NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1: Summary of Significant Accounting Policies
The Business
eMagin Corporation (the “Company”) designs, develops, manufactures, and markets OLED (organic light emitting diode)–on-silicon microdisplays and virtual imaging products which utilize OLED microdisplays. The Company’s products are sold mainly in North America, Asia, and Europe.
Basis of Presentation
In the opinion of management, the accompanying unaudited condensed consolidated financial statements of eMagin Corporation and its subsidiary reflect all adjustments, including normal recurring accruals, necessary for a fair presentation. All significant intercompany balances and transactions have been eliminated in consolidation. Certain information and footnote disclosure normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to instructions, rules and regulations prescribed by the Securities and Exchange Commission. The Company believes that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited condensed consolidated financial statements are read in conjunction with the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The results of operations for the period ended September 30, 2018 are not necessarily indicative of the results to be expected for the full year. The consolidated condensed financial statements as of December 31, 2017 are derived from audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
Use of estimates
In accordance with accounting principles generally accepted in the United States of America, management utilizes certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments related to, among others, allowance for doubtful accounts, warranty reserves, inventory reserves, stock-based compensation expense, deferred tax asset valuation allowances, litigation and other loss contingencies. Management bases its estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.
Reclassifications
Certain immaterial prior period amounts have been reclassified to conform to current period presentatio
n with no impact on previously reported net income, assets or shareholders’ equity.
Intangible Assets – Patents
Acquired patents are recorded at purchase price as of the date acquired and amortized over the expected useful life which is generally the remaining life of the patent.
The total intangible amortization expense was approximately
$13
thousand and
$27
thousand for the three and nine month periods ended September 30, 2018 and 2017, respectively. Estimated future amortization expense as of September 30, 2018 is as follows (in thousands):
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|
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|
|
|
|
|
Fiscal Years Ending December 31,
|
|
Total
Amortization
|
|
|
(unaudited)
|
2018 (three months remaining)
|
|
$
|
13
|
2019
|
|
|
32
|
2020
|
|
|
9
|
2021
|
|
|
8
|
2022
|
|
|
8
|
Later years
|
|
|
24
|
|
|
$
|
94
|
Product warranty
The Company generally offers a
one
-year product replacement warranty. The standard policy is to repair or replace the defective products. The Company accrues for estimated returns of defective products at the time revenue is recognized based on historical activity as well as for specific known product issues. The determination of these accruals requires the Company to make estimates of the frequency and extent of warranty activity and estimate future costs to replace the products under warranty. If the actual warranty activity and/or repair and replacement costs differ significantly from these estimates, adjustments to cost of revenue may be required in future periods.
The following table provides a summary of the activity related to the Company's warranty liability included in other current liabilities, (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
Beginning balance
|
|
$
|
382
|
|
$
|
609
|
|
$
|
468
|
|
$
|
584
|
Warranty accruals and adjustments
|
|
|
39
|
|
|
19
|
|
|
20
|
|
|
135
|
Warranty claims
|
|
|
(35)
|
|
|
(39)
|
|
|
(102)
|
|
|
(130)
|
Ending balance
|
|
$
|
386
|
|
$
|
589
|
|
$
|
386
|
|
$
|
589
|
Net Loss per Common Share
Basic loss per share is computed using the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of common stock equivalent shares such as stock options, warrants, and convertible preferred stock. Diluted loss per share is computed using the weighted average number of common shares outstanding and potentially dilutive common stock equivalent shares outstanding during the period. Common stock equivalent shares are excluded from the computation if their effect is anti-dilutive.
The Company’s Series B Convertible Preferred stock (“Preferred Stock – Series B”) is considered a participating security as the preferred stock participates in dividends with the common stock, which requires the use of the two-class method when computing basic and diluted earnings per share. The Preferred Stock – Series B is not required to absorb any net loss. Although the Company paid a one-time special dividend in 2012, the Company does not expect to pay dividends on its common or preferred stock in the near future.
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share and share data) for the three and nine months ended September 30, 2018 and 2017:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
|
(unaudited)
|
|
(unaudited)
|
Net income (loss)
|
|
$
|
63
|
|
$
|
(2,992)
|
|
$
|
(7,083)
|
|
$
|
(7,261)
|
Income allocated to participating securities
|
|
|
9
|
|
|
—
|
|
|
—
|
|
|
—
|
Income (loss) allocated to common shares
|
|
$
|
54
|
|
$
|
(2,992)
|
|
$
|
(7,083)
|
|
$
|
(7,261)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
- Basic
|
|
|
45,149,717
|
|
|
34,972,589
|
|
|
44,182,379
|
|
|
33,214,262
|
Dilutive effect of stock options
|
|
|
115,653
|
|
|
—
|
|
|
—
|
|
|
—
|
Weighted average common shares outstanding
- Diluted
|
|
|
45,265,370
|
|
|
34,972,589
|
|
|
44,182,379
|
|
|
33,214,262
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
-
|
|
$
|
(0.09)
|
|
$
|
(0.16)
|
|
$
|
(0.22)
|
Diluted
|
|
$
|
-
|
|
$
|
(0.09)
|
|
$
|
(0.16)
|
|
$
|
(0.22)
|
The following table sets forth the potentially dilutive common stock equivalents for the three and nine month periods ended September 30, 2018 and 2017 that were not included in diluted EPS as their effect would be anti-dilutive:
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|
|
|
|
|
|
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|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
|
(unaudited)
|
|
(unaudited)
|
Options
|
|
4,843,468
|
|
5,142,448
|
|
4,959,120
|
|
5,142,448
|
Warrants
|
|
9,055,773
|
|
5,081,449
|
|
9,055,773
|
|
5,081,449
|
Convertible preferred stock
|
|
7,545,333
|
|
7,545,333
|
|
7,545,333
|
|
7,545,333
|
Total potentially dilutive common stock equivalents
|
|
21,444,574
|
|
17,769,230
|
|
21,560,226
|
|
17,769,230
|
Fair Value of Financial Instruments
Cash, cash equivalents, accounts receivable, short-term investments and accounts payable are stated at cost, which approximates fair value due to the short-term nature of these instruments. The revolving credit facility is also stated at cost, which approximates fair value because the interest rate is based on a market based rate plus a margin.
We have categorized our assets and liabilities that are valued at fair value on a recurring basis into three-level fair value hierarchy in accordance with GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets and liabilities (Level 1) and lowest priority to unobservable inputs (Level 3).
Assets and liabilities recorded in the balance sheets at fair value are categorized based on a hierarchy of inputs as follows:
Level 1 – Unadjusted quoted prices in active markets of identical assets or liabilities.
Level 2 – Quoted prices for similar assets or liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3 – Unobservable inputs for the asset or liability.
The common stock warrant liability is currently the only financial asset or liability recorded at fair value on a recurring basis, and is considered a Level 3 liability. The fair value of the common stock warrant liability is included in current liabilities on the Condensed Consolidated Balance Sheets, as the warrants are currently exercisable.
The following table shows the reconciliation of the Level 3 warrant liability measured and recorded at fair value on a recurring basis, using significant unobservable inputs (in thousands):
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Estimated Fair Value
|
|
|
|
(unaudited)
|
Balance as of January 1, 2018
|
|
|
$
|
784
|
Fair value of warrants issuance during period
|
|
|
|
2,906
|
Change in fair value of warrant liability, net
|
|
|
|
(387)
|
Balance as of September 30, 2018
|
|
|
$
|
3,303
|
|
|
|
|
|
The fair value of the liability for common stock purchase warrants at issuance and at September 30, 2018 was estimated using the Black Scholes option pricing model based on the market value of the underlying common stock at the measurement date, the remaining contractual term of the warrants from
3.7
to
4.3
years, risk-free interest rates ranging from
2.86%
to
2.87%
,
no
expected dividends and expected volatility of the price of the underlying common stock ranging from
47.5%
to
48.0%
.
Concentrations
The Company purchases principally all of its silicon wafers, which are a key ingredient in its OLED production process, from
two
suppliers located in Taiwan and Korea.
For the
three months ended September 30, 2018, one customer accounted for 12% of net revenues. For the nine months ended September 30, 2018, there were no single customers accounting for over 10% of net revenues.
As of September 30, 2018
,
one
customer accounted for
14%
of the Company’s consolidated accounts receivable balance and no other single customer accounted for over 10% of the consolidated accounts receivable.
Recently issued accounting pronouncements
In February 2016, the FASB issued guidance which changes the accounting for leases. The guidance requires lessees to recognize a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term and, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis for all leases (with the exception of short-term leases). Under the new guidance, leases previously defined as operating leases will be presented on the balance sheet. As a result, these leases will be recorded as an asset and a corresponding liability at the present value of the total lease payments. The asset will be decremented over the life of the lease on a pro-rata basis resulting in lease expense while the liability will be decremented using the interest method (i.e. principal and interest). Although the Company is still evaluating and quantifying the impact, the new guidance will affect the asset and liability balances of the Company’s financial statements and related disclosures at the time of adoption. The new guidance is effective January 1, 2019.
In
August 201
8, the FASB issued
guidance
which adds, amends and removes certain disclosure requirements related to fair value measurements. Among other changes, this standard requires certain additional disclosure surrounding Level 3 assets, including changes in unrealized gains or losses in other comprehensive income and certain inputs in those measurements.
This new guidance
is effective for fiscal years, and interim periods within those fiscal years, beginning after
December
15, 2019. Certain amended or eliminated disclosures in this standard may be adopted early, while certain additional disclosure requirements in this standard can be adopted on its effective date. In addition, certain changes in the standard require retrospective adoption, while other changes must be adopted prospectively. The Company is currently evaluating
this new standard
and its impact on our consolidated financial statements.
SEC Disclosure Update and Simplification
The Securities and Exchange Commission has also recently issued several final rules, including but not limited to SEC Final Rule Release No. 33-10532
Disclosure Update and Simplification
(“Final Rule”), which amends certain redundant, duplicative, outdated, superseded or overlapping disclosure requirements. This Final Rule is intended to facilitate disclosure information provided to investors and simplify compliance without significantly impacting the mix of information provided to investors. The amendments also expand the disclosure requirements regarding the analysis of stockholders' equity for interim financial statements, in which entities will be required to present a reconciliation for each period for which a statement of comprehensive income is required to be filed.
The final rule is effective on
November
5, 2018, however the SEC staff announced that it would not object if the filer's first presentation of the changes in shareholders' equity is included in its Form 10-Q for the quarter that begins after the effective date of the amendments. As such, the Company plans to use the new presentation of a condensed consolidated statement of
shareholders
equity within its interim financial statements beginning in its Form 10-Q for the quarter ending
March
31, 2019.
W
e do not anticipate any material impact to our consolidated financial statements and related disclosures upon adoption.
Note 1A:
Impairment of Consumer Night Vision Business Assets
During the quarter ended
June
30, 2018 the Company made a decision to exit the business associated with its
two
consumer night vision products, BlazeSpark and BlazeTorch (the “Consumer Night Vision Business”). The Company’s decision was based on lower than anticipated sales and an assessment performed during the quarter of the anticipated level of additional engineering, marketing and financial resources necessary to modify the products for an expanded market. As a result, the Company concluded an impairment had occurred and wrote-down
$2.7
million
of related Consumer Night Vision Business inventory, which includes an accrual of
$1.4
million
of inventory purchased by a contract manufacturer in anticipation of future production, and
$0.1
million
of production tooling, which are reflected in cost of revenues in the accompanying Condensed Consolidated Statements of Operations.
Note 2: Revenue Recognition
All of the Company’s revenues are earned from contracts with customers and are classified as either Product or Contract revenues. Contracts include written agreements and purchase orders, as well as arrangements that are implied by customary practices or law.
Product revenue is generated primarily from contracts to produce, ship and deliver OLED microdisplays. eMagin’s performance obligations are satisfied, control of our products is transferred, and revenue is recognized at a single point in time when control transfers to our customer for product shipped. Our customary terms are FOB our factory and control is deemed to transfer upon shipment. The Company has elected to treat shipping and other transportation costs charged to customers as fulfillment activities and are recorded in both revenue and cost of sales at the time control is
transferred to the customer.
As customers are invoiced at the time control transfers and the right to consideration is unconditional at that time, the Company does not maintain contract asset balances for product revenue. Additionally, the Company does not maintain contract liability balances for product revenues, as performance obligations are satisfied prior to
customer payment for product.
The Company offers a
one
-year product warranty, for replacement of product only, and does not allow returns. The Company offers industry standard payment terms that typically require payment from our customers from
30
to
60
days after title transfers.
The Company also recognizes revenues under the over time method from certain research and development (“R&D”) activities (contract revenues) under both firm fixed-price contracts and cost-type contracts. Progress and revenues from research and development activities relating to firm fixed-price contracts and cost-type contracts are generally recognized on an input method of accounting as costs are incurred. Under the
input method, revenue is recognized based on efforts expended to date (e.g., the costs of resources consumed or labor hours worked, or machine hours used) relative to total efforts intended to be expended
. Contract costs include all direct material, labor and subcontractor costs and an allocation of allowable indirect costs as defined by each contract, as periodically adjusted to reflect revised agreed upon rates. These rates are subject to audit by the other party. Any changes in estimate related to contract accounting are accounted for prospectively over the remaining life of the contract. Under the over time method, billings may not correlate directly to the revenue recognized. Based upon the terms of the specific contract, billings may be in excess of the revenue recognized, in which case the amounts are included in deferred revenues as a liability on the Condensed Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported as unbilled receivables. Unbilled revenues are expected to be billed and c
ollected within one year. The
incidental costs related to obtaining product sales contracts are non-recoverable from customers; and accordingly, are expensed as incurred.
The Company adopted the provisions of ASC No. 606,
Revenue from Contracts with Customers,
and related amendments (“ASC 606”) on
January
1, 2018 using the modified retrospective adoption method
with the cumulative effect of initially applying the guidance recognized at the date of initial application. During 2017, the Company analyzed its revenue recognition policies under ASC 606 and then current revenue recognition policies and determined that the performance obligations, transaction price, allocation of transaction price, recognition of contract costs and timing of revenue recognition would not be materially impacted by adopting ASC 606. Accordingly, there was
no
modified retrospective adoption adjustment necessary as of
January
1, 2018
.
Disaggregation of Revenue
The Company's sells its products directly to original equipment manufacturers and military contractors in a diverse range of industries
encompassing the military, industrial, medical, and consumer market sectors
. R&D activities are performed for both military customers and U.S. Government defense related agencies. Product and Contract revenues are disclosed on the Condensed Consolidated Statements of Operations. Additional disaggregated revenue information for the
three and nine month periods ended
September
30,
2018 and 2017 were as follows (in
thousands
):
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|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
September
30,
|
|
|
September
30,
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
(unaudited)
|
|
|
(unaudited)
|
North and South America
|
|
$
|
2,947
|
|
|
$
|
2,192
|
|
|
$
|
11,264
|
|
|
$
|
9,479
|
Europe, Middle East, and Africa
|
|
|
2,444
|
|
|
|
1,634
|
|
|
|
7,131
|
|
|
|
4,378
|
Asia Pacific
|
|
|
1,476
|
|
|
|
454
|
|
|
|
2,405
|
|
|
|
1,752
|
Total
|
|
$
|
6,867
|
|
|
$
|
4,280
|
|
|
$
|
20,800
|
|
|
$
|
15,609
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
Commercial
|
|
|
35
|
%
|
|
|
22
|
%
|
|
|
24
|
%
|
|
|
29
|
%
|
Military
|
|
|
46
|
%
|
|
|
45
|
%
|
|
|
53
|
%
|
|
|
50
|
%
|
Commercial and Military
|
|
|
19
|
%
|
|
|
33
|
%
|
|
|
23
|
%
|
|
|
21
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Accounts Receivable from Customers
Accounts receivable, net of allowances, associated with revenue from customers were approximately $
4.4
million
and $4.5
million
as of
September
30
, 2018 and
December
31, 2017, respectively.
Contract Assets and Liabilities
Unbilled Accounts Receivables (Contract Assets)
- Pursuant to the over time revenue recognition model, revenue may be recognized prior to the customer being invoiced. An unbilled accounts receivable is recorded to reflect revenue that is recognized when the proportional performance method is applied and such revenue exceeds the amount invoiced to the customer. Unbilled receivables are disclosed on the Condensed Consolidated Balance Sheet as of
September
30
, 2018.
Customer Advances and Deposits (Contract Liabilities)
The Company recognizes a contract liability when it has billed and received consideration from the customer pursuant to the terms of a contract but has not yet recognized the related revenue. These billings in excess of revenue are classified as deferred revenue on the Condensed Consolidated Statements of Operations.
Total contract assets and liabilities consisted of the following amounts (in
thousands
):
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|
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|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
(unaudited)
|
|
|
|
|
Unbilled Receivables (contract assets)
|
|
|
|
|
|
|
|
|
|
$
|
364
|
|
|
$
|
406
|
Deferred Revenue (contract liabilities)
|
|
|
|
|
|
|
|
|
|
|
(41)
|
|
|
|
(765)
|
Net contract asset (liability)
|
|
|
|
|
|
|
|
|
|
$
|
323
|
|
|
$
|
(359)
|
In the
third
quarter and first
nine months
of fiscal 2018, the Company recognized
no
revenue and
$7
21
thousand
of revenue
, respectively
,
related to its contract liabilities that existed at
December
31, 2017.
Remaining Performance Obligations
. The Company has elected the practical expedient, which allows disclosure of remaining performance obligations only for contracts with an original duration of greater than one year. Such remaining performance obligations primarily relate to engineering and design services. As of
September
30
, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was
$1.
2
million
. The Company expects to recognize revenue on
all of its
remaining performance obligations over the next 12 months
.
Note 3: Accounts Receivable, net
The majority of the Company’s commercial accounts receivable are due from Original Equipment Manufacturers (“OEM’s”). Credit is extended based on an evaluation of a customer’s financial condition and, generally, collateral is not required.
Accounts receivable consisted of the following (in
thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September
30,
|
|
December
31,
|
|
|
2018
|
|
2017
|
|
|
(unaudited)
|
|
|
Accounts receivable
|
|
$
|
4,520
|
|
$
|
4,643
|
Less allowance for doubtful accounts
|
|
|
(139)
|
|
|
(115)
|
Accounts receivable, net
|
|
$
|
4,381
|
|
$
|
4,528
|
Note 4: Inventories, net
The components of inventories are as follows (in
thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September
30,
|
|
December
31,
|
|
|
2018
|
|
2017
|
|
|
(unaudited)
|
|
|
Raw materials
|
|
$
|
2,982
|
|
$
|
4,054
|
Work in process
|
|
|
2,043
|
|
|
1,352
|
Finished goods
|
|
|
5,105
|
|
|
5,024
|
Total inventories
|
|
|
10,130
|
|
|
10,430
|
Less inventory reserve
|
|
|
(1,411)
|
|
|
(1,790)
|
Total inventories, net
|
|
$
|
8,719
|
|
$
|
8,640
|
Note 5: Line of Credit
On
December
21, 2016, the Company entered into a revolving credit facility with a lender that
provides for up to a maximum amount of $5
million
based on a borrowing base equivalent of 85% of eligible accounts receivable plus the lesser of $2
million
or 50% of eligible inventory
, (the “ABL facility”). The interest on the ABL facility is equal to the Prime Rate plus
3%
but may not be less than
6.5%
with a minimum monthly interest payment of
$2
thousand
. The Company is also obligated to pay the lender a monthly administrative fee of
$1
thousand
and an annual facility fee equal to
1%
of the maximum amount borrowable under the facility. The ABL facility will automatically renew on
December
31, 2019
for a
one
-year term unless written notice to terminate the agreement is provided by either party. In conjunction with entering into the financing, the Company incurred
$228
thousand
of debt issuance costs including lender and legal costs that will be amortized over the life of the ABL facility. In accordance with recently issued accounting guidance, any revolving credit facility balances outstanding are presented net of these unamortized debt issuance costs on the accompanying Consolidated Balance Sheet.
The ABL facility is secured by a lien on all receivables, property and the proceeds thereof, credit insurance policies and other insurance relating to the collateral, books, records and other general intangibles, inventory and equipment, proceeds of the collateral and accounts, instruments, chattel paper, and documents. Collections received on accounts receivable are directly used to pay down the outstanding borrowings on the credit facility.
The ABL facility contains customary representations and warranties, affirmative and negative covenants and events of default. The Company is required to maintain a minimum tangible net worth of
$13
million
and a minimum working capital balance of
$4
million
at all times. As of
September
30
, 2018, the Company had
no
borrowings outstanding, had unused borrowing availability of
$
4.9
million
and was in compliance with all financial debt covenants.
For the three months and
nine m
onths
ended
September
30
, 2018, interest expense includes interest paid, capitalized or accrued of
$30
thousand
, and
$72
thousand
, respectively, on outstanding debt. Intere
st expense for the three and nine
-month periods ended
September
30
, 2018 includes the amortization of debt issuance costs of
$20
thousand
and
$41
thousand
, respectively.
Note 6: Stock-based Compensation
The Company uses the fair value method of accounting for share-based compensation arrangements. The fair value of stock options is estimated at the date of grant using the Black-Scholes option valuation model. Stock-based compensation expense is reduced for estimated forfeitures and is amortized over the vesting period using the straight-line method.
The following table summarizes the allocation of non-cash stock-based compensation to our expense categories for the three and nine month periods ended
September
30, 2018 and 2017 (in
thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
Cost of revenues
|
|
$
|
(5)
|
|
$
|
6
|
|
$
|
29
|
|
$
|
18
|
Research and development
|
|
|
28
|
|
|
25
|
|
|
73
|
|
|
74
|
Selling, general and administrative
|
|
|
154
|
|
|
159
|
|
|
410
|
|
|
428
|
Total stock compensation expense
|
|
$
|
177
|
|
$
|
190
|
|
$
|
512
|
|
$
|
520
|
At
September
30, 2018, total unrecognized compensation costs related to stock options was approximately
$0.6
million
, net of estimated forfeitures. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and is expected to be recognized over a weighted average period of approximately
3
years.
The following key assumptions were used in the Black-Scholes option pricing model to determine the fair value of stock options granted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
September
30,
|
|
2018
|
|
2017
|
|
(unaudited)
|
Dividend yield
|
|
0
|
%
|
|
0
|
%
|
Risk free interest rates
|
|
2.16-2.75
|
%
|
|
0.71-1.65
|
%
|
Expected volatility
|
|
45.3 to 50.0
|
%
|
|
49.1 to 59.4
|
%
|
Expected term (in years)
|
|
3.5 to 4.75
|
|
|
3.5 to 5.0
|
|
The Company does not expect to pay dividends in the near future. Therefore, the Company used an expected dividend yield of
0%
. The risk-free interest rate used in the Black-Scholes option pricing model is based on yield available at dates of option grant, on U.S. Treasury securities with an equivalent term. Expected volatility is based on the weighted average historical volatility of the Company’s common stock for the equivalent term. The expected term of the options represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience and vesting schedules of similar awards.
A summary of the Company’s stock option activity for the nine months ended
September
30, 2018 is presented in the following table (unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Life (In Years)
|
|
Aggregate
Intrinsic
Value
|
Outstanding at December 31, 2017
|
|
|
4,768,838
|
|
$
|
3.02
|
|
|
|
|
|
|
Options granted
|
|
|
587,350
|
|
|
1.70
|
|
|
|
|
|
|
Options exercised
|
|
|
(99,937)
|
|
|
0.98
|
|
|
|
|
|
|
Options forfeited
|
|
|
(47,000)
|
|
|
1.78
|
|
|
|
|
|
|
Options cancelled or expired
|
|
|
(250,131)
|
|
|
4.15
|
|
|
|
|
|
|
Outstanding at September 30, 2018
|
|
|
4,959,120
|
|
$
|
2.86
|
|
|
4.04
|
|
$
|
146,325
|
Vested or expected to vest at September 30, 2018
|
(1)
|
|
4,951,630
|
|
$
|
2.86
|
|
|
4.11
|
|
$
|
144,325
|
Exercisable at September 30, 2018
|
|
|
4,584,666
|
|
$
|
2.92
|
|
|
3.97
|
|
$
|
144,325
|
|
(1)
|
|
The expected to vest options are the result of applying the pre-vesting forfeiture rate assumptions to total unvested options.
|
The aggregate intrinsic value in the table above represents the difference between the exercise price of the underlying options and the quoted price of the Company’s common stock.
For the three months and nine month periods ended
September
30, 2018, the aggregate intrinsic value of options exercised was
$49
thousand
and
$56
thousand
, respectively.
The Company issues new shares of common stock upon exercise of stock options.
Note 7: Shareholders’ Equity
Preferred Stock - Series B Convertible Preferred Stock
As of
September
30
, 2018 and
December
31, 2017, there were
5,659
shares of Preferred Stock – Series B issued and
outstanding
.
Common Stock
Du
ring the nine
-month period ended
September
30
, 2018, options to purchase
9
9,937
s
hares were exercised for proceeds of
$
98
thousand
; and warrants to purchase
30,000
shares were exercised for proceeds of
$46
thousand
.
O
ptions
to purchase
50,000
shares were exercised
during the three
months
ended
September
30
, 2018
.
Underwritten Public Offering
On
January
25, 2018 we entered into an underwriting agreement to issue and sell
9,807,105
shares of Company Common Stock, together with warrants to purchase
3,922,842
shares of Common Stock with an initial exercise price of
$1.55
per share (at a public offering price of
$1.35
per fixed combination consisting of one share of Common Stock and associated warrant to purchase
four
tenths of one share of Common Stock). These share and warrant amounts include the exercise of an overallotment option by the underwriter to purchase
1,279,187
additional shares of Common Stock and additional warrants to purchase
511,674
shares of Common Stock. The Common Stock and Warrants were registered on a Form S-1. The offering closed on
January
29, 2018
and the Company received net proceeds after underwriting discounts and expenses of
$11.9
million
.
In a concurrent private placement, certain of our directors and officers purchased an aggregate of
203,708
shares of Common Stock, together with warrants to purchase up to
81,487
shares of Common Stock at the public offering price of
$1.35
per fixed combination. The sale of these shares of common stock and warrants was not registered under the Securities Act and is subject to a 180-day lock-up. The private placement closed on
February
15, 2018
, and the Company received net proceeds of
$0.3
million
.
Note 8: Income Taxes
On
December
22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (“TCJA”). This legislation makes broad and complex changes to the U.S. tax code, including, but not limited to, (i) reducing the U.S. federal statutory tax rate from
35%
to
21%
; (ii) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized; (iii) modifying the officer’s compensation limitation, and (iv) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after
December
31, 2017. Specifically, the TCJA limits the amount the Company is able to deduct for net operating loss carryforwards generated in taxable years beginning after
December
31, 2017 to 80% of taxable income; however, these net operating loss carryforwards can be carried forward indefinitely. The Company recognizes the effects of changes in tax law, including the TCJA, in the period the law is enacted. Accordingly, the effects of certain provisions of the TCJA have been recognized in the financial statements for the year ended
December
31, 2017. As a result of the change in law, the Company recorded a reduction to its deferred tax assets of
$19.0
million
and a corresponding reduction to its valuation allowance due to the reduction in the U.S. federal statutory rate from 35% to 21%. In addition, the Company expects to file a claim for a federal tax refund of approximately
$0.2
million
for its AMT credit carryforward in tax years
2018
to
2021
pursuant to the applicable provisions of the TCJA.
The Company’s effective tax rate is calculated quarterly based upon current assumptions relating to the full year’s estimated operating results and various tax-related items. The Company’s effective tax rate for the three
and nine
month periods ended
September
30
, 2018 and 2017 was
0%
.
The difference between the effective tax rate of 0% and the U.S. federal statutory rate of
21%
for the three and
nine month
periods ended
September
30
, 2018 and 2017 was primarily due to recognizing a full valuation allowance on deferred tax assets.
As of
September
30
, 2018, the Company determined that based on all available evidence, both positive and negative, including the Company’s latest forecasts and cumulative losses in recent years, it was more likely than not that
none
of its deferred tax assets would be realized and therefore it continued to record a full valuation allowance.
The Company’s net operating loss carryforward amounts expire through
2037
and are subject to certain limitations that may occur due to change in ownership provisions
under Section 382 of the Internal Revenue Code and similar state provisions.
Due to the Company’s operating loss carryforwards, all tax years remain open to examination by the major taxing jurisdictions to which the Company is subject. In the event that the Company is assessed interest or penalties at some point in the future, it will be classified in the financial statements as tax expense.
Note 9: Commitments and Contingencies
Equipment Purchase Commitments
The Company has committed to equipment purchases of approximately
$1.
5
million
at
September
30
, 2018.
Litigation
From time to time, the Company is subject to various legal proceedings and claims that arise in the ordinary course of business. The Company accrues for losses related to litigation when a potential loss is probable and the loss can be reasonably estimated. Significant judgment is required to determine the probability that a liability has been incurred and whether such liability is reasonably estimable. All estimates are based on the best information available at the time which can be highly subjective.
Note 10: Common Stock Warrant Liability
We account for common stock warrants pursuant to applicable accounting guidance contained in ASC 815 "Derivatives and Hedging - Contracts in Entity's Own Equity" and make a determination as to their treatment as either equity instruments or a warrant liability.
During
January 201
8, in conjunction with a registered equity offering and a concurrent private placement that closed in
February 201
8, the Company issued warrants to purchase an aggregate of
4,004,324
common shares at an exercise price of
$1.55
. As of
September
30
, 2018 related warrants to purchase
3,974,324
shares of common stock remain outstanding. The warrants have alternative settlement provisions that, at the option of the holder, provide for physical settlement or if, at the time of settlement there is no effective registration statement, a cashless exercise, as defined in the warrant agreement.
Based on analysis of the underlying warrant agreement, and applicable accounting guidance, the Company concluded that these registered warrants require the issuance of registered securities upon exercise and do not sufficiently preclude an implied right to net cash settlement. Accordingly, these warrants were classified on the Condensed Consolidated Balance Sheet as a current liability upon issuance and will be revalued at each subsequent balance sheet date.
The fair value of the liability for common stock purchase warrants is estimated using the Black Scholes option pricing model based on the market value of the underlying common stock at the measurement date, the contractual term of the warrant, risk-free interest rates, expected dividends and expected volatility of the price of the underlying common stock.
We determined that, based on the Black Sholes methodology, the liability for the
January
and
February
common stock warrants had a combined initial fair value of
$2.9
million
, and a fair value as of
September
30
, 2018 of
$
2
.
7
million
. In addition
,
warrants the company issued that were classified as liabilities had a fair value of
$0.8
million
at
December
31, 2017 and
$0.
6
million
as of
September
30
, 2018. The combined changes in fair value as of
September
30
, 2018 was reflected as
i
n
come
from change in the fair market value of common stock warrant liability of $1.
3
million
and $0.
4
million
in the condensed consolidated statement of operations for the three and
nine month
periods ended
September
30
, 2018, respectively.