N
OTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. ORGANIZATION AND DESCRIPTION OF
BUSINESS
Overview
As
used in this Quarterly 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 A Convertible Preferred Stock
On September 15, 2017, the Company filed the
Certificate of Designations, Preferences, and Rights of the Series
A Convertible Preferred Stock with the Delaware Division of
Corporations, designating 31,021 shares of the Company’s
preferred stock, par value $0.01 per share, as Series A Convertible
Preferred Stock (“
Series A
Preferred
”). See Note
6,
Equity
, below, for a description of the Series A
Preferred.
Series A Financing and Preferred Stock Exchange
On September 18, 2017, the Company offered and
sold a total of 11,000 shares of Series A Preferred at a purchase
price of $1,000 per share (the “
Series A
Financing
”), which amount
includes an aggregate total of 875 shares of Series A Preferred
issuable to Neal Goldman, a member of the Board, and S. James
Miller, the Company’s Chief Executive Officer and member of
the Board, in connection with cash advances of $875,000 previously
made to the Company. The net proceeds to the Company from the
Series A Financing were approximately $10.9 million. Concurrently
with the Series A Financing, the Company entered into Exchange
Agreements with holders of all outstanding shares of the
Company’s Series E Convertible Preferred Stock, all
outstanding shares of Series F Convertible Preferred Stock, and all
outstanding shares of Series G Convertible Preferred Stock
(collectively, “
Exchanged
Preferred
”), pursuant to
which the holders thereof agreed to cancel their Exchanged
Preferred in exchange for the same number of shares of Series A
Preferred (the “
Preferred Stock
Exchange
”). As a result
of the Preferred Stock Exchange, the Company issued to the holders
of Exchanged Preferred an aggregate total of 20,021 shares of
Series A Preferred.
The Company evaluated the Preferred Stock Exchange
and determined that the Exchange Preferred Stock was both an
induced conversion and an extinguishment transaction. Using the
guidance in ASC 260-10-S99-2,
Earnings Per Share – SEC
Materials – SEC Staff Announcement: The Effect on the
Calculations of Earnings Per Share for a Period That Includes the
Redemption or Induced Conversion of Preferred Stock and
ASC 470-50,
Debt – Modifications and
Extinguishments,
the Company
recorded the fair value differential of the Exchanged Preferred as
adjustments within Shareholders’ Deficit and in the
computation of Net Loss Available to Common Shareholders in the
computation of basic and diluted loss per share. The Company
utilized the services an independent third-party valuation firm to
perform the computation of the fair value of the Exchanged
Preferred. Based on the fair value using these methodologies, the
Company recorded approximately $1,245,000 in fair value
differential as adjustments within Shareholders’ Deficit in
the Company’s Condensed Consolidated Balance Sheet for the
period ended September 30, 2017 and in the computation of basic and
diluted loss per share in the Company’s Condensed
Consolidated Statement of Operations for the three and nine months
ended September 30, 2017.
As
a result of the Preferred Stock Exchange, on October 19, 2017, the
Company filed Certificates of Elimination with the Delaware
Secretary of State to eliminate the Exchanged
Preferred.
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
below). 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.
Going Concern
At
September 30, 2017, we had positive working capital of
approximately $7,326,000. Our principal sources of liquidity at
September 30, 2017 consisted of approximately $9,866,000 of cash
and $217,000 of trade accounts receivable.
Considering our projected cash requirements, and assuming we are
unable to generate incremental revenue, our available cash may be
insufficient to satisfy our cash requirements for the next twelve
months from the date of this filing. These factors raise
substantial doubt about our ability to continue as a going concern.
To address our working capital requirements, management may seek
additional equity and/or debt financing through the issuance of
additional debt and/or equity securities, or may seek strategic or
other transactions intended to increase shareholder value. 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 other agreements, and
no assurances can be given that we will be successful in raising
additional debt and/or equity securities, or entering into any
other transaction that addresses our ability to continue as a going
concern.
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.
These
condensed 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.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF
PRESENTATION
Basis of Presentation
The accompanying
condensed consolidated balance sheet as of December 31, 2016, which
has been derived from audited financial statements, and the
unaudited interim condensed consolidated financial statements have
been prepared by the Company in accordance with accounting
principles generally accepted in the United States of America
(“
GAAP
”)
and the rules and regulations of the Securities and Exchange
Commission (“
SEC
”)
related to a quarterly report on Form 10-Q. Certain information and
note disclosures normally included in annual financial statements
prepared in accordance with GAAP have been condensed or omitted
pursuant to those rules and regulations, although the Company
believes that the disclosures made are adequate to make the
information not misleading. The interim financial statements
reflect all adjustments, which, in the opinion of management, are
necessary for a fair statement of the results for the periods
presented. All such adjustments are of a normal and recurring
nature. These unaudited condensed consolidated financial statements
should be read in conjunction with the Company’s audited
financial statements for the year ended December 31, 2016, which
are included in the Company’s Annual Report on Form 10-K for
the year ended December 31, 2016 that was filed with the SEC on
March 30, 2017.
Operating
results for the three and nine months ended September 30, 2017 are
not necessarily indicative of the results that may be expected for
the year ended December 31, 2017, or any other future
periods.
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.
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 evaluation of our ability to continue as a going concern, 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, fair value of Exchanged Preferred, 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 4, “
Inventory
,” below.
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
|
●
|
Post-contract customer support (“
PCS
”)
|
The Company’s revenue recognition policies
are consistent with 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
, SEC 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: (i) persuasive evidence that an
arrangement exists, (ii) delivery has occurred or services have
been rendered, (iii) the fee is fixed or determinable and (iv)
collectability is reasonably assured.
The Company recognizes revenue and profit as work
progresses on long-term, fixed-price contracts involving
significant amounts of hardware and software customization using
the percentage of completion method based on costs incurred to
date, compared to total estimated costs upon completion. The
primary components of costs incurred are third party software and
direct labor cost including fringe benefits. Revenue
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 revenue 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 and when all other significant
obligations have been fulfilled. 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.
Amounts collected in advance for maintenance services are included
in current liabilities under "Deferred revenue". Sales
tax collected from customers is excluded from
revenue.
Customer Concentration
For
the three months ended September 30, 2017, two customers
accounted for approximately 31% or $338,000 of our total revenue
and had trade receivables at September 30, 2017 of $0. For the nine
months ended September 30, 2017, one customer accounted for
approximately 24% or $742,000 of our total revenue and had trade
receivables at September 30, 2017 of $0.
For
the three months ended September 30, 2016, one customer
accounted for approximately 22% or $185,000 of our total revenue
and had trade receivables at September 30, 2016 of $0. For the nine
months ended September 30, 2016, two customers accounted for
approximately 31% or $903,000 of our total revenue and had trade
receivables at September 30, 2016 of $53,000.
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. We have begun to evaluate the effect
the new revenue standard will have on our consolidated financial
statements and related disclosures, but have not completed our
evaluation and implementation process. We intend to complete that
process during the fourth quarter of 2017 and adopt the new
standard on January 1, 2018 using the cumulative effect transition
method during the first fiscal quarter in 2018. Once we adopt ASU
2014-09, we do not anticipate that our internal control framework
will materially change, but rather that existing internal controls
will be modified and augmented, as necessary, to consider our new
revenue recognition policy effective January 1, 2018. As we
implement the new standard, we are developing internal controls to
ensure that we adequately evaluate or portfolio of contracts under
the five-step model.
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 third fiscal quarter of
2018.
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.
2016-10
. 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.
FASB ASU No.
2017-09.
In May 2017,
the FASB issued ASU
No. 2017-09, “
Scope
of Modification Accounting
”, to reduce
diversity in practice and provide clarity regarding existing
guidance in ASC 718, “
Stock
Compensation
”. The amendments
in this updated guidance clarify that an entity should apply
modification accounting in response to a change in the terms and
conditions of an entity’s share-based payment awards unless
three newly specified criteria are met. This guidance is effective
for fiscal years beginning after December 15, 2017, including
interim periods within that reporting
period. Early adoption is permitted. The Company is
currently evaluating the potential impact of this updated guidance
on its consolidated financial statements.
FASB ASU No. 2017-11.
In July 2017, the FASB issued ASU No
2017-11, “
Earnings Per Share (Topic
260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for
Certain Financial Instruments with Down Round Features, (Part II)
Replacement of the Indefinite Deferral”
. The ASU applies to issuers of financial
instruments with down-round features. It amends (1) the
classification of such instruments as liabilities or equity by
revising the guidance in ASC 815 on the evaluation of whether
instruments or embedded features with down-round provisions must be
accounted for as derivative instruments and (2) the guidance on
recognition and measurement of the value transferred upon the
trigger of a down-round feature for equity-classified instruments
by revising ASC 260. The ASU is effective for public business
entities for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2018. For all other
organizations, the amendments are effective for fiscal years
beginning after December 15, 2019, and interim periods within
fiscal years beginning after December 15, 2020. Early adoption is
permitted.
The Company is
currently evaluating the potential impact of this updated guidance
on its consolidated financial statements.
NOTE 3. NET LOSS PER COMMON 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 related party lines of credit, 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 common shareholders
is adjusted to add back any preferred stock dividends and any
interest on convertible debt reflected in the condensed
consolidated statement of operations for the respective
periods.
For the three and nine month periods ended
September 30, 2017, net loss available to common shareholders
includes an adjustment for the Preferred Stock Exchange. Pursuant
to the guidance in ASC 260-10-S99-2,
Earnings Per Share – SEC
Materials – SEC Staff Announcement: The Effect on the
Calculations of Earnings Per Share for a Period That Includes the
Redemption or Induced Conversion of Preferred Stock,
the Company recorded approximately
$1,245,000 in fair value differential as adjustments in the
computation of basic and diluted loss per share in the
Company’s Condensed Consolidated Statement of Operations for
the three and nine months ended September 30,
2017.
The
table below presents the computation of basic and diluted loss per
share:
(Amounts in thousands except share and per share
amounts)
|
Three Months Ended
September 30,
|
Nine months Ended
September 30,
|
|
|
|
|
|
Numerator
for basic and diluted loss per share:
|
|
|
|
|
Net
loss
|
$
(2,390
)
|
$
(2,431
)
|
$
(7,668
)
|
$
(6,822
)
|
Preferred
dividends
|
(553
)
|
(317
)
|
(1,575
)
|
(986
)
|
Preferred
stock exchange
|
(1,245
)
|
—
|
(1,245
)
|
—
|
|
|
|
|
|
Net
loss available to common shareholders
|
$
(4,188
)
|
$
(2,748
)
|
$
(10,488
)
|
$
(7,808
)
|
|
|
|
|
|
Denominator
for basic and dilutive loss per share – weighted-average
shares outstanding
|
93,197,689
|
94,550,721
|
92,538,582
|
94,309,309
|
|
|
|
|
|
Net
loss
|
$
(0.03
)
|
$
(0.03
)
|
$
(0.08
)
|
$
(0.07
)
|
Preferred
dividends
|
(0.00
)
|
(0.00
)
|
(0.02
)
|
(0.01
)
|
Preferred
stock exchange
|
(0.01
)
|
—
|
(0.01
)
|
—
|
|
|
|
|
|
Basic
and diluted loss per share available to common
shareholders
|
$
(0.04
)
|
$
(0.03
)
|
$
(0.11
)
|
$
(0.08
)
|
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
|
Three and Nine Months Ended
September 30,
|
|
|
|
|
|
|
Related
party lines of credit
|
5,118,066
|
1,759,888
|
Convertible
preferred stock
|
27,021,784
|
7,696,123
|
Stock
options
|
6,116,318
|
6,529,510
|
Warrants
|
150,000
|
425,000
|
Total
potential dilutive securities
|
38,406,168
|
16,410,521
|
NOTE 4. SELECT BALANCE SHEET DETAILS
Inventory
Inventories of $100,000 as of September 30, 2017 were comprised of
work in process of $70,000 representing direct labor costs on
in-process projects and finished goods of $30,000 net of reserves
for obsolete and slow-moving items of $3,000.
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.
Intangible Assets
The
carrying amounts of the Company’s patent intangible assets
were $97,000 and $106,000 as of September 30, 2017 and December 31,
2016, respectively, which includes accumulated amortization of
$563,000 and $554,000 as of September 30, 2017 and December 31,
2016, respectively. Amortization expense for patent
intangible assets was $3,000 and $9,000 for the three and nine
months ended September 30, 2017 and 2016, respectively. Patent
intangible assets are being amortized on a straight-line basis over
their remaining life of approximately 8.75 years.
The
estimated acquired intangible amortization expense for the next
five fiscal years is as follows:
Fiscal Year Ended December 31,
|
Estimated Amortization
Expense
($ in
thousands)
|
2017
(three months)
|
$
3
|
2018
|
12
|
2019
|
12
|
2020
|
12
|
2021
|
12
|
Thereafter
|
46
|
Totals
|
$
97
|
Goodwill
The
Company annually, or more frequently if events or circumstances
indicate a need, tests the carrying amount of goodwill for
impairment. 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 as of September 30, 2017 and December 31,
2016.
NOTE 5. LINES OF CREDIT WITH RELATED
PARTIES
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 $6,000 and $2,650 at September 30, 2017 and December 31,
2016, respectively. Discount on advances under lines of credit is
$271 at September 30, 2017 and $122 at December 31, 2016. Maturity
date is December 31, 2018.
|
$
5,729
|
$
2,528
|
|
|
|
Total
lines of credit to related parties
|
5,729
|
2,528
|
Less
current portion
|
(—
)
|
(2,528
)
|
Long-term
lines of credit to related parties
|
$
5,729
|
$
—
|
Lines of Credit
In March 2013, the Company and Neal Goldman, a
member of the Company’s Board of Directors
(“
Goldman
”), entered into a line of credit (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, Goldman 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 Goldman, 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 Goldman 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 three and nine months ended September 30, 2017, the Company
recorded an aggregate of approximately $3,000 and $9,000,
respectively in deferred financing fee amortization expense. During
the three and nine months ended September 30, 2016, the Company
recorded an aggregate of approximately $9,000 and 33,000,
respectively in deferred financing fee amortization expense. Such
expense is recorded as a component of interest expense in the
Company’s condensed consolidated statements of
operations.
In April 2014, the Company and Goldman 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 Charles Crocker, a member of the
Company’s Board of Directors (“
Crocker
”), 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,
Goldman assigned and transferred to Crocker one-half of the
Amendment Warrant.
In December 2014, the Company and Goldman 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, Goldman 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 Goldman 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 Crocker LOC was terminated in
accordance with its terms.
In March 2016, the Company and Goldman 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 (the
“
New
Crocker LOC
”) with
available borrowings of up to $500,000 with Crocker, which replaced
the original Crocker LOC that terminated as a result of the
consummation of the Series E Financing. Similar to the
Fourth Amendment, the New Crocker LOC with Crocker originally
matured on June 30, 2017, and provides for the conversion of
the outstanding balance due under the terms of the New Crocker LOC
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 Crocker amended
the New Crocker LOC to extend the maturity date thereof to December
31, 2017. No other amendments were made to the New Crocker
LOC.
On May 10, 2017, Goldman and Crocker agreed to further extend the
maturity dates of Lines of Credit to December 31,
2018.
As the aforementioned amendments to the Lines of Credit resulted in
an increase to the borrowing capacity of the Lines of Credit, the
Company adjusted the amortization period of any remaining
unamortized deferred costs and note discounts to the term of the
new arrangement.
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. The Company incurred borrowings of $3,350,000
during the nine months ended September 30, 2017, and incurred
borrowings of $2,650,000 during the year ended December 31, 2016.
As a result of these borrowings under the Lines of Credit, the
Company recorded approximately $292,000 in debt discount
attributable to beneficial conversion feature during the nine
months ended September 30, 2017, and recorded approximately
$220,000 in debt discount attributable to the beneficial conversion
feature during the year ended December 31, 2016.
During the
three and nine months ended September 30, 2017, the Company
accreted approximately $53,000 and $143,000, respectively, of debt
discount. During the three and nine months ended September 30,
2016, the Company accreted approximately $39,000 and $52,000 of the
note discount.
Such expense is
recorded as a component of interest expense in the Company’s
condensed consolidated statements of
operations.
NOTE 6. 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 A Convertible Preferred Stock
On
September 15, 2017, the Company filed the Certificate of
Designations of the Series A Preferred with the Delaware Secretary
of State, designating 31,021 shares of the Company’s
preferred stock, par value $0.01 per share, as Series A Preferred.
Shares of Series A 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 A 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 $1.15. Each holder of the Series A Preferred is entitled
to vote on all matters, together with the holders of Common Stock,
on an as converted basis.
Holders of Series A Preferred may elect to convert
shares of Series A Preferred into Conversion Shares at any time. In
the event the volume-weighted average price
(“
VWAP
”) of the Company’s Common Stock is at
least $2.15 per share for at least 20 consecutive trading days, the
Company may elect to convert one-half of the shares of Series A
Preferred issued and outstanding, on a pro-rata basis, into
Conversion Shares, or, if the VWAP of the Company’s Common
Stock is at least $2.15 for 80 consecutive trading days, the
Company may convert all issued and outstanding shares of Series A
Preferred into Conversion Shares. In addition, in the event of a
Change of Control, the Company will have the option to redeem all
issued and outstanding shares of Series A Preferred for 115% of the
Liquidation Preference per share.
On
September 18, 2017, the Company offered and sold a total of 11,000
shares of Series A Preferred at a purchase price of $1,000 per
share. The total net proceeds to the Company from the Series A
Financing were approximately $10.9 million.
Concurrently with the Series A Financing, the Company entered into
Exchange Agreements with holders of all outstanding shares of the
Company's Series E Convertible Preferred Stock, all outstanding
shares of the Company's Series F Convertible Preferred Stock and
all outstanding shares of the Company's Series G Convertible
Preferred Stock (collectively "Exchanged Preferred") pursuant to
which the holders thereof agreed to cancel their respective shares
of Exchanged Preferred in exchange for shares of Series A
Preferred. As a result of the Preferred Stock Exchange, the Company
issued to the holders of the Exchanged Preferred an aggregate total
of 20,021 shares of Series A Preferred.
The Company evaluated the Preferred Stock Exchange
and determined that the Preferred Stock Exchange was both an
induced conversion and an extinguishment transaction. Using the
guidance in ASC 260-10-S99-2,
Earnings Per Share – SEC
Materials – SEC Staff Announcement: The Effect on the
Calculations of Earnings Per Share for a Period That Includes the
Redemption or Induced Conversion of Preferred Stock and
ASC 470-50,
Debt – Modifications and
Extinguishments,
the Company
recorded the fair value differential of the Exchanged Preferred as
adjustments within Shareholders’ Deficit and in the
computation of Net Loss Available to Common Shareholders in the
computation of basic and diluted loss per share. The Company
utilized the services an independent third-party valuation firm to
perform the computation of the fair value of the Exchanged
Preferred. Based on the fair value using these methodologies, the
Company recorded approximately $1,245,000 in fair value
differential as adjustments within Shareholders’ Deficit in
the Company’s Condensed Consolidated Balance Sheet for the
period ended September 30, 2017 and in the computation of basic and
diluted loss per share in the Company’s Condensed
Consolidated Statement of Operations for the three and nine months
ended September 30, 2017.
The Company had 31,021 shares and 0 shares of
Series A Preferred outstanding as of September 30, 2017 and
December 31, 2016, respectively. At September 30, 2017,
the Company had cumulative undeclared dividends of
$0. There were no conversions of Series A Preferred into
Common Stock during the nine months ended September 30,
2017.
The Company issued the
holders of Series A Preferred 74,036 shares of Common Stock on
September 30, 2017 as payment of dividends due on that
date.
Series B Convertible Preferred Stock
The Company had 239,400 shares of Series B
Convertible Preferred Stock (“
Series B
Preferred
”) outstanding
as of September 30, 2017 and December 31, 2016. At September 30,
2017 and December 31, 2016, the Company had cumulative undeclared
dividends of approximately $21,000. There were no conversions of
Series B Preferred into Common Stock during the nine months ended
September 30, 2017 and 2016.
Series E Convertible 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 A Preferred, 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, in the event the arithmetic average of the closing
sales price of the Company’s Common Stock is or was at least
$2.85 for twenty (20) consecutive trading days, 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 0 shares of Series E Preferred
outstanding as of September 30, 2017 as a result of the Preferred
Stock Exchange, and 12,000 shares of Series E Preferred at December
31, 2016. At September 30, 2017 and December 31, 2016,
the Company had cumulative undeclared dividends of
$0. There were no conversions of Series E Preferred into
Common Stock during the nine months ended September 30, 2017 and
2016.
The Company issued the
holders of Series E Preferred 237,685 shares of Common Stock on
September 30, 2017 as payment of dividends due on that
date.
For the nine months
ended September 30, 2017, the Company has issued the holders of
Series E Preferred 822,122 shares of Common Stock as payment of
dividends due. With the payment of the quarterly dividends due
September 30, 2017 to the holders of Series E Preferred in shares
of Common Stock, the Director Appointment Provision became
effective as of that date resulting in the Company adding two Board
members as of September 15, 2017.
Series F Convertible 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 Preferred Stock
(“
Series F
Preferred
”). Shares of
Series F Preferred rank junior to shares of Series A Preferred,
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 0 shares of Series F Preferred
outstanding as of
September 30, 2017 as a
result of the Preferred Stock Exchange, and 2,000 shares of Series
F Preferred at December 31, 2016
. At September 30, 2017 and December
31, 2016, the Company had cumulative undeclared dividends of $0.
There were no conversions of Series F Preferred into Common Stock
during the nine months ended September 30, 2017 and 2016. The
Company issued the holders of Series F Preferred 39,139 shares of
Common Stock on September 30, 2017 as payment of dividends due on
that date. For the nine months ended September 30, 2017, the
Company has issued the holders of Series F Preferred 135,855 shares
of Common Stock as payment of dividends due.
Series G Convertible 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 A
Preferred, 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.
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 G Preferred outstanding upon thirty (30)
calendar days prior written notice in cash at a price per share of
Series G Preferred equal to 110% of the Series G 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 G Preferred in cash at a price per share of
Series G Preferred equal to 110% of the Liquidation Preference
Amount plus all accrued and unpaid dividends.
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 0 shares of Series G Preferred outstanding as of
September 30, 2017 as a result of the Preferred Stock Exchange, and
6,021 shares of Series G Preferred at December 31,
2016. At September 30, 2017 and December 31, 2016, the
Company had cumulative undeclared dividends of $0. There
were no conversions of Series G Preferred into Common Stock during
the nine months ended September 30, 2017 and 2016. The Company
issued the holders of Series G Preferred 117,832 shares of Common
Stock on September 30, 2017 as payment of dividends due on that
date. For the nine months ended September 30, 2017, the Company has
issued the holders of Series G Preferred 409,002 shares of Common
Stock as payment of dividends due.
Common Stock
The
following table summarizes Common Stock activity for the nine
months ended September 30, 2017:
|
|
Shares
outstanding at December 31, 2016
|
91,846,795
|
Shares
issued as payment of stock dividend on Series A
Preferred
|
74,036
|
Shares
issued as payment of stock dividend on Series E
Preferred
|
822,122
|
Shares
issued as payment of stock dividend on Series F
Preferred
|
135,855
|
Shares
issued as payment of stock dividend on Series G
Preferred
|
409,002
|
Shares
issued pursuant to option exercises
|
322,000
|
Shares
outstanding at September 30, 2017
|
93,609,810
|
Warrants
The
following table summarizes warrant activity for the following
periods:
|
|
Weighted- Average
Exercise Price
|
Balance
at December 31, 2016
|
175,000
|
$
0.84
|
Granted
|
—
|
—
|
Expired/Canceled
|
(25,000
)
|
1.10
|
Exercised
|
—
|
—
|
Balance
at September 30, 2017
|
150,000
|
$
0.80
|
As
of September 30, 2017, warrants to purchase 150,000 shares of
Common Stock at an exercise price of $0.80 were outstanding. These
150,000 warrants become exercisable only upon the attainment of
specified events. The intrinsic value of warrants outstanding at
September 30, 2017 was approximately $104,000.
Stock-Based Compensation
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
September 30, 2017 was 6,240,781. The number of available shares
under the plan for issuance at September 30, 2017 was
124,263.
The Company estimates the fair value of its stock
options using a Black-Scholes option-valuation model, consistent
with the provisions of ASC No. 718
, Compensation – Stock
Compensation
. The fair value of
stock options granted is recognized to expense over the requisite
service period. Stock-based compensation expense is reported in
general and administrative, sales and marketing, engineering and
customer service expense 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 $238,000 and $718,000
for the three and nine months ended September 30, 2017,
respectively. Stock-based compensation expense related to equity
options was approximately $243,000 and $718,000 for the three and
nine months ended September 30, 2016, respectively. Stock-based
compensation expense related to options to purchase shares of the
Company’s Common Stock issued to certain members of the
Company’s Board of Directors in return for their service
(disclosed more fully below) was approximately $35,000 and $105,000
for the three and nine months ended September 30, 2017,
respectively. Stock-based compensation expense related to options
to purchase shares of the Company’s Common Stock issued to
certain members of the Company’s Board of Directors in return
for their service was approximately $49,000 and $139,000 for the
three and nine months ended September 30, 2016,
respectively.
ASC No. 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-valuation 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-valuation 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 the nine months ended September 30, 2017 and 2016
ranged from 58% to 103%. 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 nine months ended September 30, 2017 and 2016 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 nine months ended September 30, 2017 and 2016 was 2.6%.
Dividend yield is zero, as the Company does not expect to declare
any dividends on the Company’s Common Stock 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.
A
summary of the activity under the Company’s stock option
plans is as follows:
|
|
Weighted-Average
Exercise Price
|
Balance
at December 31, 2016
|
6,506,843
|
$
1.21
|
Granted
|
35,000
|
$
1.05
|
Expired/Cancelled
|
(103,325
)
|
$
1.63
|
Exercised
|
(322,000
)
|
$
0.71
|
Balance
at September 30, 2017
|
6,116,318
|
$
1.22
|
The
intrinsic value of options exercisable at September 30, 2017 was
approximately $2,039,000. The aggregate intrinsic value
for all options outstanding as of September 30, 2017 was
approximately $2,197,000. The weighted-average grant-date per share
fair value of options granted during the nine months ended
September 30, 2017 was $0.56. At September 30, 2017, the total
remaining unrecognized compensation cost related to unvested stock
options amounted to approximately $1,055,000 which will be
recognized over a weighted-average period of 1.5
years.
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 began recognition of compensation based on the grant-date
fair value ratably over the 2017 requisite service
period.
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 based on the grant-date fair
value ratably over the 2016 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 based on the
grant-date fair value ratably over the 2016 requisite service
period.
Stock-based
compensation related to equity options, including options granted
to certain members of the Company’s Board of Directors, has
been classified as follows in the accompanying condensed
consolidated statements of operations (in thousands):
|
Three Months Ended
September 30,
|
Nine months Ended
September 30,
|
|
|
|
|
|
Cost
of revenue
|
$
5
|
$
5
|
$
14
|
$
14
|
General
and administrative
|
163
|
180
|
493
|
529
|
Sales
and marketing
|
55
|
56
|
165
|
165
|
Research
and development
|
50
|
51
|
151
|
151
|
|
|
|
|
|
Total
|
$
273
|
$
292
|
$
823
|
$
859
|
NOTE 7. 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 September 30, 2017
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$
1,855
|
$
1,855
|
$
—
|
$
—
|
Totals
|
$
1,855
|
$
1,855
|
$
—
|
$
—
|
|
Fair Value at December 31,
2016
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$
1,645
|
$
1,645
|
$
—
|
$
—
|
Totals
|
$
1,645
|
$
1,645
|
$
—
|
$
—
|
NOTE 8. RELATED PARTY TRANSACTIONS
Lines of Credit
The Company has certain Lines of Credit extended
by certain members of the Company’s Board of Directors. For a
more detailed discussion of the Company’s Lines of Credit,
see Note 5, “
Lines of
Credit
.” As of
September 30, 2017, the Company
had borrowed $5,500,000
under the terms of the Goldman LOC and $500,000 under the terms of
the New Crocker LOC. Each of Messrs. Goldman and Crocker are
members of the Board of Directors of the
Company.
Series A Financing
Messrs. Miller and Goldman, Wayne Wetherell, the Company’s
Chief Financial Officer, Robert T. Clutterbuck and Charles
Frischer, two directors appointed as members of the Company’s
Board of Directors in connection with the Series A Financing,
purchased an aggregate of 1,450 Series A Preferred in connection
with the Series A Financing resulting in gross proceeds of
$1,450,000 to the Company. Messrs. Goldman, Clutterbuck and
Frischer also exchanged an aggregate 11,364 shares of Series E
Preferred, Series F Preferred and Series G Preferred for 11,364
shares of Series A Preferred in connection with the Series A
Financing.
NOTE 9. CONTINGENT LIABILITIES
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
months of base salary; (ii) continuation of their fringe benefits
and medical insurance for a period of six months; and (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; and (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.
Effective
September 15, 2017, the employment agreements for the Company's
Chief Executive Officer, Chief Financial Officer and Chief
Technical Officer were amended to extend the term of each executive
officer's employment agreement until December 31,
2018.
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’s lease was renewed in September 2017 through
October 2018 at a cost of approximately $30,000 per month. In
addition to our corporate headquarters, we also occupied the
following spaces at September 30, 2017:
●
|
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;
|
●
|
9,720 square feet in Portland, Oregon, at a cost of approximately
$21,000 per month until the expiration of the lease on December 31,
2021. This lease was renewed in September 2017 resulting in an
additional 1,675 feet, an increase from approximately $18,000 to
approximately $21,000 per month and the extension of the term from
October 2018 to December 2021; and
|
●
|
304 square feet of office space in Mexico City, Mexico, at a cost
of approximately $3,000 per month until November 30,
2017.
|
At
September 30, 2017, future minimum lease payments are as
follows:
($ in thousands)
|
|
2017
(three months)
|
$
144
|
2018
|
546
|
2019
|
284
|
2020
|
292
|
2021
|
272
|
Total
|
$
1,538
|
Rental
expense incurred under operating leases for the nine months ended
September 30, 2017 and 2016 was approximately $389,000 and
$364,000, respectively.