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 the
products are integrated into the IWS Biometric
Engine.
Recent Developments
Creation of Series C Convertible Redeemable Preferred
Stock
On September 10, 2018, the Company filed the
Certificate of Designations, Preferences, and Rights of Series C
Convertible Redeemable Preferred Stock with the Secretary of State
for the State of Delaware – Division of Corporations,
designating 1,000 shares of the Company’s preferred stock,
par value $0.01 per share, as Series C Convertible Redeemable
Preferred Stock (“
Series C
Preferred
”), each share
with a stated value of $10,000 per share.
Series C Financing
From September 10, 2018 through September 21,
2018, the Company offered and sold an aggregate of 1,000 shares of
Series C Preferred at a purchase price of $10,000 per share (the
“
Series C
Financing
”). The
aggregate gross proceeds to the Company from the Series C Financing
were approximately $10,000,000. Issuance costs incurred in
conjunction with the Series C Financing were approximately
$1,211,000, resulting in net proceeds to the Company of
approximately $8,789,000.
Amendment to Certificate of Designations of Series A Convertible
Preferred Stock
On September 10, 2018, the Company
filed an Amendment to the Certificate of Designations, Preferences,
and Rights of Series A Convertible Preferred Stock with the
Secretary of State for the State of Delaware – Division of
Corporations, to increase the number of shares of Series A
Convertible Preferred Stock, par value $0.01 per share
(“
Series A
Preferred
”), authorized
for issuance thereunder to 38,000 shares, in order to permit the
Debt Exchange (as defined below).
Debt Exchange
On September 10, 2018, the Company entered into
exchange agreements (the “
Exchange
Agreements
”) with Neal
Goldman and Charles Crocker, pursuant to which Messrs. Goldman and
Crocker agreed to exchange approximately $6.3 million and $0.6
million, respectively, of outstanding debt (including accrued and
unpaid interest) owed under the terms of their respective lines of
credit for an aggregate of 6,896 shares of Series A Preferred (the
“
Debt
Exchange
”). As a result of the Debt Exchange, all
indebtedness, liabilities and other obligations arising under the
respective lines of credit were cancelled and deemed satisfied in
full. Messrs. Goldman and Crocker are members of the
Company’s Board of Directors and related
parties.
Declaration of Special Dividend
Concurrently with the Series C Financing, the
Company’s Board of Directors declared a special dividend (the
“
Special
Dividend
”) for holders of
the Series A Preferred (each a “
Holder
”), pursuant to which each Holder received a
warrant (“
Dividend
Warrant
”) to purchase
39.87 shares of Company common stock, par value $0.01 per share
(“
Common
Stock
”), for every share
of Series A Preferred held, which resulted in the issuance of
Dividend Warrants to the Holders as a group to purchase an
aggregate of 1,493,856 shares of Common Stock. Each Dividend
Warrant has an exercise price of $0.01 per share, and is
exercisable immediately upon issuance;
provided,
however
, that a Dividend
Warrant may only be exercised concurrently with the conversion of
shares of Series A Preferred held by a Holder into shares of Common
Stock. In addition, each Dividend Warrant held by a Holder shall
expire on the earliest to occur of (i) the conversion of all Series
A Preferred held by such Holder into Common Stock, (ii) the
redemption by the Company of all outstanding shares of Series A
Preferred held by such Holder, (iii) the Dividend Warrant no longer
representing the right to purchase any shares of Common Stock, and
(iv) the tenth anniversary of the date of issuance.
The
Company evaluated this warrant issuance in conjunction with the
Series A Preferred Stock becoming junior to the Series C in
liquidation preference and determined such warrants and changes in
liquidation preference to be in effect a modification of the Series
A Preferred Stock. To determine the effect of this modification,
the Company, using fair value methodologies, determined the value
of the Series A Preferred Stock both pre and post warrant issuance.
The valuation indicated an increase in the fair value of the Series
A Preferred post issuance of approximately $92,000. The Company
recorded this incremental increase as a deemed
dividend.
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, and payments relating to purchases
of property and equipment. 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 revenue grows, 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 revenue to achieve and sustain
income from operations.
Going Concern
At
September 30, 2018, we had positive working capital of
approximately $6,065,000. Our principal sources of liquidity at
September 30, 2018 consisted of approximately $9,058,000 of cash
and $600,000 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, 2017, 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, 2017, which
are included in the Company’s Annual Report on Form 10-K for
the year ended December 31, 2017 that was filed with the SEC on
March 19, 2018.
Operating
results for the three and nine months ended September 30, 2018 are
not necessarily indicative of the results that may be expected for
the year ended December 31, 2018, or any other future
periods.
Certain prior period amounts have been
reclassified to conform with current period presentation.
These
reclassifications have no impact on net
loss.
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, 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 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,
deferred tax asset valuation allowances, recoverability of
goodwill, assumptions used in the Black-Scholes model to calculate
the fair value of share based payments, fair value of financial
instruments issued with and affected by the Series C Preferred
Financing (defined below), fair value of Exchanged Preferred
(defined below), assumptions used in the application of revenue
recognition policies 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 net
realizable value. See Note 4, “
Inventory
,” below.
Fair Value of Financial Instruments
For
certain of the Company’s financial instruments, including
accounts receivable, accounts payable, accrued expense, deferred
revenue and lines of credit payable to related parties, the
carrying amounts approximate fair value due to their relatively
short maturities.
Revenue Recognition
Effective January 1, 2018, we adopted Accounting
Standards Codification (“
ASC
”), Topic 606, Revenue from Contracts with
Customers (“
ASC 606
”), using the modified retrospective
transition method.
In
accordance with ASC 606, revenue is recognized when control of the
promised goods or services is transferred to our customers, in an
amount that reflects the consideration we expect to be entitled to
in exchange for those goods or services.
The
core principle of the standard is that we should recognize revenue
to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which we expect to
be entitled in exchange for those goods or services. To achieve
that core principle, we apply the following five step
model:
1.
Identify
the contract with the customer;
2.
Identify
the performance obligation in the contract;
3.
Determine
the transaction price;
4.
Allocate
the transaction price to the performance obligations in the
contract; and
5.
Recognize
revenue when (or as) each performance obligation is
satisfied.
At
contract inception, we assess the goods and services promised in a
contract with a customer and identify as a performance obligation
each promise to transfer to the customer either: (i) a good or
service (or a bundle of goods or services) that is distinct, or
(ii) a series of distinct goods or services that are substantially
the same and that have the same pattern of transfer to the
customer. We recognize revenue only when we satisfy a performance
obligation by transferring a promised good or service to a
customer.
Determining
the timing of the satisfaction of performance obligations as well
as the transaction price and the amounts allocated to performance
obligations requires judgement.
We
disclose disaggregation of our customer revenue by classes of
similar products and services as follows:
●
Software
licensing and royalties;
●
Sales of computer hardware and identification
media
;
●
Post-contract customer
support
.
Software Licensing and Royalties
Software licenses
consist of revenue from the sale of software for identity
management applications. Our software licenses are functional
intellectual property and typically provide customers with the
right to use our software in perpetuity as it exists when made
available to the customer. We recognize revenue from software
licensing at a point in time upon delivery, provided all other
revenue recognition criteria are met.
Royalties
consist of revenue from usage-based arrangements and guaranteed
minimum-based arrangements. We recognize revenue for royalty
arrangements at the later of (i) when the related sales occur, or
(ii) when the performance obligation to which some or all of the
royalty has been allocated has been satisfied.
Computer Hardware and Identification Media
We
generate revenue from the sale of computer hardware and
identification media. Revenue for these items is recognized upon
delivery of these products to the customer, provided all other
revenue recognition criteria are met.
Services
Services
revenue is comprised primarily of software customization services,
software integration services, system installation services and
customer training. Revenue is generally recognized upon completion
of services and customer acceptance provided all other revenue
recognition criteria are met.
Post-Contract Customer Support (“PCS”)
Post contract customer support consists of
maintenance on software and hardware for our identity management
solutions.
We recognize PCS revenue from periodic maintenance
agreements. Revenue is generally recognized ratably over the
respective maintenance periods provided no significant obligations
remain. Costs related to such contracts are expensed as
incurred.
Arrangements with Multiple Performance Obligations
A
performance obligation is a promise in a contract to transfer a
distinct good or service to the customer. In addition to selling
software licenses, hardware and identification media, services and
post-contract customer support on a standalone basis, certain
contracts include multiple performance obligations. For such
arrangements, we allocate revenue to each performance obligation
based on our best estimate of the relative standalone selling
price. The standalone selling price for a performance obligation is
the price at which we would sell a promised good or service
separately to a customer. The primary methods used to estimate
standalone selling price are as follows: (i) the expected cost-plus
margin approach, under which we forecast our expected costs of
satisfying a performance obligation and then add an appropriate
margin for that distinct good or service, and (ii) the percent
discount off of list price approach.
Contract Costs
We
recognize an asset for the incremental costs of obtaining a
contract with a customer if we expect the benefit of those costs to
be longer than one year. We apply a practical expedient to expense
costs as incurred for costs to obtain a contract when the
amortization period is one year or less.
Other Items
We
do not offer rights of return for our products and services in the
normal course of business.
Sales
tax collected from customers is excluded from revenue.
The
adoption of ASC 606 as of January 1, 2018 resulted in a cumulative
positive adjustment to beginning accumulated deficit and accounts
receivable of approximately $95,000. For the three and nine months
ended September 30, 2018, the adoption of ASC 606 resulted in a
reduction in royalty revenue of approximately $28,000 and $84,000,
respectively. The following table sets forth our disaggregated
revenue for the three months and nine months ended September 30,
2018 and 2017:
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
Net
Revenue
|
|
|
|
|
(dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
Software and
royalties
|
$
61
|
$
395
|
$
1,015
|
$
902
|
Hardware and
consumables
|
7
|
1
|
130
|
87
|
Services
|
10
|
29
|
212
|
116
|
Maintenance
|
658
|
659
|
1,980
|
1,967
|
Total
revenue
|
$
736
|
$
1,084
|
$
3,337
|
$
3,072
|
Customer Concentration
For the
three months ended September 30, 2018, two customers accounted for
approximately 41% or $302,000 of our total revenue and had trade
receivables at September 30, 2018 of $51,000. For the
nine months ended September 30, 2018, one customer accounted for
approximately 40% or $1,348,000 of our total revenue and had trade
receivables at September 30, 2018 of $0.
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.
Recently Issued Accounting Standards
From time to time, new accounting pronouncements
are issued by the Financial Accounting Standards Board
(“
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.
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 began commencement of
adoption planning in the third fiscal quarter of
2018.
FASB ASU No.
2016-13
. In June 2016, the FASB
issued Accounting Standard Update No. 2016-13,
Financial
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.
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.
2017-07.
Effective January
1, 2018, we adopted ASU No. 2017-07,
Compensation –
Retirement Benefits (Topic 715): Improving the Presentation of
Periodic Pension Cost and Net Periodic Postretirement Benefit
Cost
issued by the FASB, which
requires employers to present the service cost component of net
periodic benefit cost in the same income statement line item(s) as
other employee compensation costs arising from services rendered
during the period. The adoption of this standard did not have a
material effect on our 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.
FASB ASU No. 2018-07.
In June 2018, the FASB issued
ASU 2018-07, “
Shared-Based Payment Arrangements with
Nonemployees
”
(Topic
505)
, which simplifies the accounting for share-based
payments granted to nonemployees for goods and services. Under the
ASU, most of the guidance on such payments to nonemployees will be
aligned with the requirements for share-based payments granted to
employees. Under the ASU 2018-07, the measurement of
equity-classified nonemployee share-based payments will be fixed on
the grant date, as defined in ASC 718, and will use the term
nonemployee vesting period, rather than requisite service period.
The amendments in this update are effective for fiscal years
beginning after December 15, 2018, including interim periods within
those fiscal years. Early adoption is permitted if financial
statements have not yet been issued. The Company is currently
evaluating the impact of the adoption
of ASU 2018-07 on the Company’s financial
statements.
FASB ASU No.
2018-13
. In August 2018, the
FASB issued ASU 2018-13,
“Fair Value Measurement
(Topic 820) —Disclosure Framework —Changes to the
Disclosure Requirements for Fair Value
Measurement”
(“
ASU 2018-13
”). The amendments in this update improve
the effectiveness of fair value measurement disclosures. ASU
2018-13 is effective for fiscal years ending after December 15,
2019. Early adoption is permitted. The adoption of this standard
should be applied to all periods presented. The adoption of this
standard will not have a material impact on the Company’s
consolidated financial statements.
FASB ASU No.
2018-14
. In August 2018, the
FASB issued ASU 2018-14,
“Compensation
—Retirement Benefits —Defined Benefit Plans
—General (Subtopic 715-20) —Disclosure Framework
—Changes to the Disclosure Requirements for Defined Benefit
Plans”
(“
ASU 2018-14
”). The amendments in this update remove
defined benefit plan disclosures that are no longer considered
cost-beneficial, clarify the specific requirements of disclosures,
and add disclosure requirements identified as relevant. ASU 2018-14
is effective for fiscal years ending after December 15, 2020. Early
adoption is permitted. The adoption of this standard should be
applied to all periods presented. The adoption of this standard
will not have a material impact on the Company’s consolidated
financial statements.
FASB ASU No.
2018-15
. In August 2018, the
FASB issued ASU 2018-15,
“Intangibles
—Goodwill and Other —Internal-Use Software (Subtopic
350-40): Customer’s Accounting for Implementation Costs
Incurred in a Cloud Computing Arrangement That Is a Service
Contract”
(“
ASU 2018-15
”). The amendments in this update align the
requirements for capitalizing implementation costs incurred in a
hosting arrangement that is a service contract with the
requirements for capitalizing implementation costs incurred to
develop or obtain internal-use software (and hosting arrangements
that include an internal-use software license). ASU 2018-15 is
effective for fiscal years ending after December 15, 2019. Early
adoption is permitted. The adoption of this standard is not
expected to have a material impact on the Company’s
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.
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
|
$
(3,482
)
|
$
(2,390
)
|
$
(9,351
)
|
$
(7,668
)
|
|
(949
)
|
(553
)
|
(2,437
)
|
(1,575
)
|
Preferred
stock exchange
|
—
|
(1,245
)
|
—
|
(1,245
)
|
|
|
|
|
|
Net
loss available to common shareholders
|
$
(4,431
)
|
$
(4,188
)
|
$
(11,788
)
|
$
(10,488
)
|
|
|
|
|
|
Denominator
for basic and dilutive loss per share – weighted-average
shares outstanding
|
95,838,813
|
93,197,689
|
95,116,862
|
92,538,582
|
|
|
|
|
|
Net
loss
|
$
(0.04
)
|
$
(0.03
)
|
$
(0.10
)
|
$
(0.08
)
|
|
(0.01
)
|
(0.00
)
|
(0.02
)
|
(0.02
)
|
|
—
|
(0.01
)
|
—
|
(0.01
)
|
|
|
|
|
|
Basic
and diluted loss per share available to common
shareholders
|
$
(0.05
)
|
$
(0.04
)
|
$
(0.12
)
|
$
(0.11
)
|
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
|
Convertible
redeemable preferred stock
|
42,627,000
|
27,021,784
|
Stock
options
|
7,318,179
|
6,116,318
|
Warrants
|
1,763,856
|
150,000
|
Total potential
dilutive securities
|
51,709,035
|
38,406,168
|
NOTE 4. SELECT BALANCE SHEET DETAILS
Inventory
Inventories of $15,000 as of September 30, 2018 were comprised of
work in process of $2,000 representing direct labor costs on
in-process projects and finished goods of $13,000 net of reserves
for obsolete and slow-moving items of $3,000.
Inventories of $79,000 as of December 31, 2017 were comprised of
work in process of $30,000 representing direct labor costs on
in-process projects and finished goods of $26,000 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 $84,000 and $93,000 as of September 30, 2018 and December 31,
2017, respectively, which includes accumulated amortization of
$575,000 and $566,000 as of September 30, 2018 and December 31,
2017, respectively. Amortization expense for patent intangible
assets was $3,000 and $9,000 for the three and nine months ended
September 30, 2018 and 2017, respectively. Patent intangible assets
are being amortized on a straight-line basis over their remaining
life of approximately 7.5 years.
The
estimated acquired intangible amortization expense for the next
five fiscal years is as follows:
Fiscal Year Ended December 31,
|
Estimated
Amortization
Expense
($ in
thousands)
|
2018
(three months)
|
$
3
|
2019
|
12
|
2020
|
12
|
2021
|
12
|
2022
|
12
|
Thereafter
|
33
|
Totals
|
$
84
|
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, 2018 and December 31,
2017.
NOTE 5. LINES OF CREDIT WITH RELATED
PARTIES
Outstanding
lines of credit consist of the following:
($ in thousands)
|
|
|
Lines
of Credit with Related Parties
|
|
|
8% convertible lines of credit. Face value of
advances under lines of credit $0 and $6,000 at
September 30, 2018 and December 31, 2017,
respectively. Discount on advances under lines of credit was $0 at
September 30, 2018 and $226 at December 31, 2017. Maturity
date was December 31, 2018; however, the lines of credit were
terminated on September 10, 2018, as more thoroughly discussed
below.
|
$
—
|
$
5,774
|
|
|
|
Total
lines of credit to related parties
|
—
|
5,774
|
Less
current portion
|
—
|
(5,774
)
|
Long-term
lines of credit to related parties
|
$
—
|
$
—
|
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
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 of 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, 2018, the Company
recorded an aggregate of approximately $2,000 and $6,000 in
deferred financing fee amortization expense, respectively. During
the three and nine months ended September 30, 2017, the Company
recorded an aggregate of approximately $3,000 and $9,000 in
deferred financing fee amortization expense, respectively. 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 an
aggregate 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 of 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 $500,000 line of credit
with Crocker (the “
New Crocker
LOC
”) with available
borrowings of up to $500,000, 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 originally matured on June 30, 2017, and provided 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 Goldman
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.
On May 10, 2017,
Goldman and Crocker agreed to further extend the maturity dates of
the Goldman Line of Credit and the New Crocker Line of Credit
(collectively, the “
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 contained a contingent beneficial conversion feature,
i.e. an embedded conversion right that enabled the holder to obtain
the underlying Common Stock at a price below market value. The
beneficial conversion feature was contingent, as the terms of the
conversion did not permit the Company to compute the number of
shares that the holder would receive if the contingent event
occurred (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 borrowings under the Line of
Credit were to 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).
For the three and nine months ended September 30,
2018, the Company recorded approximately $9,000 and $30,000,
respectively,
in debt discount
attributable to beneficial conversion feature and accreted
approximately $44,000 and $162,000, respectively, of debt
discount.
Such expense is
recorded as a component of interest expense in the Company’s
condensed consolidated statements of
operations.
The Company incurred borrowings of $3,350,00
during the nine months ended September 30, 2017.
During the
three and nine months ended September 30, 2017, the Company
recorded approximately $292,000 in debt discount attributable to
beneficial conversion feature and accreted approximately $53,000
and $143,000, respectively, of debt discount.
Such expense is recorded as a component of
interest expense in the Company’s condensed consolidated
statements of operations.
The Company incurred no additional borrowings
under the Lines of Credit during the nine months ended September
30, 2018. On September 10, 2018, the Company entered into the
Exchange Agreements with Goldman and Crocker, pursuant to which
Goldman and Crocker agreed to exchange approximately $6.3 million
and $0.6 million, respectively, of outstanding debt (including
accrued and unpaid interest) owed under the terms of their
respective Lines of Credit for an aggregate of 6,896 shares of the
Company’s Series A Preferred. As a result of the Debt
Exchange, all indebtedness, liabilities and other obligations
arising under the Lines of Credit were terminated, cancelled and
deemed satisfied in full.
As a result, no future
borrowings are available under the Lines of Credit
and the Lines of Credit were
terminated on September 10, 2018. Because Messrs. Goldman and
Crocker are members of the Company’s Board of Directors and
shareholders of the Company, they are considered related parties
and the Debt Exchanage transaction is considered a capital
transaction and is recorded within the equity accounts of the
Company.
NOTE 6. MEZZANINE EQUITY
Series C Convertible Redeemable Preferred Stock
On September 10, 2018, the Company filed the
Certificate of Designations, Preferences, and Rights of Series C
Convertible Redeemable Preferred stock (the
“
Series C
COD
”) with the Secretary
of State for the State of Delaware – Division of
Corporations, designating 1,000 shares of the Company’s
preferred stock, par value $0.01 per share, as Series C Preferred,
each share with a stated value of $10,000 per share (the
“
Stated
Value
”). Shares of Series
C Preferred
accrue dividends
cumulatively and are payable quarterly at a rate of 8% per annum if
paid in cash, or 10% per annum if paid by the issuance of shares of
Common Stock. Each share of Series C Preferred has a liquidation
preference
equal to the
greater of (i) the Stated Value plus all accrued and unpaid
dividends, and (ii) such amount per share as would have been
payable had each share been converted into Common Stock immediately
prior to the occurrence of a Liquidation Event or Deemed
Liquidation Event. Each share of Series C Preferred is convertible
into that number of shares of the Company’s Common Stock
(“
Conversion
Shares
”) equal to the
Stated Value, divided by $1.00, which conversion rate is subject to
adjustment in accordance with the terms of the Series C COD.
Holders of Series C Preferred may elect to convert shares of Series
C Preferred into Conversion Shares at any time. Holders of the
Series C Preferred may also require the Company to redeem all or
any portion of such holder’s shares of Series C Preferred at
any time from and after the third anniversary of the issuance date
or in the event of the consummation of a Change of Control (as such
term is defined in the Series C COD). Subject to the terms and
conditions set forth in the Series C COD, in the event the
volume-weighted average price of the Company’s Common Stock
is at least $3.00 per share (subject to adjustment in accordance
with the terms of the Series C COD) for at least 20 consecutive
trading days, the Company may convert all, but not less than all,
issued and outstanding shares of Series C Preferred into Conversion
Shares. In addition, in the event of a Change of Control, the
Company will have the option to redeem all, but not less than all,
issued and outstanding shares of Series C Preferred for 115% of the
Liquidation Preference Amount per share. Holders of Series C
Preferred will have the right to vote, on an as-converted basis,
with the holders of the Company’s Common Stock on any matter
presented to the Company’s stockholders for their action or
consideration. Shares of Series C Preferred rank senior to the
Company’s Common Stock and Series A Preferred, and junior to
the Company’s Series B
Preferred.
On
September 10, 2018, the Company offered and sold a total of 890
shares of Series C Preferred at a purchase price of $10,000 per
share, and on September 21, 2018, the Company offered and sold an
additional 110 shares of Series C Preferred at a purchase price of
$10,000 per share. The total gross proceeds to the Company from the
Series C Financing were $10,000,000. Issuance costs incurred in
conjunction with the Series C Financing were approximately
$1,211,000. Such costs have been recorded as a discount on the
Series C Preferred Stock and will be accreted to the point of
earliest redemption which is the third anniversary of the Series C
Financing or September 10, 2021 using the effective interest rate
method. The accretion of these costs is recorded as a deemed
dividend.
The Company had 1,000 shares of Series C Preferred
outstanding as of September 30, 2018.
The Company issued the
holders of Series C Preferred
55,736
shares of Common Stock
on September 30, 2018, as payment of dividends due on that
date.
Guidance for
accounting for freestanding financial instruments that contain
characteristics of both liabilities and equity are contained in ASC
480,
Distinguishing Liabilities
From Equity
and Accounting
Series Release 268 (“
ASR 268
”)
Redeemable Preferred
Stocks.
The Company evaluated
the provisions of the Series C Preferred and determined that the
provisions of the Series C Preferred grant the holders of the
Series C Preferred a redemption right whereby the holders of the
Series C Preferred may, at any time after the third anniversary of
the Series C Preferred issuance, require the Company to redeem in
cash any or all of the holder’s outstanding Series C
Preferred at an amount equal to the Liquidation Preference Amount
(“
Liquidation Preference
Amount
”). The Liquidation
Preference Amount is defined as the greater of the stated value of
the Series C Preferred plus any accrued unpaid interest or such
amount per share as would have been payable had each such share
been converted into Common Stock. In the event of a Change of
Control, the holders of Series C Preferred shall have the right to
require the Company to redeem in cash all or any portion of such
holder’s shares at the Liquidation Preference Amount. The
Company has concluded that because the redemption features of the
Series C Preferred are outside of the control of the Company, the
instrument is to be recorded as temporary or mezzanine equity in
accordance with the provisions of ASR
268.
The Company noted
that the Series C Preferred Stock instrument was a hybrid
instrument that contains several embedded features. In November
2014, the FASB issued ASU 2014-16 to amend ASC 815,
“
Derivatives and
Hedging
,” (“
ASC
815
”) and require the use of the whole instrument
approach (described below) to determine whether the nature of the
host contract in a hybrid instrument issued in the form of a share
is more akin to debt or to equity. ASU 2014-16 is effective for
public business entities for fiscal years, and interim periods
within those years, beginning after December 15,
2015.
The whole
instrument approach requires an issuer or investor to consider the
economic characteristics and risks of the entire hybrid instrument,
including all of its stated and implied substantive terms and
features. Under this approach, all stated and implied features,
including the embedded feature being evaluated for bifurcation,
must be considered. Each term and feature should be weighed based
on the relevant facts and circumstances to determine the nature of
the host contract. This approach results in a single, consistent
determination of the nature of the host contract, which is then
used to evaluate each embedded feature for bifurcation. That is,
the host contract does not change as each feature is
evaluated.
The
revised guidance further clarifies that the existence or omission
of any single feature, including an investor-held, fixed-price,
noncontingent redemption option, does not determine the economic
characteristics and risks of the host contract. Instead, an entity
must base that determination on an evaluation of the entire hybrid
instrument, including all substantive terms and
features.
However, an
individual term or feature may be weighed more heavily in the
evaluation based on facts and circumstances. An evaluation of all
relevant terms and features, including the circumstances
surrounding the issuance or acquisition of the equity share, as
well as the likelihood that an issuer or investor is expected to
exercise any options within the host contract, to determine the
nature of the host contract, requires judgement.
Using
the whole instrument approach, the Company concluded that the host
instrument is more akin to debt than equity as the majority of
identified features contain more characteristics of
debt.
The
Company evaluated the identified embedded features of the Series C
Preferred host instrument and determined that certain features meet
the definition of and contained the characteristics of derivative
financial instruments requiring bifurcation at fair value from the
host instrument.
Accordingly, the
Company has bifurcated from the Series C Preferred host instrument
the conversion options, redemption option and participating
dividend feature in accordance with the guidance in ASC 815. These
bifurcated features aggregated approximately $833,000 at issuance
and have been recorded as a discount to the Series C Preferred.
Such amount will be accreted
to the
point of earliest redemption which is the third anniversary of the
Series C Financing or September 10, 2021 using the effective
interest rate method. The accretion of these features is recorded
as a deemed dividend.
For the
three and nine months ended September 30, 2018 the Company recorded
the accretion of debt issuance costs and derivative liabilities
aggregating approximately $11,000 using the effective interest rate
method.
NOTE 7. DERIVATIVE LIABILITIES
The Company accounts
for its derivative instruments under the provisions of ASC
815, “
Derivatives
and Hedging
.” Under the
provisions of ASC 815, the Company identified embedded features
within the Series C Preferred host contract that
qualify
as derivative instruments and require
bifurcation.
The
Company determined that the conversion option, redemption option
and participating dividend feature contained in the Series C
Preferred host instrument required bifurcation. The Company valued
the bifurcatable features at fair value. Such liabilities
aggregated approximately $833,000 at inception and are classified
as current liabilities on the Company’s condensed
consolidated balance sheet under the caption “Derivative
liabilities.” The Company will revalue these features at each
balance sheet date and record any change in fair value in the
determination of period net income or loss. Such amounts are
recorded in the caption “Change in fair value of derivative
liabilities” in the Company’s consolidated statement of
operations. During the three and nine months ended September 30,
2018, the Company recorded an increase to these derivative
liabilities using fair value methodologies of approximately
$186,000.
NOTE 8. EQUITY
The
Company’s Certificate of Incorporation, as amended,
authorizes 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 (“
Conversion
Shares
”). 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 “
Series A
Financing
”). 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,
the “
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
(the “
Preferred Stock
Exchange
”). 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
performed 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
year ended December 31, 2017.
On
September 10, 2018, the Company filed an Amendment to the
Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock with the Delaware Division of
Corporations to increase the number of shares of Series A Preferred
authorized for issuance thereunder to 38,000 shares.
On
September 10, 2018, the Company entered into the Exchange
Agreements with Goldman and Crocker, pursuant to which Goldman and
Crocker agreed to exchange approximately $6.3 million and $0.6
million, respectively, of outstanding debt (including accrued and
unpaid interest) owed under the terms of their respective Lines of
Credit for an aggregate of 6,896 shares of Series A
Preferred.
On September 10, 2018 the Company’s Board of
Directors also declared a Special Dividend for Holders of the
Series A Preferred, pursuant to which each Holder received a
Dividend Warrant to purchase 39.87 shares of Common Stock for every
share of Series A Preferred held, which resulted in the issuance of
Dividend Warrants to the Holders as a group to purchase an
aggregate of 1,493,856 shares of Common Stock. Each Dividend
Warrant has an exercise price of $0.01 per share, and is
exercisable immediately upon issuance;
provided,
however
, that a Dividend
Warrant may only be exercised concurrently with the conversion
of shares of Series A Preferred held by a Holder into shares of
Common Stock. In addition, each Dividend Warrant held by a Holder
shall expire on the earliest to occur of (i) the conversion of all
Series A Preferred held by such Holder into Common Stock, (ii) the
redemption by the Company of all outstanding shares of Series A
Preferred held by such Holder, (iii) the Dividend Warrant no longer
representing the right to purchase any shares of Common Stock, and
(iv) the tenth anniversary of the date of
issuance.
The
Company evaluated this warrant issuance in conjunction with the
Series A Preferred becoming junior to the Series C Preferred in
liquidation preference and determined such warrants and changes in
liquidation preference to be in effect a modification of the Series
A Preferred. To determine the effect of this modification, the
Company, using fair value methodologies, determined the value of
the Series A Preferred both pre and post warrant issuance. The
valuation indicated an increase in the fair value of the Series A
Preferred post issuance of approximately $92,000. The Company
recorded this incremental increase as a deemed
dividend.
The Company had 37,467 shares and 31,021 shares of
Series A Preferred outstanding as of September 30, 2018 and
December 31, 2017, respectively. At September 30, 2018 and
December 31, 2017, the Company had cumulative undeclared dividends
of $0.
During the nine months ended September 30, 2018
certain holders of Series A Preferred converted 450 shares of
Series A Preferred into 391,304 shares of the Company’s
Common Stock.
The Company issued the
holders of Series A Preferred
472,562, 648,696
and
832,835
shares of
Common Stock on March 31, 2018, June 30, 2018 and September 30,
2018, respectively, 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, par value $0.01 per share
(“
Series B
Preferred
”), outstanding
as of September 30, 2018 and December 31, 2017. At September 30,
2018 and December 31, 2017, the Company had cumulative undeclared
dividends of approximately $21,000 and $8,000, respectively. There
were no conversions of Series B Preferred into Common Stock during
the nine months ended September 30, 2018 and 2017. The Company paid
dividends of approximately $51,000 to the holders of our Series B
Preferred during the twelve months ended December 31, 2017, and
approximately $25,000 during the nine months ended September 30,
2018.
Common Stock
On February 8,
2018, the Company filed with the Secretary of the State of Delaware
a Certificate of Amendment to its Certificate of Incorporation, as
amended, to increase the authorized number of shares of its Common
Stock to from 150,000,000 shares to 175,000,000
shares.
The
following table summarizes Common Stock activity for the nine
months ended September 30, 2018:
|
|
Shares
outstanding at December 31, 2017
|
94,167,836
|
Shares
issued as payment of stock dividend on Series A
Preferred
|
1,954,093
|
Shares
issued as payment of stock dividend on Series C
Preferred
|
55,736
|
Shares
issued pursuant to conversion of Series A Preferred
|
391,304
|
Shares
issued pursuant to option exercises
|
148,757
|
Shares
outstanding at September 30, 2018
|
96,717,726
|
Warrants
The
following table summarizes warrant activity for the following
periods:
|
|
Weighted- Average
Exercise Price
|
Balance
at December 31, 2017
|
230,000
|
$
0.91
|
Granted
|
1,533,856
|
0.05
|
Expired/Canceled
|
—
|
—
|
Exercised
|
—
|
—
|
Balance
at September 30, 2018
|
1,763,856
|
$
0.16
|
As of September 30, 2018, warrants to purchase 1,763,856 shares of
Common Stock at exercise prices ranging from $0.01 to $1.46 were
outstanding. All warrants are exercisable as of September 30, 2018
except for an aggregate of 1,643,856 warrants, which become
exercisable only upon the attainment of specified events, and
20,000 warrants that become exercisable on June 7, 2019. Such
warrants expire at various dates through September 2028. The
intrinsic value of warrants outstanding at September 30, 2018 was
approximately $22,500. The Company has excluded from this
computation any intrinsic value of the 1,426,725 warrants issued to
the Series A Preferred stockholders due to the conversion exercise
contingency more fully described below.
As discussed above, on September 10, 2018 the
Company’s Board of Directors declared a Special Dividend for
Holders of the Series A Preferred, pursuant to which each Holder
received a Dividend Warrant to purchase 39.87 shares of Common
Stock for every share of Series A Preferred held, which resulted in
the issuance of Dividend Warrants to the Holders as a group to
purchase an aggregate of 1,493,856 shares of Common Stock. Each
Dividend Warrant has an exercise price of $0.01 per share, and is
exercisable immediately upon issuance;
provided,
however
, that a Dividend
Warrant may only be exercised concurrently with the conversion
of shares of Series A Preferred held by a Holder into shares of
Common Stock. In addition, each Dividend Warrant held by a Holder
shall expire on the earliest to occur of (i) the conversion of all
Series A Preferred held by such Holder into Common Stock, (ii) the
redemption by the Company of all outstanding shares of Series A
Preferred held by such Holder, (iii) the Dividend Warrant no longer
representing the right to purchase any shares of Common Stock, and
(iv) the tenth anniversary of the date of issuance.
The
accounting treatment for the issuance of these warrants is
discussed above in the Company’s description of its Series A
Preferred Stock.
Stock-Based Compensation
The Company’s 1999 Stock Award
Plan (the “
1999 Plan
”) was adopted by the Company’s Board
of Directors on December 17, 1999. Under the terms of the 1999
Plan, the Company could, originally, issue up to 350,000
non-qualified or incentive stock options to purchase Common Stock
of the Company. During the year ended December 31, 2014, the
Company subsequently amended and restated the 1999 Plan, whereby it
increased the share reserve for issuance to approximately 7.0
million shares of the Company’s Common Stock. Subsequently,
in February 2018, the Company amended and restated the 1999 Plan,
whereby it increased the share reserve for issuance by an
additional 2.0 million shares. 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. The number of authorized shares available for issuance under
the plan at September 30, 2018 was
726,841.
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 $227,000 and $774,000
for the three and nine months ended September 30, 2018,
respectively. 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 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 $80,000 and $240,000
for the three and nine months ended September 30, 2018,
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 $35,000 and $105,000 for the
three and nine months ended September 30, 2017,
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, 2018 and 2017
ranged from 58% to 64%. 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, 2018 and 2017 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.
The interest rate used
in the Company’s Black-Scholes calculations for the nine
months ended September 30, 2018 and 2017 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, 2017
|
6,093,512
|
$
1.23
|
Granted
|
1,505,500
|
$
1.69
|
Expired/Cancelled
|
(132,076
)
|
$
0.83
|
Exercised
|
(148,757
)
|
$
1.00
|
Balance
at September 30, 2018
|
7,318,179
|
$
1.32
|
The intrinsic value of options exercisable at
September 30, 2018 was approximately $412,000. The aggregate
intrinsic value for all options outstanding as of September 30,
2018 was approximately $412,000.
The weighted-average grant-date per share fair
value of options granted during the three and nine months ended
September 30, 2018 was $0.55 and $0.95, respectively. The
weighted-average grant-date per share fair value of options granted
during the three and nine months ended September 30, 2017 was $0.87
and $0.56, respectively.
At
September 30, 2018, the total remaining unrecognized compensation
cost related to unvested stock options amounted to approximately
$1,235,000, which will be recognized over a weighted-average period
of 2.0 years.
In
January 2018, the Company issued an aggregate of 324,000 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 on the Board from January 1, 2018 through December
31, 2018. Such options vest at the rate of 27,000 options per month
on the last day of each month during the 2018 year. The options
have an exercise price of $1.75 per share and a term of 10 years.
Pursuant to this issuance, the Company recorded compensation
expense of approximately $80,000 and $240,000 during the three and
nine months ended September 30, 2018, respectively, based on the
grant-date fair value of the options determined using the
Black-Scholes option-valuation model.
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
|
$
16
|
$
14
|
General
and administrative
|
202
|
163
|
663
|
493
|
Sales
and marketing
|
52
|
55
|
175
|
165
|
|
49
|
50
|
160
|
151
|
|
|
|
|
|
Total
|
$
308
|
$
273
|
$
1,014
|
$
823
|
NOTE 9. 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, 2018
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$
1,743
|
$
1,743
|
$
—
|
$
—
|
Totals
|
$
1,743
|
$
1,743
|
$
—
|
$
—
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
$
1,019
|
$
—
|
$
—
|
$
1,019
|
Totals
|
$
1,019
|
$
—
|
$
—
|
$
1,019
|
|
Fair Value at December 31, 2017
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$
1,806
|
$
1,806
|
$
—
|
$
—
|
Totals
|
$
1,806
|
$
1,806
|
$
—
|
$
—
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
$
—
|
$
—
|
$
—
|
$
—
|
Totals
|
$
—
|
$
—
|
$
—
|
$
—
|
As of September 30, 2018, the Company had embedded
features contained in the Series C Preferred host instrument
(issued in September 2018) that qualified
for derivative liability treatment. The
recorded fair market value of these features at September 30, 2018
was approximately $1,019,000, which is reflected as a current
liability in the consolidated balance sheet as of September 30,
2018. The fair value of the
Company’s derivative liabilities are classified
within Level 3 of the fair value hierarchy because they are valued
using pricing models that incorporate management assumptions that
cannot be corroborated with observable market data. The
Company uses the lattice framework, Monte-Carlo simulations and
other fair value methodologies in the determination of the fair
value of
derivative liabilities.
The aforementioned fair value methodologies are
affected by the Company’s stock price as well as assumptions
regarding the expected stock price volatility over the term of the
derivative
liabilities in
addition to the probability of future events.
The
Company monitors the activity within each level and any changes
with the underlying valuation techniques or inputs utilized to
recognize if any transfers between levels are
necessary. That determination is made, in part, by
working with outside valuation experts for Level 3 instruments and
monitoring market related data and other valuation inputs for Level
1 and Level 2 instruments.
A
reconciliation of the Company’s liabilities measured at fair
value on a recurring basis using significant unobservable inputs
(Level 3) is as follows:
|
|
|
|
Balance at
December 31, 2017
|
$
—
|
Total unrealized
gains
|
—
|
Included in
earnings
|
186
|
Settlements
|
—
|
Issuances
|
833
|
Transfers in and/or
out of Level 3
|
—
|
Balance at
September 30, 2018
|
$
1,019
|
All unrealized gains or losses resulting from
changes in value of any Level 3 instruments are reflected as a
separate line in the condensed consolidated statement of operations
in arriving at net income (loss). The Company is not a
party to any hedge arrangements, commodity swap agreement or any
other derivative
financial
instruments.
NOTE 10. RELATED PARTY TRANSACTIONS
Lines of Credit
Prior to their termination on September 10, 2018,
the Company had certain Lines of Credit extended by certain members
of the Company’s Board of Directors. On September 10, 2018,
the Company entered into Exchange Agreements with Neal Goldman and
Charles Crocker, pursuant to which Messrs. Goldman and Crocker
agreed to exchange approximately $6.3 million and $0.6 million,
respectively, of outstanding debt (including accrued and unpaid
interest) owed under the terms of their respective lines of credit
for an aggregate of 6,896 shares of Series A Preferred. As a result
of the Debt Exchange, all indebtedness, liabilities and other
obligations arising under the respective lines of credit were
cancelled and deemed satisfied in full. For a more detailed
discussion of the Lines of Credit and Debt Exchange, see Note 5,
“
Lines of
Credit
.”
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 during
2017, 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 11. CONTINGENT LIABILITIES
Employment Agreements
The
Company has employment agreements with its Chief Executive 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 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 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 it occupies 8,511 square feet of office
space at a cost of approximately $30,000 per month. This
facility’s lease was entered into by the Company in July
2018. This new lease commenced on November 1, 2018 and terminates
on April 30, 2025. In addition to its corporate headquarters, the
Company also occupied the following spaces at September 30,
2018:
●
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;
●
9,720
square feet in Portland, Oregon, at a cost of approximately $22,000
per month until the expiration of the lease on February 28, 2023;
and
●
304
square feet of office space in Mexico City, Mexico, at a cost of
approximately $3,000 per month until November 30,
2018.
Prior
to entering into the new lease agreement in July 2018 and moving
its corporate headquarters to a new location, the Company occupied
9,927 of office space in San Diego, at a cost of approximately
$30,000 per month.
At
September 30, 2018, future minimum lease payments are as
follows:
($ in thousands)
|
|
2018 (three months)
|
$
147
|
2019
|
464
|
2020
|
634
|
2021
|
625
|
2022
|
635
|
Thereafter
|
940
|
Total
|
$
3,445
|
Rental
expense incurred under operating leases for the nine months ended
September 30, 2018 and 2017 was approximately $522,000 and
$389,000, respectively.
NOTE 12. SUBSEQUENT EVENTS
During October and November 2018, the Company issued 82,095 shares
of Common Stock pursuant to the exercise of 82,095 option,
resulting in proceeds to the Company of approximately
$14,000.