse management,
facilities management and card production
systems.
IWS EPI
PrintFarm.
While it
is the last stage of PIV Card Issuance, the PIV smart card printing
process is by no means the least important
stage. Production printing of tens of thousands of PIV
cards requires a significant investment and a well-engineered
system. The IWS EPI PrintFarm software offers a
cost-effective yet high-performance method for high-volume card
printing.
IWS PIV
Encoder.
PIV smart
cards must be programmed with specific mandatory data, digital
signatures and programs in order to maintain the interoperability
as well as the security features specified for the cards. The IWS
PIV Encoder could be considered to be a complex device driver that
properly programs the PIV smart cards. The Encoder
interacts with the Card Management System for data payload
elements. It interacts with the Certificate Authority to encrypt or
sign the PIV smart card data with trusted certificates. Finally, it
acts as the application-level device driver to make the specific
PIV smart card encoding system properly program the smart card,
regardless if the system is a standalone encoding system or one
integrated into a card printer.
Law Enforcement and Public Safety
We believe our integrated suite of software
products significantly reduces the inefficiencies and expands the
capabilities of traditional booking and mug shot systems. Using our
products, an agency can create a digital database of thousands of
criminal history records, each including one or more full-color
facial images, finger and palm prints, biographic text information
and images of other distinctive physical features such as scars,
marks and tattoos (“
SMT’s
”). This database can be quickly searched
using text queries, or biometric technology that can compare
biometric characteristics of an unknown suspect with those in the
database.
Our
investigative software products can be used to create, edit and
distribute both mug photo and SMT photo lineups of any
size. In addition, electronic mug books display hundreds
of images for a witness to review and from which electronic
selections are made. The Witness View software component records
the viewing of a lineup (mug photo or SMT) detailing the images
provided for viewing along with the image or images selected. In
addition to a printed report, the Witness View module provides a
non-editable executable file (.exe) that may be played on any
computer for court exhibit viewing purposes.
Our
IWS Law Enforcement solution consists of software modules, which
may also be purchased individually. The IWS Law Enforcement Capture
and Investigative module make up our booking system and database.
Our add-on modules include LiveScan, Facial Recognition, Law
Enforcement Web and Witness View as well as the IWS Biometric
Engine.
IWS Law
Enforcement.
IWS Law
Enforcement is a digital booking, identification and investigative
solution that enables users to digitally capture, store, search and
retrieve images and demographic data including mug shots,
fingerprints and SMT’s. Law enforcement may choose between
submitting fingerprint data directly to the State Automated
Fingerprint Identification System (“
AFIS
”), FBI criminal repository, or other
agencies as required. Additional features and functionality include
real-time access to images and data, creation of photo lineups and
electronic mug books, and production of identification cards and
credentials. IWS Law Enforcement also uses off-the-shelf
hardware and is designed to comply with open industry standards so
that it can operate on an array of systems ranging from a
stand-alone personal computer to a wide area network. To avoid
duplication of entries, the system can be integrated easily with
several other information storage and retrieval systems, such as a
records/jail management system (“
RMS
/
JMS
”) or an automated fingerprint
identification system.
Capture.
This
software module allows users to capture and store a variety of
images (facial, SMT and others such as evidence photos) as well as
biographical text information. Each record includes images and text
information in an easy-to-view format made up of fields designed
and defined by the individual agency. Current customers of this
module range from agencies that capture a few thousand mug shots
per year to those that capture hundreds of thousands of mug shots
each year.
LiveScan.
This
software module is FBI certified and complies with the FBI
Integrated Automated Fingerprint Identification System
(“
IAFIS
”) Image Quality Specifications
(“
IQS
”) while utilizing FBI certified LiveScan
devices from most major vendors. LiveScan allows users to capture
single to ten prints and palm data, providing an integrated
biometric management solution for both civil and law enforcement
use. By adding LiveScan capabilities, law enforcement organizations
further enhance the investigative process by providing additional
identifiers to identify suspects involved in a crime. In
addition, officers no longer need to travel to multiple booking
stations to capture fingerprints and mug shots. All
booking information including images may be located at a central
designation and from there routed to the State AFIS or FBI criminal
history record repository.
Investigative.
This
software module allows users to search the database created with
IWS Law Enforcement. Officers can conduct text searches in many
fields, including file number, name, alias, distinctive features,
and other information such as gang membership and criminal history.
The Investigative module creates a catalogue of possible matches,
allowing officers or witnesses to save time by looking only at mug
shots that closely resemble the description of the suspect. This
module can also be used to create a line-up of similar facial
images from which a witness may identify the
suspect.
Facial
Recognition.
This
software module uses biometric facial recognition and retrieval
technology to help authorities identify possible suspects. Images
taken from surveillance videos or photographs can be searched
against a digital database of facial images to retrieve any desired
number of faces with similar characteristics. This module can also
be used at the time of booking to identify persons using multiple
aliases. Using biometrics-based technology, the application can
search through thousands of facial images in a matter of seconds,
reducing the time it would otherwise take a witness to flip through
a paper book of facial images that may or may not be similar to the
description of the suspect. The Facial Recognition module then
creates a selection of possible matches ranked in order of
similarity to the suspect, and a percentage confidence level is
attributed to each possible match. The application incorporates
search engine technology, which we license from various facial
recognition algorithm providers.
LE
Web.
This software
module enables authorized personnel to access and search agency
booking records stored in IWS Law Enforcement through a standard
Web browser from within the agency’s intranet. This module
allows remote access to the IWS Law Enforcement database without
requiring the user to be physically connected to the
customer’s network. This application requires only that the
user have access to the Internet and authorization to access the
law enforcement agency’s intranet.
EPI Designer for Law
Enforcement.
The EPI
Designer for LE software is a design solution created for the IWS
Law Enforcement databases based on the IWS EPI Suite
program. This program allows integration with various IWS
databases for the production of unique booking/inmate reports,
wristbands, photo ID cards, Wanted or BOLO fliers, etc., created
from the information stored in booking records. Designs can be
created in minutes and quickly added to the IWS Law Enforcement
system allowing all users with appropriate permissions immediate
access to the newly added form.
Maintenance and Customer Support
We
offer software and hardware support to our customers. Customers can
contract with us for technical support that enables them to use a
toll-free number to speak with our technical support center for
software support and general assistance 24 hours a day, seven days
a week. As many of our government customers operate around the
clock and perceive our systems as critical to their day-to-day
operations, a very high percentage contract for technical
support. For the years ended December 31, 2016, 2015 and
2014, maintenance revenues accounted for approximately 67%, 54% and
61% of our total revenues, respectively.
Software Customization and Fulfillment
We
directly employ computer programmers and retain independent
programmers to develop our software and perform quality control. We
provide customers with software that we specifically customize to
operate on their existing computer system. We work directly with
purchasers of our system to ensure that the system they purchase
will meet their unique needs. We configure and test the system
either at our facilities or on-site and conduct any customized
programming necessary to connect the system with any legacy systems
already in place. We can also provide customers with a
complete computer hardware system with our software already
installed and configured. In either case, the customer is provided
with a complete turnkey solution, which can be used immediately.
When we provide our customers with a complete solution including
hardware, we use off-the-shelf computers, cameras and other
components purchased from other companies such as Dell or Hewlett
Packard. Systems are assembled and configured either at our
facilities or at the customer’s location.
Customers
We
have a wide variety of domestic and international customers. Most
of our IWS Law Enforcement customers are government agencies at the
federal, state and local levels in the United States. Our secure
credential products are also being used in Australia, Canada, the
United Arab Emirates, Kuwait, Saudi Arabia, Mexico, Colombia, Costa
Rica, Venezuela, Singapore, Indonesia and the Philippines. For the
year ended December 31, 2016, two customers accounted for
approximately 30% or $1,162,000 of total revenue and had $78,000
trade receivables as of the end of the year, as compared to two
customers that accounted for approximately 37% or $1,753,000 of
total revenue and had $78,000 trade receivables as of the end of
the December 31, 2015. For the year ended December 31, 2014, one
customer accounted for approximately 17% or $725,000 of total
revenue and had $0 trade receivables as of the end of the
year.
Our Strategy
Our
strategy is to provide patented open-architected identity
management solutions including multi-biometric, secure credential
and law enforcement technologies that are stand alone, integrated
and/or bundled with key partners including channel relationships
and large systems integrators such as, United Technology Security,
GCR, Unisys, Lockheed Martin, IBM and Fujitsu, among others. Key
elements of our strategy for growth include the
following:
Fully Exploit the Biometrics, Access Control and Identification
Markets
The
establishment of the Department of Homeland Security coupled with
the movement by governments around the world to authenticate the
identity of their citizens, employees and contractors has
accelerated the adoption of biometric identification systems that
can provide secure credentials and instant access to centrally
maintained records for real-time verification of identity and
access (physical and logical) privileges. Using our products, an
organization can create secure credentials that correspond to
records including images and biographic data in a digital database.
A border guard or customs agent can stop an individual to quickly
and accurately verify his identity against a database of authorized
persons, and either allow or deny access as required. Our
technology is also standards based and applied to facilitate
activities such as federal identification mandates while complying
with personal identification verification standards such as
HSPD-12, International Civil Aviation Organization standards,
American Association of Motor Vehicle Administrators driver
licenses, voter registration, immigration control and welfare fraud
identification. We believe that these or very similar
standards are applicable in markets throughout the
world.
With
the identity management market growing at a rapid pace, biometric
identifiers are becoming recognized and accepted as integral
components to the identification process in the public and private
sectors. As biometric technologies (facial recognition,
fingerprint, iris, etc.) are adopted, identification systems must
be updated to enable their use in the field. We have
built our solutions to enable the incorporation of one or multiple
biometrics, which can be associated with a record and stored both
in a database and on a card for later retrieval and verification
without regard to the specific hardware employed. We
believe the increasing demand for biometric technology will drive
demand for our solutions. Our identity management
products are built to accommodate the use of biometrics and meet
the demanding requirements across the entire identity life
cycle.
Expand Law Enforcement and Public Safety Markets
We
intend to use our successful installations with customers such as
the Arizona Department of Public Safety, New South Wales Police,
and the San Bernardino County Sheriff’s Department as
reference accounts and to market IWS Law Enforcement as a superior
technological solution. Our recent addition of the LiveScan module
and support for local AFIS to our IWS Law Enforcement will enhance
its functionality and value to the law enforcement customer as well
as increase the potential revenue the Company can generate from a
system sale. We primarily sell directly to the law
enforcement community. Our sales strategy is to increase sales to
new and existing customers including renewing supporting
maintenance agreements. We have also established relationships with
large systems integrators such as Sagem Morpho to OEM our law
enforcement solution utilizing their worldwide sales force. We will
focus our sales efforts in the near term to establish IWS Law
Enforcement as the integrated mug shot and LiveScan system adopted
in as many countries, states, large counties and municipalities as
possible. Once we have a system installed in a region, we intend to
then sell additional systems or retrieval seats to other agencies
within the primary customer’s region and in neighboring
regions. In addition, we plan to market our integrated
investigative modules to the customer, including Facial
Recognition, Web and WitnessView. As customer databases of digital
mug shots grow, we expect that the perceived value of our
investigative modules, and corresponding revenues from sales of
those modules, will also grow.
Software as a Service Business Model
With the advent of cloud based
computing, the proliferation of smart mobile devices which allow
for reliable biometric capture and the need to secure access to
data, products and services, the Company believes that the market
for multi-biometric solutions will expand to encompass significant
deployments of biometric systems in the commercial and consumer
markets. The Company therefore intends to leverage the
strength of its experience servicing existing government clients
who have deployed the Company’s products for large
populations, as well as its foundational patent portfolio in the
field of multi-modal biometrics and the fusion of multiple
biometric algorithms, to address the growing commercial and
consumer market. As part of its marketing plan, the Company offered
new versions of its product suite on a Software as a Service
(“SaaS”) model during 2016. This new business model,
which is intended to supplement the Company’s existing
business model, will allow new commercial and consumer clients to
biometrically verify identity in order to access data, products or
services from mobile and desktop devices. As of December 2016, we
have received significant interest and have entered into a number
of proof of concept arrangements with customers and partners who we
anticipate will initiate programs in the first half of
2017
.
Mobile Applications
The
Company strengthened its patent portfolio in June 2012 with the
purchase of four U.S. patents relating to wireless technology from
Vocel. These patents, combined with the Company’s existing
foundational patents in the areas of biometric identification,
verification, enrollment and fusion, provide a unique and protected
foundation on which to build interactive mobile applications that
are secured using biometrics.
The
combination of our biometric identification technologies and
wireless technologies has led to the development of the IWS
Interactive Messaging System, which is a push application platform
secured by biometrics that transforms mobile devices into a
complete mobile ID, enabling companies to create applications that
allow a range of unprecedented activities – from secure
sharing of sensitive information to biometrically securing a mobile
wallet. Identity authentication, using multi-modal biometrics gives
users the confidence that their personal information is secure
while the push marketing capabilities of the technology allow
companies unparalleled interactivity that can be personalized to
the needs and interests of their customers.
Sales and Marketing
We
market and sell our products through our direct sales force and
through indirect distribution channels, including systems
integrators. As of December 31, 2016, we had sales and account
representatives based domestically in the District of Columbia,
California and internationally in Mexico. Geographically, our sales
and marketing force consisted of nine persons in the United
States, and one person in Mexico as of December 31,
2016.
Our direct
sales organization is supported by technical
experts. Our technical experts are available by
telephone and conduct on-site customer presentations in support of
our sales professionals.
The
typical sales cycle for IWS Biometric Engine and IWS Law
Enforcement includes a pre-sale process to define the potential
customer’s needs and budget, an on-site demonstration and
conversations between the potential customer and existing
customers. Government agencies are typically required to purchase
large systems by including a list of requirements in a Request for
Proposal, known as an “RFP,” and by allowing several
companies to openly bid for the project by responding to the RFP.
If our response is selected, we enter into negotiations for the
contract and, if successful, ultimately receive a purchase order
from the customer. This process can take anywhere from a few months
to over a year.
Our
Biometric and ID products are also sold to large integrators,
direct via our sales force and to end users through distributors.
Depending on the customer’s requirements, there may be
instances that require an RFP. The sales cycle can vary from a few
weeks to a year.
In
addition to our direct sales force, we have developed relationships
with a number of systems integrators who contract with government
agencies for the installation and integration of large computer and
communication systems. By acting as a subcontractor to these
systems integrators, we are able to avoid the time consuming and
often-expensive task of submitting proposals to government
agencies, and we also gain access to large clients.
We
also work with companies that offer complementary products, where
value is created through product integration. Through teaming
arrangements, we are able to enhance our products and to expand our
customer base through the relationships and contracts of our
strategic partners.
We
plan to continue to market and sell our products internationally.
Some of the challenges and risks associated with international
sales include the difficulty in protecting our intellectual
property rights, difficulty in enforcing agreements through foreign
legal systems and volatility and unpredictability in the political
and economic conditions of foreign countries. We believe we can
work to successfully overcome these challenges.
Competition
The Law Enforcement and Public Safety Markets
Due
to the fragmented nature of the law enforcement and public safety
market and the modular nature of our product suite, we face
different degrees of competition with respect to each IWS Law
Enforcement module. We believe the principal bases on which we
compete with respect to all of our products are:
●
the unique ability to integrate our modular products into a
complete biometric, LiveScan, imaging and investigative
system;
●
our reputation as a reliable systems supplier;
●
the usability and functionality of our products; and
●
the responsiveness, availability and reliability of our customer
support.
Our
law enforcement product line faces competition from other companies
such as DataWorks Plus and 3M. Internationally, there
are often a number of local companies offering solutions in most
countries.
Secure Credential Market
Due
to the breadth of our software offering in the secure credential
market space, we face differing degrees of competition in certain
market segments. The strength of our competitive position is based
upon:
●
our strong brand reputation with a customer base which includes
small and medium-sized businesses, Fortune 500 corporations and
large government agencies;
●
the ease of integrating our technology into other complex
applications; and
●
the leveraged strength that comes from offering customers software
tools, packaged solutions and Web-based service applications that
support a wide range of hardware peripherals.
Our
software faces competition from Datacard Corporation, a privately
held manufacturer of hardware, software and consumables for the ID
market as well as small, regionally based companies.
Biometric Market
The
market to provide biometric systems to the identity management
market is evolving and we face competition from a number of
sources. We believe that the strength of our competitive position
is based on:
●
our ability to provide a system which enables the enrollment,
management and authentication of multiple biometrics managing
population databases of unlimited sizes;
●
searches can be 1:1 (verification), 1:N (identification), X:N
(investigative), and N:N (database integrity); and
●
the system is technology and biometric agnostic, enabling the use
of biometric devices and algorithms from any vendor, and the
support of the following biometric types: finger, face, iris, hand
geometry, palm, DNA, signature, voice, and 3D face and
retin.
Our
multi-biometric product faces competition from French-based Safran,
Irish-based Daon, 3M and Aware Inc., none of which have offerings
with the scope and flexibility of our IWS Biometric Engine and its
companion suite of products or relevant patent
protection.
Intellectual Property
We
rely on trademark, patent, trade secret and copyright laws and
confidentiality and license agreements to protect our intellectual
property. We have several federally registered trademarks including
the trademark ImageWare and IWS Biometric Engine as well as
trademarks for which there are pending trademark registrations with
the United States, Canadian and other International Patent &
Trademark Offices.
We
hold several issued patents and have several other patent
applications pending for elements of our products. We believe we
have the foundational patents regarding the use of multiple
biometrics and continue to be an IP leader in the biometric arena.
It is our belief that this intellectual property leadership will
create a sustainable competitive advantage. We are an
early pioneer in the first to file patents related to Multi-Modal
Biometrics and currently are the worldwide leader in Multi-Modal
Biometric patents with 20 patents worldwide and 14 patents pending.
These technologies will allow biometric matching for identity
verification while protecting the privacy of an
individual. It is our belief that such technology will
be critical to providing biometric management solutions for the
consumer market where privacy protection has been a historical
issue and barrier to biometric adoption.
The
Company strengthened its patent portfolio in June 2012 with the
purchase of four U.S. patents relating to wireless technology from
Vocel. These patents, combined with the Company’s existing
foundational patents in the areas of biometric identification,
verification, enrollment and fusion, provide a unique and protected
foundation on which to build interactive mobile applications that
are secured using biometrics.
The
combination of our biometric identification technologies and
wireless technologies has led to the development of the IWS
Interactive Messaging System, which is a push application platform
secured by biometrics that transforms mobile devices into a
complete mobile ID, enabling companies to create applications that
allow a range of unprecedented activities – from secure
sharing of sensitive information to biometrically securing a mobile
wallet. Identity authentication, using multi-modal biometrics,
gives users the confidence that their personal information is
secure while the push marketing capabilities of the technology
allow companies unparalleled interactivity that can be personalized
to the needs and interests of their customers.
We
regard our software as proprietary and retain title to and
ownership of the software we develop. We attempt to
protect our rights in the software primarily through patents and
trade secrets. We have not published the source code of
most of our software products and require employees and other third
parties who have access to the source code and other trade secret
information to sign confidentiality agreements acknowledging our
ownership and the nature of these materials as our trade
secrets.
Despite
these precautions, it may be possible for unauthorized parties to
copy or reverse-engineer portions of our products. While
our competitive position could be threatened by disclosure or
reverse engineering of this proprietary information, we believe
that copyright and trademark protection are less important than
other factors such as the knowledge, ability, and experience of our
personnel, name recognition and ongoing product development and
support.
Our
software products are licensed to end users under a perpetual,
nontransferable, nonexclusive license that stipulates which modules
can be used and how many concurrent users may use
them. These forms of licenses are typically not signed
by the licensee and may be more difficult to enforce than signed
agreements in some jurisdictions.
Research and Development
Our
research and development team consisted of 38, 38 and 32
programmers, engineers and other employees as of December 31, 2016,
2015 and 2014, respectively. We also contract with outside
programmers for specific projects as needed. We spent approximately
$5.3 million, $4.6 million and $4.5 million on research and
development in 2016, 2015 and 2014, respectively. We continually
work to increase the speed, accuracy, and functionality of our
existing products. We anticipate that our research and development
efforts will continue to focus on new technology and products for
the identity management markets.
Employees
We
had a total of 69, 67 and 61 full-time employees as of
December 31, 2016, 2015 and 2014, respectively. Our employees are
not covered by any collective bargaining agreement, and we have
never experienced a work stoppage. We believe that our relations
with our employees are good.
Environmental Regulation
Our
business does not require us to comply with any particular
environmental regulations.
An investment in our Common Stock involves a high degree of risk.
Before investing in our Common Stock, you should consider carefully
the specific risks detailed in this “Risk Factors”
section and any prospectus or prospectus supplement. If any of
these risks occur, our business, results of operations and
financial condition could be harmed, the price of our Common Stock
could decline, and you may lose all or part of your
investment.
Available borrowings under our Lines of Credit may be insufficient
to provide for our working capital needs for the next twelve
months. In the event such Lines of Credit are
insufficient to provide for our working capital requirements, we
will need to raise additional capital to continue as a going
concern.
During the year ended
December 31, 2016, we incurred borrowings under the Lines of Credit
of approximately $2,650,000, which amounts are due and payable on
December 31, 2017. Subsequent to December 31, 2016
through the date of this report, we incurred additional borrowings
under the Lines of Credit of $1,000,000. As a result, available
borrowings under our Lines of Credit are $2,350,000. We anticipate
needing to increase our borrowings under the Line of Credits to
continue to fund our working capital needs, thereby increasing the
aggregate amount of indebtedness due and payable on or before
December 31, 2017.
If
we are unable to implement our business plan, we may not generate
sufficient revenue and profit to repay these borrowings in full
when due. As a result, unless the holders of the notes issued under
the Lines of Credit convert any outstanding balance into shares of
Common Stock, we will need to seek an extension of the maturity
date of the Lines of Credit on or before December 31, 2017. If we
are unable to extend the maturity date of the Lines of Credit, we
will be required to raise additional capital through debt and/or
equity financing to continue as a going concern. No
assurances can be given that any such financing will be available
to us on favorable terms, if at all. At this time, we do not have
any commitments for alternative financing or for an extension of
the maturity date of the Lines of Credit. The inability to obtain
debt or equity financing in a timely manner and in amounts
sufficient to fund our operations, if necessary, would have an
immediate and substantial adverse impact on our business, financial
condition and results of operations.
We have a history of significant recurring losses totaling
approximately $156.8
million at
December 31, 2016, and these losses may continue in the
future
.
As of December 31, 2016, we had an accumulated
deficit of approximately $156.8
million,
and these losses may continue in the future. We expect to continue
to incur significant sales and marketing, research and development,
and general and administrative expenses. As a result, we will need
to generate significant revenues to achieve profitability, and we
may never achieve profitability.
Our operating results have fluctuated in the past and are likely to
fluctuate significantly in the future.
Our
operating results have fluctuated in the past. These
fluctuations in operating results are the consequence
of:
●
varying demand for and market acceptance of our technology and
products;
●
changes in our product or customer mix;
●
the gain or loss of one or more key customers or their key
customers, or significant changes in the financial condition of one
or more of our key customers or their key customers;
●
our ability to introduce, certify and deliver new products and
technologies on a timely basis;
●
the announcement or introduction of products and technologies by
our competitors;
●
competitive pressures on selling prices;
●
costs associated with acquisitions and the integration of acquired
companies, products and technologies;
●
our ability to successfully integrate acquired companies, products
and technologies;
●
our accounting and legal expenses; and
●
general economic conditions.
These
factors, some of which are not within our control, will likely
continue in the future. To respond to these and other factors, we
may need to make business decisions that could result in failure to
meet financial expectations. If our quarterly operating results
fail to meet or exceed the expectations of securities analysts or
investors, our stock price could drop suddenly and significantly.
Most of our expenses, such as employee compensation
and inventory, are relatively fixed in the short term.
Moreover, our expense levels are based, in part, on our
expectations regarding future revenue levels. As a result, if our
revenue for a particular period were below our expectations, we
would not be able to proportionately reduce our operating expenses
for that period. Any revenue shortfall would have a
disproportionately negative effect on our operating results for the
period.
We depend upon a
small number of large system sales ranging from $100,000 to in
excess of $2,000,000 and we may fail to achieve one or more large
system sales in the future
.
Historically,
we have derived a substantial portion of our revenues from a small
number of sales of large, relatively expensive systems, typically
ranging in price from $100,000 to $2,000,000. If we fail to receive
orders for these large systems in a given sales cycle on a
consistent basis, our business could be significantly harmed.
Further, our quarterly results are difficult to predict because we
cannot predict in which quarter, if any, large system sales will
occur in a given year. As a result, we believe that
quarter-to-quarter comparisons of our results of operations are not
a good indication of our future performance. In some future
quarters, our operating results may be below the expectations of
securities analysts and investors, in which case the market price
of our Common Stock may decrease significantly.
Our lengthy sales
cycle may cause us to expend significant resources for as long as
one year in anticipation of a sale to certain customers, yet we
still may fail to complete the sale
.
When
considering the purchase of a large computerized identity
management system, potential customers may take as long as eighteen
months to evaluate different systems and obtain approval for the
purchase. Under these circumstances, if we fail to complete a sale,
we will have expended significant resources and received no revenue
in return. Generally, customers consider a wide range of issues
before committing to purchase our products, including product
benefits, ability to operate with their current systems, product
reliability and their own budgetary constraints. While potential
customers are evaluating our products, we may incur substantial
selling costs and expend significant management resources in an
effort to accomplish potential sales that may never occur. In times
of economic recession, our potential customers may be unwilling or
unable to commit resources to the purchase of new and costly
systems.
A significant
number of our customers and potential customers are government
agencies that are subject to unique political and budgetary
constraints and have special contracting requirements, which may
affect our ability to obtain new and retain current government
customers
.
A
significant number of our customers are government agencies. These
agencies often do not set their own budgets and therefore have
little control over the amount of money they can spend from
quarter-to-quarter or year-to-year. In addition, these agencies
experience political pressure that may dictate the manner in which
they spend money. Due to political and budgetary processes and
other scheduling delays that may frequently occur relating to the
contract or bidding process, some government agency orders may be
canceled or substantially delayed, and the receipt of revenues or
payments from these agencies may be substantially delayed. In
addition, future sales to government agencies will depend on our
ability to meet government contracting requirements, certain of
which may be onerous or impossible to meet, resulting in our
inability to obtain a particular contract. Common requirements in
government contracts include bonding requirements, provisions
permitting the purchasing agency to modify or terminate at will the
contract without penalty, and provisions permitting the agency to
perform investigations or audits of our business practices, any of
which may limit our ability to enter into new contracts or maintain
our current contracts.
During the year ended December 31, 2016, two customers
accounted for approximately 30% of our total revenues. Any material
decrease in revenue from these customers, or in the event the
Company is unable to replace the revenue with additional customers,
our financial condition and results from operations could be
materially and adversely affected.
During the year ended December 31,
2016, two customers accounted for approximately 30% or
$1,162,000
of
our total revenues. If these customers were to significantly reduce
its relationship with the Company, or in the event the Company is
unable to replace the revenue through the sale of its products to
additional customers, the Company’s financial condition and
results from operations could be negatively impacted, and such
impact would be material.
We occasionally
rely on systems integrators to manage our large projects, and if
these companies do not perform adequately, we may lose
business
.
We
occasionally act as a subcontractor to systems integrators who
manage large projects that incorporate our systems, particularly in
foreign countries. We cannot control these companies, and they may
decide not to promote our products or may price their services in
such a way as to make it unprofitable for us to continue our
relationship with them. Further, they may fail to perform under
agreements with their customers, in which case we might lose sales
to these customers. If we lose our relationships with these
companies, our business, financial condition and results of
operations may suffer.
We are
dependent upon third parties for the successful integration of our
products, and/or the launch of our products. Any delay in the
integration of our products, or the launch of third party products
may materially affect our results from operations and financial
condition.
Our current marketing strategy involves
the distribution of our products through larger product partners
and/or resellers that will either resell our product alongside
theirs, OEM a white label version of our products, or sell our
products fully integrated into their offerings. Our strategy
leaves us largely dependent upon the successful rollout of our
products by our distribution partners. We have experienced
delays in the rollout of our products due to these factors in 2016
and so far in 2017, and no assurances can be given that we will not
experience delays in the future. Any delays negatively affect our
results from operations and financial
condition.
If the patents we
own or license, or our other intellectual property rights, do not
adequately protect our products and technologies, we may lose
market share to our competitors and our business, financial
condition and results of operations would be adversely
affected
.
Our success depends significantly on our ability
to protect our rights to the technologies used in our products. We
rely on patent protection, trade secrets, as well as a combination
of copyright and trademark laws and nondisclosure, confidentiality
and other contractual arrangements to protect our technology.
However, these legal means afford only limited protection and may
not adequately protect our rights or permit us to gain or keep any
competitive advantage. In addition, we cannot be assured that any
of our current and future pending patent applications will result
in the issuance of a patent to us. The U.S. Patent and Trademark
Office (“
PTO
”) may deny or require significant narrowing
of claims in our pending patent applications, and patents issued as
a result of the pending patent applications, if any, may not
provide us with significant commercial protection or may not be
issued in a form that is advantageous to us. We could also incur
substantial costs in proceedings before the PTO. These proceedings
could result in adverse decisions as to the claims included in our
patents.
Our
issued and licensed patents and those that may be issued or
licensed in the future may be challenged, invalidated or
circumvented, which could limit our ability to stop competitors
from marketing related products. Additionally, upon expiration of
our issued or licensed patents, we may lose some of our rights to
exclude others from making, using, selling or importing products
using the technology based on the expired patents. We also must
rely on contractual rights with the third parties that license
technology to us to protect our rights in the technology licensed
to us. Although we have taken steps to protect our intellectual
property and technology, there is no assurance that competitors
will not be able to design around our patents. We also rely on
unpatented proprietary technology. We cannot assure you that we can
meaningfully protect all our rights in our unpatented proprietary
technology or that others will not independently develop
substantially equivalent proprietary products or processes or
otherwise gain access to our unpatented proprietary technology. We
seek to protect our know-how and other unpatented proprietary
technology with confidentiality agreements and intellectual
property assignment agreements with our employees. However, such
agreements may not provide meaningful protection for our
proprietary information in the event of unauthorized use or
disclosure or other breaches of the agreements or in the event that
our competitors discover or independently develop similar or
identical designs or other proprietary information. In addition, we
rely on the use of registered and common law trademarks with
respect to the brand names of some of our products. Our common law
trademarks provide less protection than our registered trademarks.
Loss of rights in our trademarks could adversely affect our
business, financial condition and results of
operations.
Furthermore,
the laws of foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United
States. If we fail to apply for intellectual property protection or
if we cannot adequately protect our intellectual property rights in
these foreign countries, our competitors may be able to compete
more effectively against us, which could adversely affect our
competitive position, as well as our business, financial condition
and results of operations.
If third parties
claim that we infringe their intellectual property rights, we may
incur liabilities and costs and may have to redesign or discontinue
selling certain products
.
Whether
a product infringes a patent involves complex legal and factual
issues, the determination of which is often uncertain. We face the
risk of claims that we have infringed on third parties’
intellectual property rights. Searching for existing intellectual
property rights may not reveal important intellectual property and
our competitors may also have filed for patent protection, which is
not yet a matter of public knowledge, or claimed trademark rights
that have not been revealed through our availability searches. Our
efforts to identify and avoid infringing on third parties’
intellectual property rights may not always be successful. Any
claims of patent or other intellectual property infringement, even
those without merit, could:
●
increase the cost of our products;
●
be expensive and time consuming to defend;
●
result in us being required to pay significant damages to third
parties;
●
force us to cease making or selling products that incorporate the
challenged intellectual property;
●
require us to redesign, reengineer or rebrand our
products;
●
require us to enter into royalty or licensing agreements in order
to obtain the right to use a third party’s intellectual
property, the terms of which may not be acceptable to
us;
●
require us to indemnify third parties pursuant to contracts in
which we have agreed to provide indemnification to such parties for
intellectual property infringement claims;
●
divert the attention of our management; and
●
result in our customers or potential customers deferring or
limiting their purchase or use of the affected products until the
litigation is resolved.
In
addition, new patents obtained by our competitors could threaten a
product’s continued life in the market even after it has
already been introduced.
We operate in
foreign countries and are exposed to risks associated with foreign
political, economic and legal environments and with foreign
currency exchange rates
.
We
have significant foreign operations. As a result, we are exposed to
risks, including among others, risks associated with foreign
political, economic and legal environments and with foreign
currency exchange rates. Our results may be adversely affected by,
among other things, changes in government policies with respect to
laws and regulations, anti-inflation measures, currency
conversions, collection of receivables abroad and rates and methods
of taxation.
We depend on key personnel, the loss of any of whom could
materially adversely affect future operations
.
Our
success will depend to a significant extent upon the efforts and
abilities of our executive officers and other key personnel. The
loss of the services of one or more of these key employees and any
negative market or industry perception arising from the loss of
such services could have a material adverse effect on us and the
trading price of our Common Stock. Our business will
also be dependent upon our ability to attract and retain qualified
personnel. Acquiring and keeping these personnel could prove more
difficult or cost substantially more than estimated and we cannot
be certain that we will be able to retain such personnel or attract
a high caliber of personnel in the future.
We face competition from companies with greater financial,
technical, sales, marketing and other resources, and, if we are
unable to compete effectively with these competitors, our market
share may decline and our business could be
harmed
.
We
face competition from other established companies. A number of our
competitors have longer operating histories, larger customer bases,
significantly greater financial, technological, sales, marketing
and other resources than we do. As a result, our
competitors may be able to respond more quickly than we can to new
or changing opportunities, technologies, standards or client
requirements, more quickly develop new products or devote greater
resources to the promotion and sale of their products and services
than we can. Likewise, their greater capabilities in
these areas may enable them to better withstand periodic downturns
in the identity management solutions industry and compete more
effectively on the basis of price and production. In
addition, new companies may enter the markets in which we compete,
further increasing competition in the identity management solutions
industry.
We
believe that our ability to compete successfully depends on a
number of factors, including the type and quality of our products
and the strength of our brand names, as well as many factors beyond
our control. We may not be able to compete successfully against
current or future competitors, and increased competition may result
in price reductions, reduced profit margins, loss of market share
and an inability to generate cash flows that are sufficient to
maintain or expand the development and marketing of new products,
any of which would adversely impact our results of operations and
financial condition.
Risks Related to Our Securities
Our Common Stock
is subject to “penny stock” rules
.
Our
Common Stock is currently defined as a “penny stock”
under Rule 3a51-1 promulgated under the Exchange Act. “Penny
stocks” are subject to Rules 15g-2 through 15g-7 and Rule
15g-9, which impose additional sales practice requirements on
broker-dealers that sell penny stocks to persons other than
established customers and institutional accredited investors. Among
other things, for transactions covered by these rules, a
broker-dealer must make a special suitability determination for the
purchaser and have received the purchaser’s written consent
to the transaction prior to sale. Consequently, these rules may
affect the ability of broker-dealers to sell our Common Stock and
affect the ability of holders to sell their shares of our Common
Stock in the secondary market. To the extent our Common Stock is
subject to the penny stock regulations, the market liquidity for
our shares will be adversely affected.
Our stock price
has been volatile, and your investment in our Common Stock could
suffer a decline in value
.
There
has been significant volatility in the market price and trading
volume of equity securities, which is unrelated to the financial
performance of the companies issuing the securities. These broad
market fluctuations may negatively affect the market price of our
Common Stock. You may not be able to resell your shares at or above
the price you pay for those shares due to fluctuations in the
market price of our Common Stock caused by changes in our operating
performance or prospects and other factors.
Some
specific factors that may have a significant effect on our Common
Stock market price include:
●
actual or anticipated fluctuations in our operating results or
future prospects;
●
our announcements or our competitors’ announcements of new
products;
●
the public’s reaction to our press
releases, our other public announcements and our filings with the
Securities and Exchange Commission (the “
SEC
”);
●
strategic actions by us or our competitors, such as acquisitions or
restructurings;
●
new laws or regulations or new interpretations of existing laws or
regulations applicable to our business;
●
changes in accounting standards, policies, guidance,
interpretations or principles;
●
changes in our growth rates or our competitors’ growth
rates;
●
developments regarding our patents or proprietary rights or those
of our competitors;
●
our inability to raise additional capital as needed;
●
substantial sales of Common Stock underlying warrants and preferred
stock;
●
concern as to the efficacy of our products;
●
changes in financial markets or general economic
conditions;
●
sales of Common Stock by us or members of our management team;
and
●
changes in stock market analyst recommendations or earnings
estimates regarding our Common Stock, other comparable companies or
our industry generally.
Our future sales
of our Common Stock could adversely affect its price and our future
capital-raising activities could involve the issuance of equity
securities, which would dilute shareholders’ investments and
could result in a decline in the trading price of our Common
Stock
.
We
may sell securities in the public or private equity markets if and
when conditions are favorable, even if we do not have an immediate
need for additional capital at that time. Sales of substantial
amounts of our Common Stock, or the perception that such sales
could occur, could adversely affect the prevailing market price of
our Common Stock and our ability to raise capital. We may issue
additional Common Stock in future financing transactions or as
incentive compensation for our executive management and other key
personnel, consultants and advisors. Issuing any equity securities
would be dilutive to the equity interests represented by our
then-outstanding shares of Common Stock. The market price for our
Common Stock could decrease as the market takes into account the
dilutive effect of any of these issuances. Furthermore, we may
enter into financing transactions at prices that represent a
substantial discount to the market price of our Common Stock. A
negative reaction by investors and securities analysts to any
discounted sale of our equity securities could result in a decline
in the trading price of our Common Stock.
The holders of our
preferred stock have certain rights and privileges that are senior
to our Common Stock, and we may issue additional shares of
preferred stock without stockholder approval that could have a
material adverse effect on the market value of the Common
Stock
.
Our Board of Directors (“
Board
”) has the authority to issue a total of up
to four million shares of preferred stock and to fix the rights,
preferences, privileges, and restrictions, including voting rights,
of the preferred stock, which typically are senior to the rights of
the Common Stockholders, without any further vote or action by the
Common Stockholders. The rights of our Common Stockholders will be
subject to, and may be adversely affected by, the rights of the
holders of the preferred stock that have been issued, or might be
issued in the future. Preferred stock also could have the effect of
making it more difficult for a third party to acquire a majority of
our outstanding voting stock. This could delay, defer, or prevent a
change in control. Furthermore, holders of preferred stock may have
other rights, including economic rights, senior to the Common
Stock. As a result, their existence and issuance could have a
material adverse effect on the market value of the Common Stock. We
have in the past issued and may from time to time in the future
issue, preferred stock for financing or other purposes with rights,
preferences, or privileges senior to the Common Stock. As of
December 31, 2016, we had four series of preferred stock
outstanding, Series B Convertible Redeemable Preferred Stock
(“
Series B
Preferred
”), Series E
Convertible Redeemable Preferred Stock
(“Series E
Preferred”
), Series F
Convertible Redeemable Preferred Stock (“
Series F
Preferred
”) and Series G
Convertible Redeemable Preferred Stock (“
Series G
Preferred
”).
The
provisions of our Series B Preferred prohibit the payment of
dividends on our Common Stock unless the dividends on our preferred
shares are first paid. In addition, upon a liquidation, dissolution
or sale of our business, the holders of our Series B Preferred will
be entitled to receive, in preference to any distribution to the
holders of Common Stock, initial distributions of $2.50 per share,
plus all accrued but unpaid dividends. As of December 31, 2016, we
had cumulative undeclared dividends on our Series B Preferred of
approximately $8,000.
The provisions of our
Series E Preferred prohibit the payment of dividends on our Common
Stock unless the dividends on our preferred shares are first
paid. In addition, upon a liquidation, dissolution or sale of
our business, the holders of our Series E Preferred will be
entitled to receive, in preference to any distribution to the
holders of Series F Preferred, Series G Preferred and Common Stock,
initial distributions of $1,000 per share, plus all accrued but
unpaid dividends.
At December
31, 2016, we had accrued $0 in Series E Preferred dividends. The
provisions of our Series E Preferred also limit indebtedness of the
Company to
any commercial bank
loan entered into by the Company to an amount not to exceed $2.0
million; and monies borrowed under credit lines of the Company
existing on the Issuance Date in an amount not to exceed $6.0
million.
The provisions of our
Series F Preferred prohibit the payment of dividends on our Common
Stock unless the dividends on our preferred shares are first
paid. In addition, upon a liquidation, dissolution or sale of
our business, the holders of our Series F Preferred will be
entitled to receive, in preference to any distribution to the
holders of Series G Preferred and Common Stock, initial
distributions of $1,000 per share, plus all accrued but unpaid
dividends.
At December 31,
2016, we had accrued $0 in Series F Preferred
dividends.
The provisions of our
Series G Preferred prohibit the payment of dividends on our Common
Stock unless the dividends on our preferred shares are first
paid. In addition, upon a liquidation, dissolution or sale of
our business, the holders of our Series G Preferred will be
entitled to receive, in preference to any distribution to the
holders of Common Stock, initial distributions of $1,000 per share,
plus all accrued but unpaid dividends.
At December 31, 2016, we had accrued $0 in Series
G Preferred dividends.
Certain
large shareholders may have certain personal interests that may
affect the Company.
As a result of the shares issued to Goldman
Capital Management and related entities controlled by Neal Goldman,
a member of our Board of Directors (together,
“
Goldman
”), Goldman beneficially owns, in the
aggregate, approximately
36.6
% of
the Company’s outstanding voting securities. As a
result, Goldman has the potential ability to exert influence over
both the actions of the Board of Directors and the outcome of
issues requiring approval by the Company’s
shareholders. This concentration of ownership may have
effects such as delaying or preventing a change in control of the
Company that may be favored by other shareholders or preventing
transactions in which shareholders might otherwise recover a
premium for their shares over current market
prices.
Our corporate
documents and Delaware law contain provisions that could
discourage, delay or prevent a change in control of the
Company
.
Provisions
in our certificate of incorporation and bylaws may discourage,
delay or prevent a merger or acquisition involving us that our
stockholders may consider favorable. For example, our certificate
of incorporation authorizes preferred stock, which carries special
rights, including voting and dividend rights. With these rights,
preferred stockholders could make it more difficult for a third
party to acquire us.
We
are also subject to the anti-takeover provisions of Section 203 of
the Delaware General Corporation Law. Under these provisions, if
anyone becomes an “interested stockholder,” we may not
enter into a “business combination” with that person
for three years without special approval, which could discourage a
third party from making a takeover offer and could delay or prevent
a change of control. For purposes of Section 203, “interested
stockholder” means, generally, someone owning 15% or more of
our outstanding voting stock or an affiliate of ours that owned 15%
or more of our outstanding voting stock during the past three
years, subject to certain exceptions as described in Section
203.
We do not expect
to pay cash dividends on our Common Stock for the foreseeable
future
.
We
have never paid cash dividends on our Common Stock and do not
anticipate that any cash dividends will be paid on the Common Stock
for the foreseeable future. The payment of any cash dividend by us
will be at the discretion of our Board of Directors and will depend
on, among other things, our earnings, capital, regulatory
requirements and financial condition. Furthermore, the terms of our
Series B Preferred and Series E Preferred directly limit our
ability to pay cash dividends on our Common Stock.
I
TEM 1B. UNRESOLVED
STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our
corporate headquarters are located in San Diego, California where
we occupy 9,927 square feet of office space. This facility is
leased through October 2017 at a cost of approximately $18,000 per
month. In addition to our corporate headquarters, we also occupied
the following spaces at December 31, 2016:
●
1,508
square feet in Ottawa, Province of Ontario, Canada, at a cost of
approximately $3,000 per month until the expiration of the lease on
March 31, 2021. This lease was renewed in April 2016 for a
five-year period ending on March 31, 2021. Renewal terms were
substantially unchanged from the existing lease;
●
8,045
square feet in Portland, Oregon, at a cost of approximately $16,000
per month until the expiration of the lease on October 31, 2018;
and
●
304
square feet of office space in Mexico City, Mexico, at a cost of
approximately $3,000 per month until the expiration of the lease on
November 30, 2017.
I
TEM 3. LEGAL
PROCEEDINGS
There is currently no action, suit, proceeding, inquiry or
investigation before or by any court, public board, government
agency, self-regulatory organization or body pending or, to the
knowledge of the executive officers of the Company or any of our
subsidiaries, threatened against or affecting the Company, our
Common Stock, any of our subsidiaries or of the Company’s or
our subsidiaries’ officers or directors in their capacities
as such, in which an adverse decision could have a material adverse
effect.
ITEM 4. MINE SAFETY DISCLOSURES
None.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2016, 2015 AND 2014
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Overview
As
used in this Annual Report, “we,” “us,”
“our,” “ImageWare,” “ImageWare
Systems,” “Company” or “our Company”
refers to ImageWare Systems, Inc. and all of its subsidiaries.
ImageWare Systems, Inc. is incorporated in the state of Delaware.
The Company is a pioneer and leader in the emerging market for
biometrically enabled software-based identity management solutions.
Using those human characteristics that are unique to us all, the
Company creates software that provides a highly reliable indication
of a person’s identity. The Company’s
“flagship” product is the patented IWS Biometric
Engine®. The Company’s products are used to manage and
issue secure credentials, including national IDs, passports, driver
licenses and access control credentials. The Company’s
products also provide law enforcement with integrated mug shot,
fingerprint LiveScan and investigative capabilities. The Company
also provides comprehensive authentication security software using
biometrics to secure physical and logical access to facilities or
computer networks or internet sites. Biometric technology is now an
integral part of all markets the Company addresses and all of the
products are integrated into the IWS Biometric Engine.
Recent Developments
Creation of Series G
Convertible Redeemable Preferred Stock and Series G
Financing
On December 27, 2016, the Company filed the
Certificate of Designations, Preferences, and Rights of the Series
G Convertible Preferred Stock with the Delaware Division of
Corporations, designating 6,120 shares of the Company’s
preferred stock, par value $0.01 per share, as Series G Convertible
Redeemable Preferred Stock (“
Series G
Preferred
”). Shares of
Series G Preferred rank junior to the Company’s Series B
Convertible Redeemable Preferred Stock, Series E Convertible
Redeemable Preferred Stock, Series F Convertible Redeemable
Preferred Stock as well as the Company’s existing
indebtedness, and accrue dividends at a rate of 10% per annum,
payable on a quarterly basis in shares of the Company’s
common stock, par value $0.01 per share (“
Common
Stock
”). Each share of
Series G Preferred has a liquidation preference of $1,000 per share
(“
Series G Liquidation
Preferenc
e”), and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Series G
Liquidation Preference, divided by $1.50.
On December 29, 2016, the Company accepted
subscription forms from certain accredited investors (the
“
Investors
”) to purchase a total of 1,625 shares of
Series G Preferred for $1,000 per share (the
“
Series G
Financing
”), resulting in
gross proceeds to the Company of $1,625,000 net of issuance costs
of approximately $11,000. In addition, the Company also received
executed exchange agreements from the Investors pursuant to which
the Company exchanged an aggregate total of approximately 3.4
million shares of Common Stock held by the Investors for an
aggregate total of approximately 4,400 shares of Series G
Preferred.
Creation of Series F Convertible Redeemable Preferred Stock and
Series F Financing
On September 2, 2016, the Company filed the
Certificate of Designations, Preferences, and Rights of the Series
F Convertible Preferred Stock with the Delaware Division of
Corporations, designating 2,000 shares of its preferred stock as
Series F Convertible Redeemable Preferred Stock
(“
Series F
Preferred
”). Shares of
Series F Preferred rank junior to the Company’s Series B
Convertible Redeemable Preferred Stock, Series E Convertible
Redeemable Preferred Stock and existing indebtedness, and accrue
dividends at a rate of 10% per annum, payable on a quarterly basis
in shares of the Company’s Common Stock. Each share of Series
F Preferred has a liquidation preference of $1,000 per share
(“
Series F Liquidation
Preference
”), and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Series F
Liquidation Preference, divided by $1.50.
On September 7, 2016, the Company and Cap 1 LLC
(the “
Investor
”), entered into a securities purchase
agreement, wherein the Investor agreed to purchase 2,000 shares of
Series F Preferred for $1,000 per share (the
“
Series F
Financing
”), resulting in
gross proceeds to the Company of $2.0 million net of issuance costs
of approximately $21,000.
Amendments to Lines of Credit
On
December 27, 2016, in connection with the consummation of the
Series G Financing, the Company and Neal Goldman, a member of the
Company’s Board of Directors (the “
Holder
”), agreed to enter
into the
fifth amendment (the “
Line
of Credit Amendment
”) to the
convertible promissory note previously issued by the Company to the
Holder on March 27, 2013 (the “
Goldman
Line of Credit
”), to provide
the Company with the ability to borrow up to $5.5 million under the
terms of the Goldman Line of Credit, bringing the total amount the
Company may borrow under its existing lines of credit to $6.0
million. In addition, the Maturity Date, as defined in the Goldman
Line of Credit, was amended to be December 31, 2017. The Line of
Credit Amendment was executed on January 23,
2017.
In
addition, on January 23, 2017, the Company and Charles Crocker,
also a member of the Board of Directors of the Company, amended the
line of credit and promissory note, dated March 9, 2016 (the
“
Crocker
LOC
”), to extend the
maturity date thereof to December 31, 2017. No other amendments
were made to the Crocker LOC.
Key Product Introduction
On
November 14, 2016, the Company introduced GoVerifyID®
Enterprise Suite, a multi-modal, multi-factor biometric
authentication solution for the enterprise market. An
algorithm-agnostic solution, GoVerify ID Enterprise Suite is an
end-to-end biometric platform that seamlessly integrates with an
enterprise’s existing Microsoft infrastructure, offering
businesses a turnkey biometric solution for quick deployment. The
Company feels that this product has the potential to dramatically
accelerate adoption of its biometric solution due to the worldwide
prevalence of enterprise use of the Microsoft
infrastructure.
Working
across the entire enterprise ecosystem, GoVerifyID Enterprise Suite
offers a consistent user experience and centralized administration
with the highest level of security, flexibility, and usability.
Specific benefits include:
●
Mobile-workforce
friendly—With GoVerifyID Enterprise Suite user authentication
logins are possible for a tablet or laptop even when disconnected
from the corporate network. Additionally, GoVerifyID Enterprise
offers a consistent user authentication experience across all login
environments.
●
Hybrid
cloud—GoVerifyID Enterprise Suite is linked from the cloud to
an enterprise’s Microsoft infrastructure and is backward
compatible with Windows 7, 8 and 10. Additionally, because the
solution is SaaS-based it can easily scale to process hundreds of
millions of transactions and store just as many
biometrics.
●
Seamless
integration—GoVerifyID Enterprise Suite is a snap-in to the
Microsoft Management console and can be centrally managed at the
server. Additionally, the solution allows for seamless movement as
it integrates with Active Directory using an organization’s
existing Microsoft security infrastructure.
Liquidity, Going Concern and Management's
Plan
Historically, our
principal sources of cash have included customer payments from the
sale of our products, proceeds from the issuance of common and
preferred stock and proceeds from the issuance of debt, including
our Lines of Credit (defined above). Our principal uses of cash
have included cash used in operations, product development,
payments relating to purchases of property and equipment and
repayments of borrowings. We expect that our principal uses of cash
in the future will be for product development including
customization of identity management products for enterprise and
consumer applications, further development of intellectual
property, development of Software-as-a-Service (“
SaaS
”) capabilities for existing
products as well as general working capital and capital expenditure
requirements. Management expects that, as our revenues grow, our
sales and marketing and research and development expenses will
continue to grow, albeit at a slower rate and, as a result, we will
need to generate significant net revenues to achieve and sustain
income from operations.
At
December 31, 2016, we had a working capital deficit of
approximately $3.0 million, compared to a working capital surplus
of approximately $1.4 million at December 31, 2015. Our principal
sources of liquidity at December 31, 2016 consisted of available
borrowings under our Lines of Credit of $3.35 million, and
approximately $1.68 million of cash and cash equivalents, compared
to approximately $3.35 million in cash and cash equivalents at
December 31, 2015.
Considering our projected cash requirements, our
available cash will be insufficient to repay borrowings under our
Lines of Credit in full when due at December 31, 2017, and may be
insufficient to satisfy our cash requirements for the next twelve
months from the date of this report, in the event our projected
revenue opportunities fail to materialize as currently anticipated.
These factors raise substantial doubt about our ability to continue
as a going concern. To address our working capital requirements,
management will continue to access available borrowings under our
existing Lines of Credit, and will continue to seek additional
equity and/or debt financing through the issuance of additional
debt and/or equity securities. In addition, management intends to
seek an extension of the maturity date of the Lines of Credit on or
before December 31, 2017. There are currently no formal committed
financing arrangements to support our projected cash shortfall,
including commitments to purchase additional debt and/or equity
securities, or extend the maturity dates of the Lines of
Credit.
In
view of the matters described in the preceding paragraph,
recoverability of a major portion of the recorded asset amounts
shown in the accompanying consolidated balance sheet is dependent
upon continued operations of the Company, which, in turn, is
dependent upon the Company’s ability to continue to raise
capital and generate positive cash flows from operations. However,
the Company operates in markets that are emerging and highly
competitive. There is no assurance that the Company will be able to
obtain additional capital, operate at a profit or generate positive
cash flows in the future.
The
consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset
amounts and classifications of liabilities that might be necessary
should the Company be unable to continue as a going
concern.
2. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Principles of Consolidation
The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. The
Company’s wholly-owned subsidiaries are XImage Corporation, a
California Corporation, ImageWare Systems ID Group, Inc. a Delaware
corporation (formerly Imaging Technology Corporation), I.W. Systems
Canada Company, a Nova Scotia unlimited liability company,
ImageWare Digital Photography Systems, Inc., LLC a Nevada limited
liability company (formerly Castleworks LLC), Digital Imaging
International GmbH, a company formed under German laws
and
Image Ware Mexico
S de RL de CV, a company formed under Mexican laws.
All significant intercompany
transactions and balances have been eliminated.
Operating Cycle
Assets
and liabilities related to long-term contracts are included in
current assets and current liabilities in the accompanying
consolidated balance sheets, although they will be liquidated in
the normal course of contract completion which may take more than
one operating cycle.
Use of Estimates
The preparation of the consolidated financial
statements in conformity with accounting principles generally
accepted in the United States of America
(“
U.S.
GAAP
”) 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 consolidated
financial statements, and the reported amounts of revenue and
expense during the reporting period. Significant estimates include
the allowance for doubtful accounts receivable, inventory carrying
values, deferred tax asset valuation allowances, accounting for
loss contingencies, recoverability of goodwill and acquired
intangible assets and amortization periods, assumptions used in the
Black-Scholes model to calculate the fair value of share based
payments, revenue and cost of revenues recognized under the
percentage of completion method and assumptions used in the
application of fair value methodologies to calculate the fair value
of pension assets and obligations. Actual results could differ from
estimates.
Accounts Receivable
In
the normal course of business, the Company extends credit without
collateral requirements to its customers that satisfy pre-defined
credit criteria. Accounts receivable are recorded net of an
allowance for doubtful accounts. Accounts receivable are considered
delinquent when the due date on the invoice has passed. The Company
records its allowance for doubtful accounts based upon its
assessment of various factors. The Company considers historical
experience, the age of the accounts receivable balances, the credit
quality of its customers, current economic conditions and other
factors that may affect customers’ ability to pay to
determine the level of allowance required. Accounts
receivable are written off against the allowance for doubtful
accounts when all collection efforts by the Company have been
unsuccessful.
Inventories
Finished
goods inventories are stated at the lower of cost, determined using
the average cost method, or market. See Note 6.
Property, Equipment and Leasehold Improvements
Property
and equipment, consisting of furniture and equipment, are stated at
cost and are being depreciated on a straight-line basis over the
estimated useful lives of the assets, which generally range from
three to five years. Maintenance and repairs are charged to expense
as incurred. Major renewals or improvements are capitalized. When
assets are sold or abandoned, the cost and related accumulated
depreciation are removed from the accounts and the resulting gain
or loss is recognized. Expenditures for leasehold improvements are
capitalized. Amortization of leasehold improvements is computed
using the straight-line method over the shorter of the remaining
lease term or the estimated useful lives of the
improvements.
Fair Value of Financial Instruments
For
certain of the Company’s financial instruments, including
accounts receivable, accounts payable, accrued expenses, deferred
revenues and lines of credit payable to related parties, the
carrying amounts approximate fair value due to their relatively
short maturities.
Revenue Recognition
The
Company recognizes revenue from the following major revenue
sources:
●
Long-term fixed-price contracts involving significant
customization;
●
Fixed-price contracts involving minimal customization;
●
Sales of computer hardware and identification media;
and
●
Post-contract customer support
(“
PCS
”).
The Company’s revenue recognition policies
are consistent with U.S. GAAP including the Financial Accounting
Standards Board (“
FASB
”) Accounting Standards Codification
(“
ASC
”) 985-605, “
Software Revenue
Recognition
”, ASC 605-35
“
Revenue Recognition,
Construction-Type and Production-Type Contracts
”, “
Securities and Exchange
Commission Staff Accounting Bulletin 104
”, and ASC 605-25 “
Revenue Recognition, Multiple
Element Arrangements
”.
Accordingly, the Company recognizes revenue when all of the
following criteria are met: persuasive evidence of an arrangement
exists, delivery has occurred or services have been rendered, the
fee is fixed or determinable, and collectability is reasonably
assured.
The Company recognizes revenue and profit as work
progresses on long-term, fixed-price contracts involving
significant amount of hardware and software customization using the
percentage of completion method based on costs incurred to date
compared to total estimated costs at completion. The primary
components of costs incurred are third party software and direct
labor cost including fringe benefits. Revenues recognized in excess
of amounts billed are classified as current assets under
“Costs and estimated earnings in excess of billings on
uncompleted contracts”. Amounts billed to customers in excess
of revenues recognized are classified as current liabilities under
“Billings in excess of costs and estimated earnings on
uncompleted contracts”. Revenue from contracts for which the
Company cannot reliably estimate total costs or there are not
significant amounts of customization are recognized upon
completion. For contracts that require significant amounts of
customization that the Company accounts for under the completed
contract method of revenue recognition, the Company defers revenue
recognition until customer acceptance is received. For contracts
containing either extended or dependent payment terms, revenue
recognition is deferred until such time as payment has been
received by the Company. The Company also generates non-recurring
revenue from the licensing of its software. Software license
revenue is recognized upon the execution of a license agreement,
upon deliverance, when fees are fixed and determinable, when
collectability is probable, when all other significant obligations
have been fulfilled a
nd the Company has
obtained vendor specific objective evidence
(“
VSOE
”) of the fair
value of the undelivered element. VSOE of fair value for customer
support services is determined by reference to the price the
customer pays for such element when sold separately; that is, the
renewal rate offered to customers. In those instances when
objective and reliable evidence of fair value exists for the
undelivered items but not for the delivered items, the residual
method is used to allocate the arrangement consideration. Under the
residual method, the amount of arrangement consideration allocated
to the delivered items equals the total arrangement consideration
less the aggregate fair value of the undelivered
items
. The Company also
generates revenue from the sale of computer hardware and
identification media. Revenue for these items is recognized upon
delivery of these products to the customer. The Company’s
revenue from periodic maintenance agreements is generally
recognized ratably over the respective maintenance periods provided
no significant obligations remain and collectability of the related
receivable is probable. Pricing of maintenance contracts is
consistent period to period and calculated as a percentage of the
software or hardware revenue. Amounts collected in
advance for maintenance services are included in current
liabilities under "Deferred revenue". Sales tax collected from
customers is excluded from revenue.
Goodwill
The Company accounts for its intangible assets
under the provisions of ASC 350, “
Intangibles - Goodwill and
Other
”. In accordance
with ASC 350, intangible assets with a definite life are analyzed
for impairment under ASC 360-10-05 “
Property, Plant and
Equipment
” and intangible
assets with an indefinite life are analyzed for impairment under
ASC 360 annually, or more often if circumstances dictate. The
Company performs its annual goodwill impairment test in the fourth
quarter of each year, or if required, at the end of each fiscal
quarter. In accordance with ASC 350, goodwill, or the
excess of cost over fair value of net assets acquired is tested for
impairment using a fair value approach at the “reporting
unit” level. A reporting unit is the operating segment, or a
business one level below that operating segment (referred to as a
component) if discrete financial information is prepared and
regularly reviewed by management at the component level. The
Company’s reporting unit is at the entity level. The Company
recognizes an impairment charge for any amount by which the
carrying amount of a reporting unit’s goodwill exceeds its
fair value. The Company uses fair value methodologies to establish
fair values.
The
Company did not record any goodwill impairment charges for the
years ended December 31, 2016, 2015 or 2014.
Intangible and Long Lived Assets
Intangible
assets are carried at their cost less any accumulated
amortization. Any costs incurred to renew or extend the
life of an intangible or long lived asset are reviewed for
capitalization. The Company evaluates long-lived assets
for impairment whenever events or changes in circumstances indicate
their net book value may not be recoverable. When such factors and
circumstances exist, the Company compares the projected
undiscounted future cash flows associated with the related asset or
group of assets over their estimated useful lives against their
respective carrying amount. Impairment, if any, is based on the
excess of the carrying amount over the fair value, based on market
value when available, or discounted expected cash flows, of those
assets and is recorded in the period in which the determination is
made. The Company’s management currently believes there is no
impairment of its long-lived assets. There can be no assurance,
however, that market conditions will not change or demand for the
Company’s products under development will continue. Either of
these could result in future impairment of long-lived
assets.
Concentration of Credit Risk
Financial
instruments which potentially subject the Company to concentrations
of credit risk consist principally of cash and trade accounts
receivable. The Company places its cash with high quality financial
institutions and at times during the years ended December 31, 2016
and 2015 exceeded the FDIC insurance limits of $250,000. Sales are
typically made on credit and the Company generally does not require
collateral. The Company performs ongoing credit evaluations of its
customers’ financial condition and maintains an allowance for
doubtful accounts. The Company considers historical experience, the
age of the accounts receivable balances, the credit quality of its
customers, current economic conditions and other factors that may
affect customers’ ability to pay to determine the level of
allowance required. Accounts receivable are presented net of an
allowance for doubtful accounts of approximately $1,000 and $3,000
at December 31, 2016 and 2015, respectively.
For
the year ended December 31, 2016 two customers accounted for
approximately 30% or $1,162,000 of total revenues and had trade
receivables of $78,000 as of the end of the year. For
the year ended December 31, 2015 two customers accounted for
approximately 37% or $1,753,000 of total revenues and had trade
receivables of $78,000 as of the end of the year. For the year
ended December 31, 2014, one customer accounted for approximately
17% or $725,000 of total revenues and $0 trade receivables as of
the end of the year.
Stock-Based Compensation
At
December 31, 2016, the Company had one stock-based compensation
plan for employees and nonemployee directors, which authorize the
granting of various equity-based incentives including stock options
and restricted stock.
The Company estimates the fair value of its stock
options using a Black-Scholes option-pricing model, consistent with
the provisions of ASC 718, “
Compensation – Stock
Compensation
”. The fair
value of stock options granted is recognized to expense over the
requisite service period. Stock-based compensation expense for all
share-based payment awards is recognized using the straight-line
single-option method. Stock-based compensation expense is reported
in operating expenses based upon the departments to which
substantially all of the associated employees report and credited
to additional paid-in-capital. Stock-based compensation expense
related to equity options was approximately $1,162,000, $744,000
and $618,000 for the years ended December 31, 2016, 2015 and 2014,
respectively.
ASC
718 requires the use of a valuation model to calculate the fair
value of stock-based awards. The Company has elected to use the
Black-Scholes option-pricing model, which incorporates various
assumptions including volatility, expected life, and interest
rates. The Company is required to make various assumptions in the
application of the Black-Scholes option-pricing model. The Company
has determined that the best measure of expected volatility is
based on the historical weekly volatility of the Company’s
Common Stock. Historical volatility factors utilized in the
Company’s Black-Scholes computations for options granted
during the years ended December 31, 2016, 2015 and 2014 ranged from
65% to 116%. The Company has elected to estimate the expected life
of an award based upon the SEC approved “simplified
method” noted under the provisions of Staff Accounting
Bulletin No. 110. The expected term used by the Company during the
years ended December 31, 2016, 2015 and 2014 was 5.17 years. The
difference between the actual historical expected life and the
simplified method was immaterial. The interest rate used is the
risk-free interest rate and is based upon U.S. Treasury rates
appropriate for the expected term. Interest rates used in the
Company’s Black-Scholes calculations for the years ended
December 31, 2016, 2015 and 2014 averaged 2.6%. Dividend yield is
zero as the Company does not expect to declare any dividends on the
Company’s common shares in the foreseeable
future.
In
addition to the key assumptions used in the Black-Scholes model,
the estimated forfeiture rate at the time of valuation is a
critical assumption. The Company has estimated an annualized
forfeiture rate of approximately 0% for corporate officers, 4.1%
for members of the Board of Directors and 6.0% for all other
employees. The Company reviews the expected forfeiture rate
annually to determine if that percent is still reasonable based on
historical experience.
Restricted
stock units are recorded at the grant date fair value with
corresponding compensation expense recorded ratably over the
requisite service period.
Income Taxes
Current
income tax expense or benefit is the amount of income taxes
expected to be payable or refundable for the current year. A
deferred income tax asset or liability is computed for the expected
future impact of differences between the financial reporting and
tax bases of assets and liabilities and for the expected future tax
benefit to be derived from tax credits and loss carryforwards.
Deferred tax assets are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be
realized.
Foreign Currency Translation
The
financial position and results of operations of the Company’s
foreign subsidiaries are measured using the foreign
subsidiary’s local currency as the functional currency.
Revenues and expenses of such subsidiaries have been translated
into U.S. dollars at weighted-average exchange rates
prevailing during the period. Assets and liabilities have been
translated at the rates of exchange on the balance sheet date. The
resulting translation gain and loss adjustments are recorded
directly as a separate component of shareholders’ equity,
unless there is a sale or complete liquidation of the underlying
foreign investments. The Company translates foreign currencies of
its German, Canadian and Mexican subsidiaries. The cumulative
translation adjustment, which is recorded in accumulated other
comprehensive loss, decreased approximately $1,000 for the year
ended December 31, 2016, increased approximately $67,000 for the
year ended December 31, 2015 and decreased approximately $20,000
for the year ended December 31, 2014.
Comprehensive Loss
Comprehensive loss consists of net gains and
losses affecting shareholders’ equity that, under generally
accepted accounting principles, are excluded from net loss. For the
Company, the only items are the cumulative translation adjustment
and the additional minimum liability related to the Company’s
defined benefit pension plan, recognized pursuant to ASC 715-30,
"
Compensation - Retirement
Benefits - Defined Benefit Plans – Pension
".
Advertising Costs
The
Company expenses advertising costs as incurred. The Company
incurred approximately $24,000 in advertising expenses during the
year ended December 31, 2016, $12,000 in advertising expenses
during the year ended December 31, 2015 and $9,000 during the year
ended December 31, 2014.
Loss Per Share
Basic
loss per common share is calculated by dividing net loss available
to common shareholders for the period by the weighted-average
number of common shares outstanding during the period. Diluted loss
per common share is calculated by dividing net loss available to
common shareholders for the period by the weighted-average number
of common shares outstanding during the period, adjusted to
include, if dilutive, potential dilutive shares consisting of
convertible preferred stock, convertible notes payable, stock
options and warrants, calculated using the treasury stock and
if-converted methods. For diluted loss per share
calculation purposes, the net loss available to commons
shareholders is adjusted to add back any preferred stock dividends
and any interest on convertible debt reflected in the consolidated
statement of operations for the respective periods.
|
(Amounts in thousands, except share and per share
amounts)
|
|
|
|
|
|
|
|
Numerator
for basic and diluted loss per share:
|
|
|
|
|
Net
loss
|
$
(9,527
)
|
$
(8,534
)
|
$
(7,940
)
|
|
Preferred
dividends
|
(1,347
)
|
(1,065
)
|
(51
)
|
|
Net
loss available to common shareholders
|
$
(10,874
)
|
$
(9,599
)
|
$
(7,991
)
|
|
|
|
|
|
|
Denominator
for basic loss per share — weighted-average shares
outstanding
|
94,426,783
|
93,786,079
|
91,795,971
|
|
Effect
of dilutive securities
|
—
|
—
|
—
|
|
Denominator
for diluted loss per share — weighted-average shares
outstanding
|
94,426,783
|
93,786,079
|
91,795,971
|
|
|
|
|
|
|
Basic and diluted loss per share:
|
|
|
|
|
Net
loss
|
$
(0.10
)
|
$
(0.09
)
|
$
(0.09
)
|
|
Preferred
dividends
|
(0.02
)
|
(0.01
)
|
(—
)
|
|
Net
loss available to common shareholders
|
$
(0.12
)
|
$
(0.10
)
|
$
(0.09
)
|
The
following potential dilutive securities have been excluded from the
computations of diluted weighted-average shares outstanding as
their effect would have been antidilutive:
|
Potential Dilutive Securities:
|
Common Share Equivalents at December 31, 2016
|
Common Share Equivalents at December 31, 2015
|
Common Share Equivalents at December 31, 2014
|
|
Convertible
lines of credit
|
2,201,903
|
—
|
1,649,548
|
|
Convertible
redeemable preferred stock – Series B
|
46,029
|
46,029
|
46,029
|
|
Convertible
redeemable preferred stock – Series E
|
6,315,789
|
6,442,105
|
—
|
|
Convertible
redeemable preferred stock – Series F
|
1,333,333
|
—
|
—
|
|
Convertible
redeemable preferred stock – Series G
|
4,014,000
|
—
|
—
|
|
Stock
options
|
6,506,843
|
5,376,969
|
4,057,296
|
|
Warrants
|
175,000
|
450,000
|
977,778
|
|
Total
Potential Dilutive Securities
|
20,592,897
|
12,315,103
|
6,730,651
|
Recently Issued Accounting Standards
From time to time, new accounting pronouncements
are issued by the Financial Accounting Standards Board (the
“
FASB
”), or other standard setting bodies, which
are adopted by us as of the specified effective date. Unless
otherwise discussed, the Company’s management believes the
impact of recently issued standards not yet effective will not have
a material impact on the Company’s consolidated financial
statements upon adoption.
FASB ASU No. 2014-09.
In May 2014, FASB issued Accounting
Standards Update (“
ASU
”) No. 2014-09,
Revenue from Contracts with
Customers
, which requires an
entity to recognize the amount of revenue to which it expects to be
entitled for the transfer of promised goods or services to
customers. ASU No. 2014-09 will replace most existing revenue
recognition guidance in U.S. GAAP when it becomes effective. In
July 2015, the FASB finalized a one-year deferral of the effective
date of the new standard. For public entities, the deferral results
in the new revenue standard being effective for fiscal years, and
interim periods within those fiscal years, beginning after December
15, 2017. Calendar year-end public companies are therefore required
to apply the revenue guidance beginning in their 2018 interim and
annual financial statements. The standard permits the use of either
the retrospective or cumulative effect transition
method.
We
currently anticipate adopting the standard using the cumulative
effect transition method during the first fiscal quarter in
2018.
FASB ASU No.
2014-15
. In August 2014, the
FASB issued ASU No. 2014-15,
Disclosure of Uncertainties
about an Entity’s Ability to Continue as a Going
Concern
, which provides
guidance on management’s responsibility in evaluating whether
there is substantial doubt about a company’s ability to
continue as a going concern and to provide related footnote
disclosures. ASU No. 2014-15 became effective in the fourth quarter
of 2016. The adoption of ASU No. 2014-15 did not have a significant
impact on our consolidated financial
statements.
FASB ASU No.
2015-03
. In April 2015, the
FASB issued ASU No. 2015-03, “
Simplifying the Presentation
of Debt Issuance Costs.”
The standard requires 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. The standard
became effective for the Company beginning January 1, 2016. The
adoption of ASU No. 2015-03 did not have a significant impact on
our consolidated financial statements.
FASB ASU No.
2015-11
. In July 2015, the FASB
issued ASU No. 2015-11,
“Simplifying the
Measurement of Inventory (Topic 330): Simplifying the Measurement
of Inventory”.
The
amendments in ASU No. 2015-11 require an entity of measure
inventory at the lower of cost or market. Market could be
replacement cost, net realizable value, or net realizable value
less an approximately normal profit margin. The amendments do not
apply to inventory that is measured using last-in, first out (LIFO)
or the retail inventory method. The amendments apply to all other
inventory, which includes inventory that is measured using
first-in, first-out (FIFO) or average cost. For public business
entities, the amendments in ASU No. 2015-11 are effective for
fiscal years beginning after December 15, 2016, including interim
periods within those fiscal years. The amendments should be applied
prospectively with earlier application permitted as of the
beginning of an interim or annual reporting period. The adoption of
ASU No. 2015-11 did not have a significant impact on our
consolidated financial statements.
FASB ASU No.
2016-01
. In January 2016, the
FASB issued ASU 2016-01, “
Financial
Instruments—Overall - Recognition and Measurement of
Financial Assets and Financial Liabilities”.
The amendments in this ASU address
certain aspects of recognition, measurement, presentation, and
disclosure of financial instruments and apply to all entities that
hold financial assets or owe financial liabilities. The amendments
in this ASU also simplify the impairment assessment of equity
investments without readily determinable fair values by requiring
assessment for impairment qualitatively at each reporting period.
That impairment assessment is similar to the qualitative assessment
for long-lived assets, goodwill, and indefinite-lived intangible
assets. This ASU is effective for fiscal years beginning after
December 15, 2017, including interim periods within those fiscal
years, with earlier application permitted for financial statements
that have not been issued. An entity should apply the amendments by
means of a cumulative-effect adjustment to the balance sheet as of
the beginning of the fiscal year of adoption. We plan to adopt the
provisions of this ASU for our fiscal year beginning January 1,
2018 and are currently evaluating the impact the adoption of this
new accounting standard will have on our consolidated financial
statements.
FASB ASU
No. 2016-02
. In February 2016,
the FASB issued ASU No. 2016-02, “
Leases”
.
This guidance will result in key changes to lease accounting and
will aim to bring leases onto balance sheets to give investors,
lenders, and other financial statement users a more comprehensive
view of a company's long-term financial obligations as well as the
assets it owns versus leases. The new leasing standard will be
effective for fiscal years beginning after December 15, 2018, and
for interim periods within those fiscal years. The Company is
currently evaluating the impact this guidance will have on our
consolidated financial statements and anticipates commencement of
adoption planning in the fourth fiscal quarter of
2018.
FASB ASU No.
2016-06
. In March 2016, the
FASB issued Accounting Standards Update No.
2016-06,
Derivatives and Hedging (Topic
815) – Contingent Put and Call Options in Debt
Instruments
(“ASU
2016-06”), which will reduce diversity of practice in
identifying embedded derivatives in debt instruments. ASU 2016-06
clarifies that the nature of an exercise contingency is not subject
to the “clearly and closely” criteria for purposes of
assessing whether the call or put option must be separated from the
debt instrument and accounted for separately as a derivative. This
guidance is effective for fiscal years beginning after December 15,
2016 and interim periods within those fiscal years. The adoption of
ASU No. 2016-06 did not have a significant impact on our
consolidated financial statements.
FASB ASU No.
2016-08
. In March 2016, the
FASB issued Accounting Standards Update No.
2016-08,
Revenue from Contracts with
Customers (Topic 606): Principal versus Agent Considerations
(Reporting Revenue Gross versus Net)
(“ASU 2016-08”). ASU 2016-08 clarifies
the implementation guidance on principal versus agent
considerations. The guidance includes indicators to assist an
entity in determining whether it controls a specified good or
service before it is transferred to the customers. This guidance is
effective for fiscal years beginning after December 15, 2017
including interim periods within those fiscal years. The Company is
currently assessing the impact that adopting this new accounting
standard will have on its consolidated financial statements and
footnote disclosures.
FASB ASU No.
2016-09
. In March 2016, the
FASB issued Accounting Standards Update No.
2016-09,
Compensation – Stock
Compensation (Topic 718)
(“ASU 2016-09”). ASU 2016-09
identifies areas for simplification involving several aspects of
accounting for share-based payment transactions, including the
income tax consequences, classification of awards as either equity
or liabilities, an option to recognize gross stock compensation
expense with actual forfeitures recognized as they occur, as well
as certain classifications on the statement of cash flows. This ASU
is effective for fiscal years beginning after December 15, 2016 and
interim periods within those annual periods. The adoption ASU No.
2016-09 did not have a significant impact on our consolidated
financial statements.
FASB ASU No.
2016-10
. In April 2016, the
FASB issued Accounting Standards Update No.
2016-10,
Revenue from Contracts with
Customers (Topic 606): Identifying Performance Obligations and
Licensing
(“ASU
2016-10”). ASU 2016-10 provides further implementation
guidance on identifying performance obligations and also improves
the operability and understandability of the licensing
implementation guidance. This guidance is effective for fiscal
years beginning after December 15, 2017 including interim periods
within those fiscal years. The Company is currently assessing the
impact that adopting this new accounting standard will have on its
consolidated financial statements and footnote
disclosures.
FASB ASU No.
2016-13
. In June 2016, the FASB
issued Accounting Standard Update No. 2016-13, F
inancial
Instruments—Credit Losses (Topic 326): Measurement of Credit
Losses on Financial Instruments.
ASU No. 2016-13 changes the impairment model
for most financial assets and certain other instruments. For trade
and other receivables, held-to-maturity debt securities, loans and
other instruments, entities will be required to use a new
forward-looking “expected loss” model that will replace
today’s “incurred loss” model and generally will
result in the earlier recognition of allowances for losses. For
available-for-sale debt securities with unrealized losses, entities
will measure credit losses in a manner similar to current practice,
except that the losses will be recognized as an allowance. This
guidance is effective for fiscal years beginning after December 15,
2019 including interim periods within those fiscal years. The
Company is currently evaluating the potential impact of adoption of
this standard on its consolidated financial
statements.
FASB ASU No.
2016-15.
In August 2016, the
FASB issued Accounting Standards Update No.
2016-15,
Statement
of Cash Flows (Topic 230)
Classification
of Certain Cash Receipts and Cash
Payments.
ASU
2016-15 eliminates the diversity in practice related to the
classification of certain cash receipts and payments for debt
prepayment or extinguishment costs, the maturing of a zero coupon
bond, the settlement of contingent liabilities arising from a
business combination, proceeds from insurance settlements,
distributions from certain equity method investees and beneficial
interests obtained in a financial asset securitization. ASU 2016-15
designates the appropriate cash flow classification, including
requirements to allocate certain components of these cash receipts
and payments among operating, investing and financing
activities.
This guidance
is effective for fiscal years beginning after December 15, 2017
including interim periods within those fiscal years.
The
retrospective transition method, requiring adjustment to all
comparative periods presented, is required unless it is
impracticable for some of the amendments, in which case those
amendments would be prospectively as of the earliest date
practicable. The Company is currently assessing the impact that
adopting this new accounting standard will have on its consolidated
financial statements and footnote disclosures.
FASB ASU No. 2017-04.
In January 2017, the FASB issued ASU
No. 2017-04,
Intangibles – Goodwill
and Other (Topic 350): Simplifying the Test for Goodwill
Impairment.
The amendments of this
ASU eliminate step 2 from the goodwill impairment test. The annual,
or interim test is performed by comparing the fair value of a
reporting unit with its carrying amount. The amendments of this ASU
also eliminate the requirements for any reporting unit with a zero
or negative carrying amount to perform a qualitative assessment and
if it fails that qualitative test, to perform step 2 of the
goodwill impairment test. ASU No. 2017-04 is effective for fiscal
years beginning after December 15, 2019.
The Company is currently evaluating the potential
impact of adoption of this standard on its consolidated financial
statements.
3. FAIR VALUE ACCOUNTING
The Company accounts for fair value measurements
in accordance with ASC 820, “
Fair Value Measurements and
Disclosures
,” which
defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands
disclosures about fair value measurements.
ASC
820 establishes a fair value hierarchy that prioritizes the inputs
to valuation techniques used to measure fair value. The hierarchy
gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements)
and the lowest priority to unobservable inputs (Level 3
measurements). The three levels of the fair value hierarchy under
ASC 820 are described below:
|
|
Level 1
|
Unadjusted quoted prices in active markets that are accessible at
the measurement date for identical, unrestricted assets or
liabilities.
|
|
|
|
|
|
|
Level 2
|
Applies to assets or liabilities for which there are inputs other
than quoted prices included within Level 1 that are observable for
the asset or liability such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets
or liabilities in markets with insufficient volume or infrequent
transactions (less active markets); or model-derived valuations in
which significant inputs are observable or can be derived
principally from, or corroborated by, observable market
data.
|
|
|
|
|
|
|
Level 3
|
Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable
(supported by little or no market activity).
|
The
following table sets forth the Company’s financial assets and
liabilities measured at fair value by level within the fair value
hierarchy. As required by ASC 820, assets and liabilities are
classified in their entirety based on the lowest level of input
that is significant to the fair value measurement.
|
|
Fair Value at December 31, 2016
|
|
($ in thousands)
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
Pension
assets
|
$
1,645
|
$
1,645
|
$
—
|
$
—
|
|
Totals
|
$
1,645
|
$
1,645
|
$
—
|
$
—
|
|
|
Fair Value at December 31, 2015
|
|
($ in thousands)
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
Pension
assets
|
$
1,557
|
$
1,557
|
$
—
|
$
—
|
|
Totals
|
$
1,557
|
$
1,557
|
$
—
|
$
—
|
The
Company’s pension assets are classified within Level 1 of the
fair value hierarchy because they are valued using market prices.
The pension assets are primarily comprised of the cash surrender
value of insurance contracts. All plan assets are managed in a
policyholder pool in Germany by outside investment managers. The
investment objectives for the plan are the preservation of capital,
current income and long-term growth of capital.
The Company monitors the activity within each level and any changes
with the underlying valuation techniques or inputs utilized to
recognize if any transfers between levels are
necessary. That determination is made, in part, by
working with outside valuation experts for Level 3 instruments and
monitoring market related data and other valuation inputs for Level
1 and Level 2 instruments.
4. INTANGIBLE ASSETS AND GOODWILL
The Company has intangible assets in the form of
trademarks, trade names and patents. The carrying amount of the
Company’s acquired trademarks and trade names was $0 as of
December 31, 2016 and 2015, respectively, which include accumulated
amortization of $347,000 as of December 31, 2016 and 2015.
Amortization expense related to trademarks and tradenames was $0,
$15,000 and $15,000 for the years ended December 31, 2016, 2015 and
2014, respectively. All intangible assets are amortized over their
estimated useful lives with no estimated residual values. Any costs
incurred by the Company to renew or extend the life of intangible
assets will be evaluated under ASC No. 350,
Intangibles – Goodwill
and Other
, for proper
treatment.
The
carrying amounts of the Company’s patent intangible assets
were $105,000 and $117,000 as of December 31, 2016 and 2015,
respectively, which includes accumulated amortization of $554,000
and $542,000 as of December 31, 2016 and 2015,
respectively. Amortization expense for patent intangible
assets was $12,000 for the years ended December 31, 2016, 2015 and
2014. Patent intangible assets are being amortized on a
straight-line basis over their remaining life of approximately 9.5
years. There was no impairment of the Company's intangible assets
during the years ended December 31, 2016, 2015 and
2014.
The
Company annually, or more frequently if events or circumstances
indicate a need, tests the carrying amount of goodwill for
impairment. The Company performs its annual impairment test in the
fourth quarter of each year. A two-step impairment test is used to
first identify potential goodwill impairment and then measure the
amount of goodwill impairment loss, if any. The first step was
conducted by determining and comparing the fair value, employing
the market approach, of the Company’s reporting unit to the
carrying value of the reporting unit. The Company continues to have
only one reporting unit, Identity Management. Based on the results
of this impairment test, the Company determined that its goodwill
was not impaired during the years ended December 31,
2016, 2015 and 2014.
The
estimated acquired intangible amortization expense for the next
five fiscal years is as follows:
|
Fiscal Year Ended December 31,
|
Estimated Amortization
Expense
($ in thousands)
|
|
2017
|
$
12
|
|
2018
|
12
|
|
2019
|
12
|
|
2020
|
12
|
|
2021
|
12
|
|
Thereafter
|
45
|
|
Totals
|
$
105
|
5. RELATED PARTIES
Related Party Convertible Notes
On November 14, 2008, the Company entered into a
series of convertible promissory notes (the
“
Related-Party Convertible
Notes
”), aggregating
$110,000 with certain officers and members of the Company’s
Board of Directors, including S. James Miller, the Company’s
Chief Executive Officer and Chairman. The Related-Party Convertible
Notes bear interest at 7.0% per annum and were originally due
February 14, 2009. In conjunction with the original issuance of the
Related-Party Convertible Notes in 2008, the Company issued an
aggregate of 149,996 warrants to the note holders to purchase
shares of Common Stock of the Company. The warrants have an
exercise price $0.50 per share and may be exercised at any time
from November 14, 2008 until November 14, 2013. No warrants to
purchase shares of Common Stock were outstanding and exercisable as
of December 31, 2015, and no warrants were issued and outstanding
as of December 31, 2015.
The
Company did not repay the Related-Party Convertible Notes on the
due date. In August 2009, the Company received from the
Related-Party Convertible Note holders a waiver of default and
extension to January 31, 2010 of the maturity date of the
Related-Party Convertible Notes. As consideration for the waiver
and note extension, the Company issued to the Related-Party
Convertible Note holders an aggregate of 150,000 warrants to
purchase shares of the Company’s Common Stock. The warrants
have an exercise price of $0.50 per share and expire on August 25,
2014, of which no warrants to purchase shares of Common Stock were
outstanding and exercisable as of December 31, 2016.
On
January 21, 2013, the holders of the Related-Party Convertible
Notes agreed to extend the due date on their respective convertible
notes to be due and payable not later than June 30, 2015, however,
the Related-Party Convertible Notes will be callable at any time,
at the option of the note holder, prior to June 30, 2015. During
the year ended December 31, 2014, holders of Related-Party
Convertible Notes in the principal amount of $85,034 elected to
convert their respective Related-Party Convertible Notes into
154,607 shares of Common Stock.
Lines of Credit
In March 2013, the Company and Holder entered into
the Goldman Line of Credit with available borrowings of up to $2.5
million. In March 2014, the Goldman Line of Credit’s
borrowing was increased to an aggregate total of $3.5 million (the
“
Amendment
”). Pursuant to the terms and conditions of
the Amendment, the Holder had the right to convert up to $2.5
million of the outstanding balance of the Goldman Line of Credit
into shares of the Company's Common Stock for $0.95 per share. Any
remaining outstanding balance was convertible into shares of
the Company's Common Stock for $2.25 per share.
As consideration for the initial Goldman Line of
Credit, the Company issued a warrant to the Holder, exercisable for
1,052,632 shares of the Company’s Common Stock (the
"
Line of
Credit Warrant
"). The Goldman
Line of Credit Warrant had a term of two years from the date of
issuance and an exercise price of $0.95 per share. As
consideration for entering into the Amendment, the Company issued
to the Holder a second warrant, exercisable for 177,778 shares of
the Company’s Common Stock (the “
Amendment
Warrant
”). The Amendment
Warrant expired on March 27, 2015 and had an exercise price of
$2.25 per share.
The
Company estimated the fair value of the Line of Credit Warrant
using the Black-Scholes option pricing model using the following
assumptions: term of two years, a risk-free interest rate of 2.58%,
a dividend yield of 0%, and volatility of 79%. The Company recorded
the fair value of the Line of Credit Warrant as a deferred
financing fee of approximately $580,000 to be amortized over the
life of the Goldman Line of Credit. The Company estimated the fair
value of the Amendment Warrant using the Black-Scholes option
pricing model using the following assumptions: term on one year, a
risk-free interest rate of 2.58%, a dividend yield of 0% and
volatility of 74%. The Company recorded the fair value of the
Amendment Warrant as an additional deferred financing fee of
approximately $127,000 to be amortized over the life of the Goldman
Line of Credit.
During
the years ended December 31, 2016, 2015 and 2014, the Company
recorded an aggregate of approximately $48,000, $53,000 and
$369,000, respectively in deferred financing fee amortization
expense which is recorded as a component of interest expense in the
Company’s consolidated statements of operations.
In April 2014, the Company and the Holder entered
into a further amendment to the Goldman Line of Credit to decrease
the available borrowings to $3.0 million (the
“
Second
Amendment
”). Contemporaneous with the
execution of the Second Amendment, the Company entered into a new
unsecured line of credit with the Second Holder with available
borrowings of up to $500,000 (the “Crocker LOC”), which
amount was convertible into shares of the Company’s
Common Stock for $2.25 per share. As a result of these amendments,
total available borrowings under the Lines of Credit available to
the Company remained unchanged at a total of $3.5 million. In
connection with the Second Amendment, the Holder assigned and
transferred to the Second Holder one-half of the Amendment
Warrant.
In December 2014, the Company and the Holder
entered into a further amendment to the Goldman Line of Credit to
increase the available borrowing to $5.0 million and extend the
maturity date of the Goldman Line of Credit to March 27, 2017 (the
“
Third
Amendment
”). Also, as a
result of the Third Amendment, the Holder had the right to convert
up to $2.5 million outstanding principal, plus any accrued but
unpaid interest (“
Outstanding
Balance
”) into shares of
the Company’s Common Stock for $0.95 per share, the next
$500,000 Outstanding Balance into shares of Common Stock for $2.25
per share and any remaining outstanding balance thereafter into
shares of Common Stock for $2.30 per share. The Third Amendment
also modified the definition of a “Qualified Financing”
to mean a debt or equity financing resulting in gross proceeds to
the Company of at least $5.0 million.
In
February 2015, as a result of the Series E Financing, the Company
issued 1,978 shares of Series E Preferred to the Holder to satisfy
$1,950,000 in principal borrowings under the Goldman Line of Credit
plus approximately $28,000 in accrued interest. As a result of the
Series E Financing, the Company’s borrowing capacity under
the Goldman Line of Credit was reduced to $3,050,000 with the
maturity date unchanged and the $500K Line of Credit was terminated
in accordance with its terms.
In March 2016, the Company and the Holder entered
into a fourth amendment to the Goldman Line of Credit (the
“
Fourth
Amendment
”) solely to (i)
increase available borrowings to $5.0 million; (ii) extend the
maturity date to June 30, 2017, and (iii) provide for the
conversion of the outstanding balance due under the terms of the
Goldman Line of Credit into that number of fully paid and
non-assessable shares of the Company’s Common Stock as is
equal to the quotient obtained by dividing the outstanding balance
by $1.25.
Contemporaneous
with the execution of the Fourth Amendment, the Company entered
into a new $500K Line of Credit with available borrowings of up to
$500,000 with the Second Holder, which replaced the original $500K
Line of Credit that terminated as a result of the consummation of
the Series E Financing. Similar to the Fourth Amendment,
the new $500K Line of Credit with the Second Holder matures
on June 30, 2017, and provides for the conversion of the
outstanding balance due under the terms of the $500K Line of Credit
into that number of fully paid and non-assessable shares of the
Company’s Common Stock as is equal to the quotient obtained
by dividing the outstanding balance by $1.25.
On
December 27, 2016, in connection with the consummation of the
Series G Financing, the Company and Holder agreed to enter
into the
Fifth Amendment (the “
Line
of Credit Amendment
”) to the Goldman
Line of Credit to provide the Company with the ability to borrow up
to $5.5 million under the terms of the Goldman Line of Credit. In
addition, the Maturity Date, as defined in the Goldman Line of
Credit was amended to be December 31, 2017. The Line of Credit
Amendment was executed on January 23, 2017.
In addition, on January 23, 2017, the Company and the Second Holder
amended the $500K Line of Credit to extend the maturity date
thereof to December 31, 2017. No other amendments were made to the
$500K Line of Credit.
The
Company evaluated the Lines of Credit and determined that the
instruments contain a contingent beneficial conversion feature,
i.e. an embedded conversion right that enables the holder to obtain
the underlying Common Stock at a price below market value. The
beneficial conversion feature is contingent as the terms of the
conversion do not permit the Company to compute the number of
shares that the holder would receive if the contingent event occurs
(i.e. future borrowings under the Line of Credit). The Company has
considered the accounting for this contingent beneficial conversion
feature using the guidance in ASC 470, Debt. The guidance in ASC
470 states that a contingent beneficial conversion feature in an
instrument shall not be recognized in earnings until the
contingency is resolved. The beneficial conversion features of
future borrowings under the Line of Credit will be measured
using the intrinsic value calculated at the date the contingency is
resolved using the conversion price and trading value of the
Company’s Common Stock at the date the Lines of Credit were
issued (commitment date). Pursuant to borrowings made during the
2015 year, the Company recognized approximately $146,000 in
beneficial conversion feature as debt discount. As a result of the
retirement of all amounts outstanding under the Lines of Credit in
2015, the Company recognized all remaining unamortized debt
discount of approximately $385,000 as a component of interest
expense during the three months ended March 31, 2015. As there was
$2,650,000 in borrowings under the Lines of Credit during the year
ended December 31, 2016, the Company recorded approximately
$146,000 in debt discount attributable to the beneficial conversion
feature during the year ended December 31, 2016. During the year
ended December 31, 2016, the Company accreted approximately
$97,000, respectively, of debt discount as a component of interest
expense. At December 31, 2016, unamortized note discount was
approximately $122,000.
The
following table sets forth the Company’s activity under its
Lines of Credit for the periods indicated:
|
Balance
outstanding under Lines of Credit as of December 31,
2014
|
$
1,550
|
|
Borrowing
under Lines of Credit
|
750
|
|
Repayments
|
(350
)
|
|
Exchange
of Indebtedness for Series E Preferred Stock
|
(1,950
)
|
|
Balance
outstanding under Lines of Credit as of December 31,
2015
|
$
—
|
|
Borrowings
under Lines of Credit
|
2,650
|
|
Repayments
|
—
|
|
Balance
outstanding under Lines of Credit as of December 31,
2016
|
$
2,650
|
6. INVENTORY
Inventories of $23,000 as of December 31, 2016 were comprised of
work in process of $19,000 representing direct labor costs on
in-process projects and finished goods of $4,000 net of reserves
for obsolete and slow-moving items of $3,000.
Inventories of $46,000 as of December 31, 2015 were comprised of
work in process of $42,000, representing direct labor costs on
in-process projects, approximately $21,000 of equipment related to
in-process projects and finished goods of $4,000 net of reserves
for obsolete and slow-moving items of $3,000. The balance of direct
labor costs on in-process projects of $42,000 at December 31, 2015,
reflects a write down of approximately $261,000 to net realizable
value.
Appropriate consideration is given to obsolescence, excessive
levels, deterioration and other factors in evaluating net
realizable value and required reserve levels.
7. PROPERTY AND EQUIPMENT
Property
and equipment at December 31, 2016 and 2015, consists
of:
|
($ in thousands)
|
|
|
|
|
|
|
|
Equipment
|
$
935
|
$
887
|
|
Leasehold
improvements
|
11
|
11
|
|
Furniture
|
101
|
101
|
|
|
1,047
|
999
|
|
Less
accumulated depreciation
|
(954
)
|
(837
)
|
|
|
$
93
|
$
162
|
Total
depreciation expense for the years ended December 31, 2016, 2015
and 2014 was approximately $117,000, $137,000 and $152,000,
respectively.
8. ACCRUED EXPENSES
Principal
components of accrued expenses consist of:
|
($ in thousands)
|
|
|
|
|
|
|
|
Compensated
absences
|
$
313
|
$
260
|
|
Wages,
payroll taxes and sales commissions
|
28
|
11
|
|
Customer
deposits
|
198
|
69
|
|
Liquidated
damages
|
—
|
200
|
|
Royalties
|
147
|
147
|
|
Pension
and employee benefit plans
|
7
|
6
|
|
Income
and sales taxes
|
161
|
131
|
|
Dividends
|
27
|
261
|
|
Interest
payable to related parties
|
102
|
—
|
|
Other
|
64
|
64
|
|
|
$
1,047
|
$
1,149
|
9. LINES OF CREDIT
Outstanding
lines of credit consist of the following:
|
($ in
thousands)
|
|
|
|
Lines
of Credit
|
|
|
8%
convertible lines of credit. Face value of advances under lines of
credit $2,650 at December 31, 2016 and $0 at December 31, 2015,
respectively. Discount on advances under lines of credit is $122 at
December 31, 2016 and $0 at December 31, 2015, respectively.
Maturity date is December 31, 2017.
|
$
2,528
|
$
—
|
|
|
|
|
|
Total
lines of credit to related parties
|
2,528
|
—
|
|
|
(2,528
)
|
—
|
Long-term
lines of credit to related parties
|
$
—
|
$
—
|
Lines of Credit
For a more detailed discussion of the Company’s Lines of
Credit, see Note 5 Related Parties.
10. INCOME TAXES
The Company accounts for income taxes in
accordance with ASC 740,
Accounting for Income
Taxes,
(ASC 740). Deferred
income taxes are recognized for the tax consequences related to
temporary differences between the carrying amount of assets and
liabilities for financial reporting purposes and the amounts used
for tax purposes at each year-end, based on enacted tax laws and
statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income. A valuation
allowance is established when necessary based on the weight of
available evidence, if it is considered more likely than not that
all or some portion of the deferred tax assets will not be
realized. Income tax expense is the sum of current income tax plus
the change in deferred tax assets and liabilities. The
Company has established a valuation allowance against its deferred
tax asset due to the uncertainty surrounding the realization of
such asset.
ASC
740 requires a company to first determine whether it is
more-likely-than-not (defined as a likelihood of more than fifty
percent) that a tax position will be sustained based on its
technical merits as of the reporting date, assuming that taxing
authorities will examine the position and have full knowledge of
all relevant information. A tax position that meets this
more-likely-than-not threshold is then measured and recognized at
the largest amount of benefit that is greater than fifty percent
likely to be realized upon effective settlement with a taxing
authority. The amount accrued for uncertain tax
positions was zero at December 31, 2016, 2015 and 2015,
respectively.
The
Company’s uncertain position relative to unrecognized tax
benefits and any potential increase in these liabilities relates
primarily to the allocations of revenue and costs among the
Company’s global operations and the impact of tax rulings
made during the period affecting its tax positions. The
Company’s existing tax position could result in liabilities
for unrecognized tax benefits. The Company recognizes interest
and/or penalties related to uncertain tax positions in income tax
expense. The amount of interest and penalties accrued as of
December 31, 2016 and 2015 was approximately $12,000 and $11,000,
respectively.
Significant
judgment is required in evaluating the Company’s uncertain
tax positions and determining the Company’s provision for
income taxes. No assurance can be given that the final tax outcome
of these matters will not be different from that which is reflected
in the Company’s historical income tax provisions and
accruals. The Company adjusts these items in light of changing
facts and circumstances. To the extent that the final tax outcome
of these matters is different than the amounts recorded, such
differences will impact the provision for income taxes in the
period in which such determination is made.
The
significant components of the income tax provision are as
follows:
|
($ in thousands)
|
|
|
Current
|
|
|
|
|
Federal
|
$
—
|
$
—
|
$
—
|
|
State
|
—
|
—
|
—
|
|
Foreign
|
21
|
22
|
25
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
Federal
|
—
|
—
|
—
|
|
State
|
—
|
—
|
—
|
|
Foreign
|
—
|
—
|
—
|
|
|
|
|
|
|
|
$
21
|
$
22
|
$
25
|
The
principal components of the Company’s deferred tax assets at
December 31, 2016, 2015 and 2014 are as follows:
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
Net
operating loss carryforwards
|
$
17,829
|
$
15,948
|
$
14,200
|
|
Intangible
and fixed assets
|
102
|
220
|
427
|
|
Stock
based compensation
|
2,324
|
1,861
|
1,565
|
|
Reserves
and accrued expenses
|
8
|
8
|
6
|
|
Other
|
—
|
—
|
(85
)
|
|
|
20,263
|
18,037
|
16,113
|
|
Less
valuation allowance
|
(20,263
)
|
(18,037
)
|
(16,113
)
|
|
|
|
|
|
|
Net
deferred tax assets
|
$
—
|
$
—
|
$
—
|
A
reconciliation of the provision for income taxes to the amount
computed by applying the statutory income tax rates to loss before
income taxes is as follows:
|
|
|
|
|
|
|
|
|
|
|
Amounts
computed at statutory rates
|
$
(3,239
)
|
$
(2,902
)
|
$
(2,699
)
|
|
State
income tax, net of federal benefit
|
(462
)
|
(262
)
|
(212
)
|
|
Expiration
of net operating loss carryforwards
|
1,082
|
695
|
708
|
|
Non-deductible
interest
|
49
|
149
|
145
|
|
Foreign
taxes
|
362
|
413
|
386
|
|
Other
|
3
|
5
|
4
|
|
Net
change in valuation allowance on deferred tax assets
|
2,226
|
1,924
|
1,693
|
|
|
|
|
|
|
|
$
21
|
$
22
|
$
25
|
The
Company has established a valuation allowance against its deferred
tax assets due to the uncertainty surrounding the realization of
such assets.
At
December 31, 2016, 2015 and 2014, the Company had federal and state
net operating loss carryforwards, a portion of which may be
available to offset future taxable income for tax purposes. The
federal net operating loss carryforwards expire at various dates
from 2021 through 2036. The state net operating loss carryforwards
expire at various dates from 2029 through 2036.
The Internal Revenue Code (the
"Code"
) limits the availability of certain tax credits
and net operating losses that arose prior to certain cumulative
changes in a corporation’s ownership resulting in a change of
control of the Company. The Company’s use of its net
operating loss carryforwards and tax credit carryforwards will be
significantly limited because the Company believes it underwent
“ownership changes”, as defined under Section 382 of
the Internal Revenue Code, in 1991, 1995, 2000, 2003, 2004, 2011
and 2012, though the Company has not performed a study to determine
the limitation. The Company has reduced its deferred tax assets to
zero relating to its federal and state research credits because of
such limitations. The Company continues to disclose the tax effect
of the net operating loss carryforwards at their original amount in
the table above as the actual limitation has not yet been
quantified. The Company has also established a full valuation
allowance for substantially all deferred tax assets due to
uncertainties surrounding its ability to generate future taxable
income to realize these assets. Since substantially all deferred
tax assets are fully reserved, future changes in tax benefits will
not impact the effective tax rate. Management periodically
evaluates the recoverability of the deferred tax assets. If it is
determined at some time in the future that it is more likely than
not that deferred tax assets will be realized, the valuation
allowance would be reduced accordingly at that
time.
Tax returns for the years 2012 through 2016 are
subject to examination by taxing authorities.
11. COMMITMENTS AND CONTINGENCIES
Employment Agreements
The
Company has employment agreements with its Chief Executive Officer,
its Senior Vice President of Administration and Chief Financial
Officer, and its Chief Technical Officer. The Company may terminate
the agreements with or without cause. Subject to the conditions and
other limitations set forth in each respective employment
agreement, each executive will be entitled to the following
severance benefits if the Company terminates the executive’s
employment without cause or in the event of an involuntary
termination (as defined in the employment agreements) by
the Company or by the executive:
Under
the terms of the agreement, the Chief Executive Officer will be
entitled to the following severance benefits if we terminate his
employment without cause or in the event of an involuntary
termination: (i) a lump sum cash payment equal to twenty-four
months base salary; (ii) continuation of fringe benefits and
medical insurance for a period of three years; and (iii) immediate
vesting of 50% of outstanding stock options and restricted stock
awards. In the event that the Chief Executive Officer’s
employment is terminated within six months prior to or thirteen
months following a change of control (as defined in the employment
agreements), the Chief Executive Officer is entitled to the
severance benefits described above, except that 100% of the Chief
Executive Officer’s outstanding stock options and restricted
stock awards will immediately vest.
Under
the terms of the employment agreements with our Senior Vice
President of Administration and Chief Financial Officer, this
executive will be entitled to the following severance benefits if
we terminate their employment without cause or in the event of an
involuntary termination: (i) a lump sum cash payment equal to six
month's of base salary; (ii) continuation of their fringe benefits
and medical insurance for a period of six months; (iii) immediate
vesting of 50% of their outstanding stock options and restricted
stock awards. In the event that their employment is terminated
within six months prior to or thirteen months following a change of
control (as defined in the employment agreements), they are
entitled to the severance benefits described above, except that
100% of their outstanding stock options and restricted stock awards
will immediately vest.
Under
the terms of the employment agreement with our Chief Technical
Officer, this executive will be entitled to the following severance
benefits if we terminate his employment without cause or in the
event of an involuntary termination: (i) a lump sum cash payment
equal to six months of base salary; (ii) continuation of their
fringe benefits and medical insurance for a period of six months.
In the event that his employment is terminated within six months
prior to or thirteen months following a change of control (as
defined in the employment agreements), he is entitled to the
severance benefits described above, except that 100% of his
outstanding stock options and restricted stock awards will
immediately vest.
On December
28, 2016, the Company entered into amendments to the employment
agreements for the Company’s Chief Executive Officer, Chief
Financial Officer, and Chief Technical Officer. Effective October
20, 2016, the term of each executive officer's employment agreement
was extended until December 31, 2017.
Litigation
There
is no action, suit, proceeding, inquiry or investigation before or
by any court, public board, government agency, self-regulatory
organization or body pending or, to the knowledge of the executive
officers of the Company or any of our subsidiaries, threatened
against or affecting the Company, our Common Stock, any of our
subsidiaries or of the Company’s or our subsidiaries’
officers or directors in their capacities as such, in which an
adverse decision could have a material adverse effect.
Leases
The
Company’s corporate headquarters are located in San Diego,
California where we occupy 9,927 square feet of office space. This
facility is leased through October 2017 at a cost of approximately
$18,000 per month. In addition to our corporate headquarters, we
also occupied the following spaces at December 31,
2016:
●
1,508
square feet in Ottawa, Province
of Ontario, Canada, at a cost of approximately $3,000 per month
until the expiration of the lease on March 31, 2021. This lease was
renewed in April 2016 for a five-year period ending on March 31,
2021. Renewal terms were substantially unchanged from the existing
lease;
●
8,045
square feet in Portland, Oregon,
at a cost of approximately $16,000 per month until the expiration
of the lease on October 31, 2018; and
●
304
square feet of office space in
Mexico City, Mexico, at a cost of approximately $3,000 per month
until November 30, 2017.
At
December 31, 2016, future minimum lease payments are as
follows:
|
($ in thousands)
|
|
|
2017
|
$
450
|
|
2018
|
201
|
|
2019
|
34
|
|
2020
|
34
|
|
2021
|
9
|
|
Total
|
$
728
|
Rental
expense incurred under operating leases for the years ended
December 31, 2016, 2015 and 2014 was approximately $492,000,
$477,000 and $430,000, respectively.
12. EQUITY
The
Company’s Articles of Incorporation, as amended, authorize
the issuance of two classes of stock to be designated “Common
Stock” and “Preferred Stock”. The Preferred Stock
may be divided into such number of series and with the rights,
preferences, privileges and restrictions as the Board of Directors
may determine.
Series B Convertible Redeemable Preferred Stock
The Company had 239,400 shares of Series B
Convertible Redeemable Preferred Stock (“
Series B
Preferred
”) outstanding
as of December 31, 2016 and 2015. At December 31, 2016 and 2015,
the Company had cumulative undeclared dividends of approximately
$8,000 ($0.03 per share). There were no conversions of Series B
Preferred into Common Stock during the years ended December 31,
2016, 2015 and 2014. The Company paid dividends of approximately
$51,000 to the holders of our Series B Preferred in 2016, 2015 and
2014.
Series E Convertible Redeemable Preferred Stock
On
January 29, 2015, the Company filed the Certificate of Designations
of the Series E Preferred Stock with the Delaware Secretary of
State, designating 12,000 shares of the Company’s preferred
stock, par value $0.01 per share, as Series E Preferred. Shares of
Series E Preferred accrue dividends at a rate of 8% per annum if
the Company chooses to pay accrued dividends in cash, and 10% per
annum if the Company chooses to pay accrued dividends in shares of
Common Stock. Each share of Series E Preferred has a liquidation
preference of $1,000 per share and is convertible, at the option of
the holder, into that number of shares of the Company’s
Common Stock equal to the Liquidation Preference, divided by $1.90.
The Series E Preferred shall be subordinate to and rank junior to
the Company's Series B Preferred and all indebtedness of the
Company. Each holder of the Series E Preferred is entitled to vote
on all matters, together with the holders of Common Stock, on an as
converted basis.
Any time after the six-month period following the
issuance date, the Company may redeem all or a portion of the
Series E Preferred outstanding upon thirty (30) calendar day's
prior written notice (the “
Company's Redemption
Notice
”) in cash at a
price per share of Series E Preferred equal to 110% of the
liquidation preference amount plus all accrued and unpaid
dividends. Also, simultaneous with the occurrence of a
change of control transaction, the Company, at its option, shall
have the right to redeem all or a portion of the outstanding Series
E Preferred in cash at a price per share of Series E Preferred
equal to 110% of the liquidation preference amount plus all accrued
and unpaid dividends.
In
February 2015, the Company consummated a registered direct offering
conducted without an underwriter or placement agent. In connection
therewith, the Company issued 12,000 shares of Series E Preferred
to certain investors at a price of $1,000 per share, with each
share convertible into 526.32 shares of the Company’s Common
Stock at $1.90 per share.
On December 29, 2016, the Company filed Amendment
No. 1 to the Certificate of Designations, Preferences and Rights of
the Series E Convertible Preferred Stock (the
“
Series E
Amendment
”) with the
Delaware Division of Corporations. The Series E Amendment made the
following changes to the Certificate of Designations, Preferences
and Rights of the Series E Convertible Preferred Stock: (i) the
Company may only make dividend payments in cash received from
positive cash flow from operations; (ii) beginning on July 1, 2017,
in the event the Company pays accrued dividend payments in shares
of Common Stock for more than four consecutive quarterly periods,
holders of shares of Series E Preferred will have the right to
immediately appoint two designees to the Company’s Board of
Directors (the “
Director Appointment
Provision
”); (iii)
dividend payments incurred on December 31, 2016 and March 31, 2017
may be paid in shares of Common Stock, without triggering the
Director Appointment Provision; and (iv) the term Permitted
Indebtedness (as defined in the Series E Certificate of
Designations) was revised to cover permitted borrowings of up to
$6.0 million.
The
Company had 12,000 shares of Series E Preferred outstanding as of
December 31, 2016 and 2015, respectively. At December
31, 2016 and 2015, the Company had cumulative undeclared dividends
of approximately $0 and $240,000, respectively. There
were no conversions of Series E Preferred into Common Stock during
the twelve months ended December 31, 2016. For the twelve-month
period ended December 31, 2016, the Company issued the holders of
Series E Preferred 950,362 shares of Common Stock as payment of
dividends due, on a quarterly basis, for the twelve months ended
December 31, 2016. For the twelve months ended December 31, 2015,
the Company paid the holders of our Series E Preferred cash
dividends of $240,000 and issued the holders of our Series E
Preferred 478,664 shares of common stock as payment of quarterly
dividends for the period of January 1, 2015 through September 30,
2015.
Series F Convertible Redeemable Preferred Stock
In September 2016, we filed the Certificate of
Designations, Preferences, and Rights of the Series F Convertible
Preferred Stock (the “
Certificate of
Designations
”) with the
Delaware Division of Corporations, designating 2,000 shares of our
preferred stock as Series F Convertible Redeemable Preferred Stock
(“
Series F
Preferred
”). Shares of
Series F Preferred rank junior to shares of Series B Preferred and
Series E Preferred, as well as our existing indebtedness, and
accrue dividends at a rate of 10% per annum, payable on a quarterly
basis in shares of Common Stock.
Each share of Series F Preferred has a liquidation
preference of $1,000 per share (“
Liquidation
Preferenc
e”), and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Series F
Liquidation Preference, divided by $1.50 (the
“
Series F
Conversion
Shares
”).
Any
time after the six-month period following the issuance date, in the
event the arithmetic average of the closing sales price of the
Company’s Common Stock is or was at least $2.50 for twenty
(20) consecutive trading days, the Company may redeem all or a
portion of the Series F Preferred outstanding upon thirty (30)
calendar days prior written notice in cash at a price per share of
Series F Preferred equal to 110% of the Series F Liquidation
Preference, plus all accrued and unpaid dividends. Also,
simultaneous with the occurrence of a Change of Control transaction
(as defined in the Certificate of Designations), the Company, at
its option, shall have the right to redeem all or a portion of the
outstanding Series F Preferred in cash at a price per share of
Series F Preferred equal to 110% of the Liquidation Preference
Amount plus all accrued and unpaid dividends.
In September 2016, the Company offered and sold
2,000 shares of Series F Preferred for $1,000 per share (the
“
Series F
Financing
”), resulting in
gross proceeds to the Company of $2,000,000 net of issuance costs
of approximately $21,000.
The
Company had 2,000 shares of Series F Preferred outstanding as of
December 31, 2016 and no shares outstanding at December 31,
2015. At December 31, 2016, the Company had cumulative
undeclared dividends of $0. There were no conversions of
Series F Preferred into Common Stock during the year ended December
31, 2016. The Company issued the holders of Series F Preferred
48,513 shares of Common Stock as payment of dividends due, on a
quarterly basis, for the twelve months ended December 31,
2016.
Series
G Convertible Redeemable Preferred Stock
In December 27, 2016, the Company filed the
Certificate of Designations, Preferences, and Rights of the Series
G Convertible Preferred Stock with the Delaware Division of
Corporations, designating 6,120 shares of the Company’s
preferred stock, par value $0.01 per share, as Series G Convertible
Preferred Stock (“
Series G
Preferred
”). Shares of
Series G Preferred rank junior to the Company’s Series B
Preferred, Series E Preferred, Series F Preferred as well as the
Company’s existing indebtedness, and accrue dividends at a
rate of 10% per annum, payable on a quarterly basis in shares of
the Company’s common stock, par value $0.01 per share. Each
share of Series G Preferred has a liquidation preference of $1,000
per share (“
Series G Liquidation
Preferenc
e”), and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Series G
Liquidation Preference, divided by $1.50.
On December 29, 2016, the Company accepted
subscription forms from certain accredited investors to purchase a
total of 1,625 shares of Series G Preferred for $1,000 per share
(the “
Series G
Financing
”), resulting in
gross proceeds to the Company of $1,625,000, net of issuance cost
of approximately $11,000. In addition, the Company also received
executed exchange agreements from the Investors pursuant to which
the Company exchanged an aggregate total of 3,383,830 shares of
common stock held by the Investors for an aggregate total of 4,396
shares of Series G Preferred.
The
Company had 6,021 shares of Series G Preferred outstanding as of
December 31, 2016 and no shares outstanding at December 31,
2015. At December 31, 2016, the Company had cumulative
undeclared dividends of $0. There were no conversions of
Series G Preferred into Common Stock during the year ended December
31, 2016. The Company issued the holders of Series G Preferred
3,770 shares of Common Stock as payment of dividends due, on a
quarterly basis, for the twelve months ended December 31,
2016.
Common Stock
The
following table summarizes outstanding Common Stock activity for
the following periods:
|
|
|
|
|
|
|
Shares
outstanding at December 31, 2013
|
87,548,613
|
|
Shares issued pursuant to warrants exercised for cash
|
4,742,632
|
|
Shares issued pursuant to cashless warrants exercised
|
868,565
|
|
Conversion of related-party notes payable into Common
Stock
|
154,607
|
|
Shares
issued as compensation in lieu of cash
|
94,116
|
|
Shares issued pursuant to option exercises
|
98,617
|
|
Shares
outstanding at December 31, 2014
|
93,507,150
|
|
Shares issued pursuant to payment of stock dividend on Series E
Preferred
|
478,664
|
|
Shares issued pursuant to cashless warrants exercised
|
45,376
|
|
Shares issued pursuant to option exercises
|
39,705
|
|
Shares
outstanding at December 31, 2015
|
94,070,895
|
|
Shares issued pursuant to payment of stock dividend on Series E
Preferred
|
950,362
|
|
Shares issued pursuant to payment of stock dividend on Series F
Preferred
|
48,513
|
|
Shares issued pursuant to payment of stock dividend on
Series G Preferred
|
3,770
|
|
Shares issued pursuant to cashless warrants exercised
|
144,459
|
|
Shares issued pursuant to option exercises
|
12,626
|
|
Exchange of common shares for Series G
Preferred
|
(3,383,830
)
|
|
Shares
outstanding at December 31, 2016
|
91,846,795
|
Warrants
As of December 31, 2016, warrants to purchase
175,000
shares
of Common Stock at prices ranging from $0.80 to $1.10 were
outstanding. All warrants are exercisable as of December 31, 2016
and expire as of September 1, 2017, with the exception of an
aggregate of 150,000 warrants, which become exercisable only upon
the attainment of specified events.
The
following table summarizes warrant activity for the following
periods:
|
|
|
Weighted-
Average
Exercise
Price
|
|
|
|
|
|
Balance
at December 31, 2013
|
6,598,416
|
$
0.63
|
|
Granted
|
302,778
|
$
2.02
|
|
Expired
/ Canceled
|
(55,000
)
|
$
1.10
|
|
Exercised
|
(5,868,416
)
|
$
0.58
|
|
Balance
at December 31, 2014
|
977,778
|
$
1.22
|
|
Granted
|
—
|
$
0.00
|
|
Expired
/ Canceled
|
(419,444
)
|
$
1.86
|
|
Exercised
|
(108,334
)
|
$
1.01
|
|
Balance
at December 31, 2015
|
450,000
|
$
0.67
|
|
Exercised
|
(275,000
)
|
0.55
|
|
Balance
at December 31, 2016
|
175,000
|
0.84
|
During
the year ended December 31, 2015, the Company modified 200,000
warrants previously issued to a consultant by eliminating certain
performance condition requirements resulting in such warrants
vesting pursuant to the passage of time. The Company determined the
modification date fair value of the vested warrants using the
Black-Scholes option valuation model and recorded approximately
$80,000 in expense for the year ended December 31, 2015. The
Company used the following assumptions in the application of the
Black-Scholes option valuation modes: an exercise price of $1.72, a
term of 0.77 years, a risk-free interest rate of 2.58%, a dividend
yield of 0% and volatility of 64%. Such expense is recorded in the
Company’s consolidated statement of operations as a component
of sales and marketing expense. There were no warrant modifications
during the year ended December 31, 2016.
During
the year ended December 31, 2016, there were 275,000 warrants
exercised pursuant to cashless transactions resulting in the
issuance of 144,459 shares of Common Stock. The intrinsic value of
warrants outstanding as of December 31, 2016 was approximately
$85,000.
13. STOCK-BASED COMPENSATION
Stock Options
As of December 31, 2016, the Company had one
active stock-based compensation plan: the 1999 Stock Option Plan
(the “
1999 Plan
”).
1999 Plan
The 1999 Plan was adopted by the Company’s
Board of Directors on December 17, 1999. Under the terms of the
1999 Plan, the Company could, originally, issue up to 350,000
non-qualified or incentive stock options to purchase Common Stock
of the Company. During the year ended December 31, 2014, the
Company subsequently amended and restated the 1999 Plan whereby it
increased the share reserve for issuance to approximately 7.0
million shares of the Company’s Common Stock. The
1999 Plan prohibits the grant of stock option or stock appreciation
right awards with an exercise price less than fair market value of
Common Stock on the date of grant. The 1999 Plan also generally
prohibits the “re-pricing” of stock options or stock
appreciation rights, although awards may be bought-out for a
payment in cash or the Company’s stock. The 1999 Plan permits
the grant of stock based awards other than stock options, including
the grant of “full value” awards such as restricted
stock, stock units and performance shares. The 1999 Plan permits
the qualification of awards under the plan (payable in either stock
or cash) as “performance-based compensation” within the
meaning of Section 162(m) of the Internal Revenue Code. The number
of options issued and outstanding and the number of options
remaining available for future issuance are shown in the table
below. On July 1, 2014, the Company began soliciting written
consents from its shareholders to approve an amendment to the
Company’s 1999 Stock Option Plan to increase the number of
shares authorized for issuance thereunder from approximately 4.0
million to approximately 7.0 million (the
“
Amendment
”). As
of July 21, 2014, the Company had received written consents
approving the Amendment from over 50% of the Company’s
stockholders. As such, the Amendment was approved. The number of
authorized shares available under the plan for issuance at December
31, 2016 was 6,562,781. The number of available shares under the
plan for issuance at December 31, 2016 was
55,938.
A
summary of the activity under the Company’s stock option
plans is as follows:
|
|
|
Weighted-
Average
Exercise
Price
|
Weighted-
Average
Remaining
Contractual
Term (Years)
|
|
Balance
at December 31, 2013
|
3,783,411
|
$
0.94
|
7.4
|
|
Granted
|
435,000
|
$
2.13
|
—
|
|
Expired/Cancelled
|
(62,498
)
|
$
1.96
|
—
|
|
Exercised
|
(98,617
)
|
$
0.68
|
—
|
|
|
|
|
|
|
Balance
at December 31, 2014
|
4,057,296
|
$
1.06
|
6.8
|
|
Granted
|
2,110,000
|
$
1.63
|
—
|
|
Expired/Cancelled
|
(750,622
)
|
$
1.86
|
—
|
|
Exercised
|
(39,705
)
|
$
0.87
|
—
|
|
|
|
|
|
|
Balance
at December 31, 2015
|
5,376,969
|
$
1.17
|
6.9
|
|
Granted
|
1,264,000
|
$
1.34
|
-
|
|
Expired/Cancelled
|
(121,500
)
|
$
1.29
|
-
|
|
Exercised
|
(12,626
)
|
$
0.21
|
-
|
|
Balance
at December 31, 2016
|
6,506,843
|
$
1.21
|
6.6
|
At
December 31, 2016, a total of 6,506,843 options were outstanding of
which 4,366,374 were exercisable at a weighted average price of
$1.08 per share with a remaining weighted average contractual term
of approximately 6.8 years. The Company expects that, in
addition to the 4,366,374 options that were exercisable as of
December 31, 2016, another 2,080,563 will ultimately vest resulting
in a combined total of 6,446,937. Those 6,446,937 shares
have a weighted average exercise price of $1.20 and an aggregate
intrinsic value of approximately $1,740,000 as of December 31,
2016. Stock-based compensation expense related to equity options
was approximately $1,162,000, $744,000 and $618,000 for the years
ended December 31, 2016, 2015 and 2014, respectively.
The weighted-average grant-date fair value per share of options
granted to employees during the years ended December 31, 2016, 2015
and 2014 was $0.82, $1.18 and $1.37, respectively. At December
31, 2016, the total remaining unrecognized compensation cost
related to unvested stock options amounted to approximately
$1,719,849, which will be amortized over the weighted-average
remaining requisite service period of 2.1 years.
During
the year ended December 31, 2016, there were 12,626 options
exercised for cash resulting in the issuance of 12,626 shares of
the Company’s Common Stock and proceeds of approximately
$3,000. During the year ended December 31, 2015, there
were 39,705 options exercised for cash resulting in the issuance of
39,705 shares of the Company’s Common Stock and proceeds of
approximately $34,000.
The
intrinsic value of options exercised during the years ended
December 31, 2016 and 2015 was approximately $11,000 and $35,000,
respectively. The intrinsic value of options exercisable at
December 31, 2016 and 2015 was approximately $1,679,000 and
$1,575,000, respectively. The intrinsic value of options
that vested during 2016 was approximately 34,000. The aggregate
intrinsic value for all options outstanding as of December 31, 2016
and 2015 was approximately $1,744,000 and $1,652,000,
respectively.
In
September 2016, the Company issued an aggregate of 168,000 options
to purchase shares of the Company’s Common Stock to certain
members of the Company’s Board of Directors in return for
their service from January 1, 2017 through December 31, 2017. Such
options will vest at the rate of 14,000 options per month on the
last day of each month during the 2017 year. The options have an
exercise price of $1.37 per share and a term of 10 years. The
Company will begin recognition of compensation based on the
grant-date fair value ratably over the 2017 requisite service
period.
In
September 2015, the Company issued an aggregate of 144,000 options
to purchase shares of the Company’s Common Stock to certain
members of the Company’s Board of Directors in return for
their service from January 1, 2016 through December 31, 2016. Such
options vest at the rate of 12,000 options per month on the last
day of each month during the 2016 year. The options have an
exercise price of $1.73 per share and a term of 10 years. Pursuant
to this issuance, the Company recorded compensation expense of
approximately $178,000 the twelve months ended December 31, 2016
based on the grant-date fair value of the options determined using
the Black-Scholes option-valuation model.
In
May 2016, the Company issued an aggregate of 16,000 options to
purchase shares of the Company’s Common Stock to a new member
of the Company’s Board of Directors in return for their
service from May 2016 through December 31, 2016. Such options vest
at the rate of 2,000 options per month on the last day of each
month during the 2016 year. The options have an exercise price of
$1.29 per share and a term of 10 years. Pursuant to this issuance,
the Company recorded compensation expense of approximately $12,000
for the twelve months ended December 31, 2016 based on the
grant-date fair value of the options determined using the
Black-Scholes option-valuation model.
Restricted Stock Awards
There
were no restricted stock awards issued during the years ended
December 31, 2016 and 2015.
In
December 2014, the Company issued 94,116 shares of its Common Stock
to certain members of the Company’s Board of Directors as
compensation for services to be rendered through December
2015. Such shares vested monthly over the 12 months of
2015 with any unvested shares being forfeitable should the Board
members’ service be terminated during 2015. For the year
ended December 31, 2015, the Company recorded approximately
$216,000 as compensation expense related to this stock
issuance.
In
December 2013, the Company issued 144,000 shares of its Common
Stock to certain members of the Company's Board of Directors as
compensation for services to be rendered through December 2014.
Such shares are forfeitable should the Board members' service be
terminated. For the year ended December 31, 2014, the Company
recorded approximately $238,000 as compensation
expense.
Stock-based Compensation
Stock-based
compensation related to equity options and restricted stock has
been classified as follows in the accompanying consolidated
statements of operations (in thousands):
|
|
|
|
|
|
|
|
|
Cost
of revenues
|
$
20
|
$
15
|
$
12
|
|
General
and administrative
|
714
|
618
|
572
|
|
Sales
and marketing
|
224
|
171
|
142
|
|
Research
and development
|
204
|
156
|
130
|
|
|
|
|
|
|
Total
|
$
1,162
|
$
960
|
$
856
|
Common Stock Reserved for Future Issuance
The
following table summarizes the Common Stock reserved for future
issuance as of December 31, 2016:
|
|
|
|
|
|
|
Convertible
preferred stock – Series B, Series E, Series F and Series
G
|
11,709,151
|
|
Convertible
lines of credit
|
2,201,903
|
|
Stock
options outstanding
|
6,506,843
|
|
Warrants
outstanding
|
175,000
|
|
Authorized
for future grant under stock option plans
|
55,938
|
|
|
20,648,835
|
14. EMPLOYEE BENEFIT PLAN
During 1995, the Company adopted a defined
contribution 401(k) retirement plan (the “
Plan
”). All U.S. based employees aged 21 years
and older are eligible to become participants after the completion
of 60 day's employment. The Plan provides for annual contributions
by the Company of 50% of employee contributions not to exceed 8% of
employee compensation. Effective April 1, 2009, the Plan
was amended to provide for Company contributions on a discretionary
basis. Participants may contribute up to 100% of the annual
contribution limitations determined by the Internal Revenue
Service.
Employees
are fully vested in their share of the Company’s
contributions after the completion of five years of
service. In 2014, the Company authorized contributions of
approximately $118,000 for the 2014 plan year of which $88,000 were
paid prior to December 31, 2014. In 2015, the Company
authorized contributions of approximately $119,000 for the 2015
plan year of which $83,000 were paid prior to December 31, 2015. In
2016, the Company authorized contributions of approximately
$150,000 for the 2016 plan year of which $111,000 were paid prior
to December 31, 2016.
15. PENSION PLAN
One
of the Company’s dormant foreign subsidiaries maintains a
defined benefit pension plan that provides benefits based on length
of service and final average earnings. The following table sets
forth the benefit obligation, fair value of plan assets, and the
funded status of the Company’s plan; amounts recognized in
the Company’s consolidated financial statements; and the
assumptions used in determining the actuarial present value of the
benefit obligations as of December 31:
|
($ in thousands)
|
|
|
|
|
Change in benefit obligation:
|
|
|
|
|
Benefit
obligation at beginning of year
|
$
3,068
|
$
3,488
|
$
2,821
|
|
Service
cost
|
—
|
—
|
—
|
|
Interest
cost
|
75
|
70
|
106
|
|
Actuarial
(gain) loss
|
542
|
(123
)
|
1,003
|
|
Effect
of exchange rate changes
|
(114
)
|
(356
)
|
(442
)
|
|
Effect
of curtailment
|
—
|
—
|
—
|
|
Benefits
paid
|
(31
)
|
(11
)
|
—
|
|
Benefit
obligation at end of year
|
3,540
|
3,068
|
3,488
|
|
|
|
|
|
|
Change
in plan assets:
|
|
|
|
|
Fair
value of plan assets at beginning of year
|
1,557
|
1,654
|
1,790
|
|
Actual
return of plan assets
|
142
|
40
|
47
|
|
Company
contributions
|
28
|
34
|
43
|
|
Benefits
paid
|
(31
)
|
—
|
—
|
|
Effect
of exchange rate changes
|
(51
)
|
(171
)
|
(226
)
|
|
Fair
value of plan assets at end of year
|
1,645
|
1,557
|
1,654
|
|
Funded
status
|
(1,895
)
|
(1,511
)
|
(1,834
)
|
|
Unrecognized
actuarial loss (gain)
|
1,831
|
1,413
|
1,911
|
|
Unrecognized
prior service (benefit) cost
|
—
|
—
|
—
|
|
Additional
minimum liability
|
(1,831
)
|
(1,413
)
|
(1,911
)
|
|
Unrecognized
transition (asset) liability
|
—
|
—
|
—
|
|
Net
amount recognized
|
$
(1,895
)
|
$
(1,511
)
|
$
(1,834
)
|
|
|
|
|
|
|
Plan
Assets
|
|
|
|
|
Pension
plan assets were comprised of the following asset categories at
December 31,
|
|
|
|
|
Equity
securities
|
5.7
%
|
5.0
%
|
6.4
%
|
|
Debt
securities
|
87.2
%
|
89.3
%
|
87.4
%
|
|
Other
|
7.1
%
|
5.7
%
|
6.2
%
|
|
Total
|
100
%
|
100
%
|
100
%
|
|
|
|
|
|
|
Components
of net periodic benefit cost are as follows:
|
|
|
|
|
Service
cost
|
$
—
|
$
—
|
$
—
|
|
Interest
cost on projected benefit obligations
|
75
|
70
|
106
|
|
Expected
return on plan assets
|
—
|
—
|
—
|
|
Amortization
of prior service costs
|
—
|
—
|
—
|
|
Amortization
of actuarial loss
|
—
|
—
|
—
|
|
Net
periodic benefit costs
|
$
75
|
$
70
|
$
106
|
|
|
|
|
|
|
The
weighted average assumptions used to determine net periodic benefit
cost for the years ended December 31, were
|
|
|
|
|
Discount
rate
|
1.7
%
|
2.4
%
|
2.2
%
|
|
Expected
return on plan assets
|
4.0
%
|
4.0
%
|
4.0
%
|
|
Rate
of pension increases
|
2.0
%
|
2.0
%
|
2.0
%
|
|
Rate
of compensation increase
|
N/A
|
N/A
|
N/A
|
|
|
|
|
|
|
The
following discloses information about the Company’s defined
benefit pension plan that had an accumulated benefit obligation in
excess of plan assets as of December 31,
|
|
|
|
|
Projected
benefit obligation
|
$
3,540
|
$
3,068
|
$
3,488
|
|
Accumulated
benefit obligation
|
$
3,540
|
$
3,068
|
$
3,488
|
|
Fair
value of plan assets
|
$
1,645
|
$
1,557
|
$
1,654
|
As
of December 31, 2016, the following benefit payments are expected
to be paid as follows (in thousands):
|
2017
|
$
76
|
|
2018
|
$
78
|
|
2019
|
$
80
|
|
2020
|
$
81
|
|
2021
|
$
97
|
|
2022
— 2026
|
$
624
|
The
Company made contributions to the plan of approximately $28,000
during year 2016, $34,000 during year 2015 and approximately
$43,000 during 2014.
The
investment objectives for the plan are the preservation of capital,
current income and long-term growth of capital. The Company’s
pension assets are classified within Level 1 of the fair value
hierarchy, as defined under ASC 820, because they are valued using
market prices. The pension assets are primarily comprised of the
cash surrender value of insurance contracts. All plan assets are
managed in a policyholder pool in Germany by outside investment
managers. The measurement date used to determine the benefit
information of the plan was January 1, 2017.
16. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive income is the
combination of the additional minimum liability related to the
Company’s defined benefit pension plan, recognized pursuant
to ASC 715-30, “
Compensation - Retirement
Benefits - Defined Benefit Plans – Pension
” and the accumulated gains or losses from
foreign currency translation adjustments. The Company translates
foreign currencies of its German, Canadian and Mexican subsidiaries
into U.S. dollars using the period end exchange rate. Revenue and
expenses were translated using the weighted-average exchange rates
for the reporting period. All items are shown net of
tax.
As
of December 31, 2016, 2015 and 2014, the components of accumulated
other comprehensive loss were as follows:
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
Additional
minimum pension liability
|
$
(1,338
)
|
$
(991
)
|
$
(1,323
)
|
|
Foreign
currency translation adjustment
|
(205
)
|
(204
)
|
(271
)
|
|
Ending
balance
|
$
(1,543
)
|
$
(1,195
)
|
$
(1,594
)
|
17. QUARTERLY INFORMATION (UNAUDITED)
The
following table sets forth selected quarterly financial data for
2016, 2015 and 2014 (in thousands, except share and per share
data):
|
|
|
|
|
1
|
2
|
3
|
4
|
|
|
|
|
|
|
|
Revenues
|
$
1,043
|
$
996
|
$
848
|
$
925
|
|
Cost
of Sales
|
279
|
275
|
232
|
284
|
|
Operating
expenses
|
3,028
|
2,995
|
2,955
|
3,226
|
|
Loss
from Operations
|
(2,264
)
|
(2,274
)
|
(2,339
)
|
(2,585
)
|
|
Interest
expense (income), net
|
11
|
36
|
89
|
109
|
|
Other
expense (income), net
|
(1
)
|
(200
)
|
-
|
-
|
|
Income
tax expense (benefit)
|
3
|
4
|
3
|
11
|
|
Net
loss
|
$
(2,277
)
|
$
(2,114
)
|
$
(2,431
)
|
$
(2,705
)
|
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
|
Net
loss
|
$
(0.03
)
|
$
(0.02
)
|
$
(0.03
)
|
$
(0.03
)
|
|
Preferred
dividends
|
$
(0.00
)
|
$
(0.01
)
|
$
(0.00
)
|
$
(0.00
)
|
|
Basic
loss per share to common shareholders
|
$
(0.03
)
|
$
(0.03
)
|
$
(0.03
)
|
$
(0.03
)
|
|
Basic
weighted-average shares outstanding
|
94,073,367
|
94,298,567
|
94,550,721
|
94,779,243
|
|
|
|
|
|
1
|
2
|
3
|
4
|
|
|
|
|
|
|
|
Revenues
|
$
991
|
$
1,695
|
$
1,181
|
$
902
|
|
Cost
of Sales
|
286
|
798
|
321
|
539
|
|
Operating
expenses
|
2,641
|
2,660
|
2,813
|
2,921
|
|
Loss
from Operations
|
(1,936
)
|
(1,763
)
|
(1,953
)
|
(2,558
)
|
|
Interest
expense (income), net
|
437
|
(2
)
|
1
|
11
|
|
Other
expense (income), net
|
(46
)
|
—
|
(99
)
|
—
|
|
Income
tax expense (benefit)
|
3
|
6
|
3
|
10
|
|
Net
loss
|
$
(2,330
)
|
$
(1,767
)
|
$
(1,858
)
|
$
(2,579
)
|
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
|
Net
loss
|
$
(0.03
)
|
$
(0.02
)
|
$
(0.02
)
|
$
(0.03
)
|
|
Preferred
dividends
|
$
(0.00
)
|
$
(0.00
)
|
$
(0.00
)
|
$
(0.00
)
|
|
Basic
loss per share to common shareholders
|
$
(0.03
)
|
$
(0.02
)
|
$
(0.02
)
|
$
(0.03
)
|
|
Basic
weighted-average shares outstanding
|
93,515,640
|
93,674,349
|
93,876,339
|
94,070,895
|
|
|
|
|
|
1
|
2
|
3
|
4
|
|
|
|
|
|
|
|
Revenues
|
$
1,063
|
$
937
|
$
919
|
$
1,240
|
|
Cost
of Sales
|
251
|
232
|
248
|
261
|
|
Operating
expenses
|
2,706
|
2,667
|
2,793
|
2,797
|
|
Loss
from Operations
|
(1,894
)
|
(1,962
)
|
(2,122
)
|
(1,818
)
|
|
Interest
expense (income), net
|
79
|
105
|
104
|
128
|
|
Other
expense (income), net
|
(283
)
|
(5
)
|
(1
)
|
(8
)
|
|
Income
tax expense (benefit)
|
—
|
12
|
3
|
10
|
|
Net
loss
|
$
(1,690
)
|
$
(2,074
)
|
$
(2,228
)
|
$
(1,948
)
|
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
|
Net
loss
|
$
(0.02
)
|
$
(0.02
)
|
$
(0.02
)
|
$
(0.02
)
|
|
Preferred
dividends
|
$
(0.00
)
|
$
(0.00
)
|
$
(0.00
)
|
$
(0.00
)
|
|
Basic
loss per share to common shareholders
|
$
(0.02
)
|
$
(0.02
)
|
$
(0.02
)
|
$
(0.02
)
|
|
Basic
weighted-average shares outstanding
|
88,604,221
|
91,930,400
|
93,162,548
|
93,384,834
|
18. SUBSEQUENT
EVENTS
Subsequent
to December 31, 2016, the Company has borrowed an additional
$1,500,000 through March 30, 2017 under the Lines of
Credit.