NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. DESCRIPTION OF
BUSINESS AND OPERATIONS
Overview
As
used in this Report, “we”, “us”,
“our”, “ImageWare”, “ImageWare
Systems” or the “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.
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. 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 expense 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
positive cash flows from operations. Historically the Company has
not been able to generate sufficient net revenue to achieve and
sustain positive cash flows from operations and management has
determined that there is substantial doubt about the
Company’s ability to continue as a going
concern.
Related Party Financings
On
February 12, 2020, the Company entered into a factoring agreement
with a member of the Company’s Board of Directors for
$350,000. Such amount is to be repaid with the proceeds from
certain of the Company’s trade accounts receivable
approximating $500,000 and were due no later than 21 days after
February 12, 2020. As of August 19, 2020, despite collection of the
Company’s trade accounts receivable, $315,000 of such amounts
have not been repaid and the Company is seeking an extension from
the Board member. During the three and six months ended June 30,
2020, the Company recorded approximately $46,000 and $70,000,
respectively in interest expense related to this factoring
agreement. In May 2020, the Company repaid $35,000 in accrued
interest to the Board member. Accrued unpaid interest at June 30,
2020 approximated $70,000 and is included in the Company’s
condensed consolidated June 30, 2020 balance sheet under the
caption “Accrued expense”.
During the three months ended June 30, 2020, two members
of the Company's Board of Directors advanced the Company an
aggregate amount of $550,000. On June 29, 2020, the Company entered into
promissory notes (the "Notes") in the principal amounts of $450,000 and
$100,000, payable to the directors, reflecting the amounts advanced
to the Company. The Notes are convertible into shares of the
Company’s common stock, par value $0.01 per share
(“Common
Stock”), at $0.16 per
share. The Notes bear interest at the rate of 5% per annum and
mature on the earlier to occur of October 13, 2020 or on such date
that the Company consummates a debt and/or equity financing
resulting in net proceeds to the Company of at least $3.0
million. During the three and six months ended June 30, 2020, the Company recorded
approximately $2,000 in interest expense related to the Notes.
Accrued unpaid interest at June 30, 2020 approximated $2,000 and is
included in the Company’s condensed consolidated balance
sheet under the caption “Accrued
expense”.
2020 Common Stock Financings
Triton Funds LP
On February 20, 2020, the Company entered into a
securities purchase agreement (the “Triton Purchase
Agreement”) with Triton
Funds LP, a Delaware limited partnership ("Triton" or the "Investor"). The Triton Purchase Agreement provides the
Company the right to sell to Triton, and Triton is obligated to
purchase, up to $2.0 million worth of shares of Common Stock under
the Triton Purchase Agreement (the "Offering”). Pursuant to the terms and conditions set
forth in the Triton Purchase Agreement, the purchase price of the
Common Stock will be based on the number of shares of Common Stock
equal to the amount in U.S. Dollars that the Company intends to
sell to the Investor to be set forth in each written notice sent to
the Investor by the Company (the "Purchase
Notice") and delivered to the
Investor (the "Purchase Notice
Amount"), divided by the lowest
daily volume weighted average price of the Company's Common stock
listed on the OTC Markets during the five business days prior to
closing (the "Purchased
Shares"). The Closing of the
purchase of the Purchased Shares as set forth in the Purchase
Notice will occur no later than three business days following
receipt of the Purchased Shares by the
Investor.
In
February and March of 2020, the Company sold, and Triton purchased,
an aggregate of 10,000,000 shares of Common Stock for cash. In
February, the Company sold 4,000,000 shares of Common Stock for
$0.16 per share resulting in gross proceeds to the Company of
$640,000. In March 2020, the Company sold 6,000,000 shares of
Common Stock resulting in gross proceeds to the Company of
$765,000, or a per share purchase price of $0.13 per share.
Aggregate net proceeds from this financing approximated $1,387,000
after recognition of direct offering costs.
Lincoln Park Capital Fund, LLC
On April 28, 2020, the Company entered into a
purchase agreement, as amended on June 11, 2020 (the
“Purchase
Agreement”), and a
registration rights agreement (the “Registration Rights
Agreement”) with Lincoln
Park Capital fund, LLC (“Lincoln
Park”) pursuant to which
Lincoln Park committed to purchase up to $10,250,000 of our Common
Stock.
Under the terms and subject to the conditions of
the Purchase Agreement, including stockholder approval of an
amendment to the Company’s Certificate of Incorporation to
increase the number of shares of the Company’s capital stock
to 350 million shares, obtained from our shareholders effective
June 9, 2020, we have the right, but
not the obligation, to sell to Lincoln Park, and Lincoln Park is
obligated to purchase up to $10,250,000 of shares of Common Stock.
On April 28, 2020, we sold 1,000,000 shares of Common Stock to
Lincoln Park under the Purchase Agreement for an aggregate purchase
price of $100,000 (the “Initial Purchase
Shares)”. On June 11,
2020, we sold an additional 1,500,000 shares of Common Stock to
Lincoln Park under the Purchase Agreement for an aggregate purchase
price of $150,000 (the “Commencement Purchase
Shares”). Future sales of
Common Stock under the Purchase Agreement, if any, will be subject
to certain limitations, and may occur from time to time, at our
sole discretion, over the 24-month period commencing on the date
that a registration statement of which this prospectus forms a
part, which we agreed to file with the Securities and Exchange
Commission (the “SEC”) pursuant to the Registration Rights
Agreement, is declared effective by the SEC and a final prospectus
in connection therewith is filed and the other conditions set forth
in the Purchase Agreement are satisfied (such date on which all of
such conditions are satisfied, the “Commencement
Date”).
After the Commencement Date, on any business day
over the term of the Purchase Agreement, the Company has the right,
in its sole discretion, to direct Lincoln Park to purchase up to
125,000 shares on such business day (the “Regular
Purchase”), subject to
increases under certain circumstances as provided in the Purchase
Agreement. The purchase price per share for each such Regular
Purchase will be based on prevailing market prices of the
Company’s Common Stock immediately preceding the time of sale
as computed under the Purchase Agreement. In each case, Lincoln
Park’s maximum commitment in any single Regular Purchase may
not exceed $500,000. In addition to Regular Purchases, provided
that the Company presents Lincoln Park with a purchase notice for
the full amount allowed for a Regular Purchase, the Company may
also direct Lincoln Park to make accelerated purchases and additional accelerated
purchases as described in the Purchase Agreement.
Pursuant to the
terms of the Purchase Agreement, in no event may the Company issue
or sell to Lincoln Park under the shares of Common Stock under the
Purchase Agreement which, when aggregated with all other shares of
Common Stock then beneficially owned by Lincoln Park and its
affiliates (as calculated pursuant to Section 13(d) of the Exchange
Act and Rule 13d-3 promulgated thereunder), would result in the
beneficial ownership by the Investor and its affiliates of more
than 4.99% of the then issued and outstanding shares of Common
Stock (the “Beneficial
Ownership Limitation”).
The
Purchase Agreement and the Registration Rights Agreement contain
customary representations, warranties, agreements and conditions
and indemnification obligations of the parties. The Company has the
right to terminate the Purchase Agreement at any time, at no cost
or penalty. The Company issued to Lincoln Park 2,500,000 shares of
Common Stock in consideration for entering into the Purchase
Agreement. Pursuant to this issuance, $400,000 was recorded by the
Company as a deferred stock issuance cost. Such amount is recorded
in the Company’s condensed consolidated June 30, 2020 balance
sheet under the caption “Other assets”. Such deferred
stock issuance costs will be recognized as a charge against paid in
capital in proportion to securities sold under this Purchase
Agreement. During the three months ended June 30, 2020, the Company
recognized approximately $10,000 as a charge against paid in
capital relating to securities sold under the Lincoln Park Purchase
Agreement.
Due
to the terms of the Purchase Agreement as described above,
management is not currently expecting the related proceeds from the
Purchase Agreement to be sufficient to sustain operations for an
extended period of time.
Subsequent
to June 30, 2020 and through August 19, 2020, the Company sold an
aggregate 3,200,000 shares of Common Stock to Lincoln Park under
the terms of the Purchase Agreement resulting in cash proceeds to
the Company of approximately $669,000.
CARES Act Financing
On March 27, 2020, President Trump signed into law
the “Coronavirus Aid, Relief and Economic Security Act
(“CARES Act”). On May 4, 2020, the Company entered into
a loan agreement (the “PPP Loan”)
with Comerica Bank (“Comerica”) under the Paycheck Protection Program
(the “PPP”), which is part of the CARES Act
administered by the United States Small Business Administration
(“SBA”). As part of the application for these
funds, the Company in good faith, has certified that the current
economic uncertainty made the loan request necessary to support the
ongoing operations of the Company. This certification further
requires the Company to take into account our current business
activity and our ability to access other sources of liquidity
sufficient to support ongoing operations in a manner that is not
significantly detrimental to the business. Under the PPP, the
Company received proceeds of approximately $1,571,000, from
the PPP Loan. In accordance with the requirements of
the PPP, the Company intends to use proceeds from
the PPP Loan primarily for payroll costs, rent and
utilities. The PPP Loan has a 1.00% interest rate per
annum, matures on May 4, 2022 and is subject to the terms and
conditions applicable to loans administered by the SBA under
the PPP. Under the terms of PPP, all or certain amounts
of the PPP Loan may be forgiven if they are used for
qualifying expenses as described in the CARES Act, which the
Company continues to evaluate. The Company has recorded the entire
amount of the PPP Loan as debt. Under the terms of the PPP Loan,
monthly payments of principal and interest commence November 1,
2020. At June 30, 2020, the Company has recorded the current
portion of the PPP Loan of approximately $517,000 as a current
liability under the caption “Notes payable - bank, current
portion” in its condensed consolidated balance sheet. The
remaining portion of approximately $1,054,000 is recorded as a
long-term liability under the caption “Note payable –
bank, net of current portion” in its condensed consolidated
June 30, 2020 balance sheet.
Amendment to Certificate of Incorporation
On June 9, 2020, the Company amended its
Certificate of Incorporation, as amended (the
“Charter’) to increase the number of shares of the
Company’s Common Stock and the number of shares of the
Company’s preferred stock, par value $0.01 per share
(“Preferred
Stock”) authorized
thereunder from an aggregate of 179 million to 350 million,
consisting of 345 million shares of Common Stock and 5 million
shares of Preferred Stock.
Going Concern
At
June 30, 2020, we had negative working capital of approximately
$6,950,000. Our principal sources of liquidity at June 30, 2020
consisted of approximately $431,000 of cash and cash
equivalents.
On
March 11, 2020, the World Health Organization declared
the COVID-19 outbreak a pandemic.
The COVID-19 pandemic is affecting the United States and
global economies and may affect the Company's operations and those
of third parties on which the Company relies. Additionally, as the
duration of the COVID-19 pandemic is difficult to assess
or predict, the impact of the COVID-19 pandemic on the
financial markets may reduce our ability to access capital, which
could negatively impact the Company's short-term and long-term
liquidity. These effects could have a material impact on the
Company's liquidity, capital resources, operations and business and
those of the third parties on which the Company
relies.
Considering the financings consummated in 2020, as
well as our projected cash requirements, and assuming we are unable
to generate incremental revenue, our available cash will be
insufficient to satisfy our cash requirements for the next twelve
months from the date of this filing. At August 17, 2020, cash on
hand approximated $351,000.Based on the Company’s rate of cash
consumption in the first six months of 2020, the Company will need
additional capital in the third quarter of 2020 and its prospects
for obtaining that capital are uncertain. As a result of the
Company’s historical losses and financial condition, there is
substantial doubt about the Company’s ability to continue as
a going concern.
To address our working capital requirements,
management has instituted several cost cutting measures and has
utilized cash proceeds available under the Lincoln Park facility to
satisfy its working capital requirements. Additionally, management
has consummated a restructuring of its Series A Convertible
Preferred Stock ("Series A
Preferred"), and is negotiating with holders of its Series C
Convertible Preferred Stock (“Series C
Preferred”) to
restructure the same to facilitate additional equity and/or debt
financing, and may seek strategic or other transactions intended to
provide necessary working capital and increase shareholder value.
There are currently no agreements with the holders of our Series C
Preferred or 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 such efforts, including our
ability to raise 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 condensed 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. Therefore, management’s
plans do not alleviate the substantial doubt regarding the
Company’s ability to continue as a going
concern.
The
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, 2019, 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 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, 2019, which are included in the
Company’s Annual Report on Form 10-K for the year ended
December 31, 2019 as filed with the SEC on May 15,
2020.
Operating
results for the three and six months ended June 30, 2020 are not
necessarily indicative of the results that may be expected for the
year ending December 31, 2020, or any other future
periods.
Significant Accounting Policies
Principles of Consolidation
The
condensed 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.
Operating Cycle
Assets
and liabilities related to long-term contracts are included in
current assets and current liabilities in the accompanying
condensed consolidated balance sheets, although they will be
liquidated in the normal course of contract completion which may
take more than one operating cycle.
Use of Estimates
The preparation of the condensed
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 condensed
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, assumptions used in the application of revenue
recognition policies, assumptions used in the derivation of the
Company’s incremental borrowing rate used in the computation
of the Company’s operating lease liabilities 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.
Property, Equipment and Leasehold Improvements
Property
and equipment, consisting of furniture and equipment, are stated at
cost and are being depreciated on a straight-line basis over the
estimated useful lives of the assets, which generally range from
three to five years. Maintenance and repairs are charged to expense
as incurred. Major renewals or improvements are capitalized. When
assets are sold or abandoned, the cost and related accumulated
depreciation are removed from the accounts and the resulting gain
or loss is recognized. Expenditures for leasehold improvements are
capitalized. Amortization of leasehold improvements is computed
using the straight-line method over the shorter of the remaining
lease term or the estimated useful lives of the
improvements.
Fair Value of Financial Instruments
For
certain of the Company’s financial instruments, including
accounts receivable, accounts payable, accrued expense, and
deferred revenue, the carrying amounts approximate fair value due
to their relatively short maturities.
Lease Liabilities and Operating Lease Right-of-Use
Assets
The
Company is a party to certain contractual arrangements for office
space which meet the definition of leases under Accounting
Standards Codification (“ASC”) Topic 842 – Leases
(“ASC 842”). In
accordance with ASC 842, the Company has determined that such
arrangements are operating leases and accordingly the Company has,
as of January 1, 2019, recorded operating lease right-of-use assets
and related lease liability for the present value of the lease
payments over the lease terms using the Company’s estimated
weighted-average incremental borrowing rate of approximately 14.5%
using a capital asset pricing model. The Company has utilized the
practical expedient regarding lease and nonlease components and has
combined such items into a single combined component. The Company
has also utilized the practical expedient regarding leases of
twelve months or less and has excluded such leases from its
computation of lease liability and related right-of-use assets. The
Company has also elected the optional transition package of
practical expedients which include:
A
package of practical expedients to not reassess:
●
Whether
a contract is or contains a lease
●
Lease
classification, and
Revenue Recognition
Effective January 1, 2018, we adopted ASC 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. At June 30, 2020 and
December 31, 2019, we had capitalized incremental costs of
obtaining a contract with a customer of approximately $118,000. We
recorded no additional contract costs during the three and six
months ended June 30, 2020. Additionally, we recognized no revenue
during the three and six months ended June 30, 2020 that was
related to contract costs at the beginning of the
period.
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
following table sets forth our disaggregated revenue for the three
and six months ended June 30, 2020 and 2019:
|
Three
Months Ended
June
30,
|
Six
Months Ended
June
30,
|
Net
Revenue
|
|
|
|
|
(dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
Software and
royalties
|
$68
|
$122
|
$193
|
$234
|
Hardware and
consumables
|
47
|
27
|
62
|
38
|
Services
|
6
|
11
|
17
|
166
|
Maintenance
|
612
|
652
|
1,257
|
1,305
|
Total
revenue
|
$733
|
$812
|
$1,529
|
$1,743
|
Customer Concentration
For the
three months ended June 30, 2020, one customer accounted for
approximately 30% or $216,000 of our total revenue and had trade
receivables at June 30, 2020 of $0. For the six months ended June
30, 2020, one customer accounted for approximately 28% or $433,000
of our total revenue and had trade receivables at June 30, 2020 of
$0.
For the
three months ended June 30, 2019, one customer accounted for
approximately 27% or $216,000 of our total revenue and had trade
receivables at June 30, 2019 of $0. For the six months
ended June 30, 2019, two customers accounted for approximately 41%
or $717,000 of our total revenue and had trade receivables at June
30, 2019 of $161,000.
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 Accounting Standards
Update (‘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.
2019-12. In December 2019, the
FASB issued ASU No. 2019-12, “Income Taxes (Topic
740). The amendments in
this update simplify the accounting for income taxes by removing
certain exceptions to the general principles in Topic 740. The
amendments also improve consistent application of and simplify GAAP
for other areas of Topic 740 by clarifying and amending existing
guidance. Early adoption of the amendments is
permitted. For public business entities, the amendments in
this update are effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2020.
The adoption of this standard will not have a material impact on
the Company’s consolidated financial
statements.
FASB ASU No.
2020-01. In January 2020, the
FASB issued ASU 2020-01 “Investments-Equity Securities (Topic 321),
Investments-Equity Method and Joint Ventures (Topic 323), and
Derivatives and Hedging (Topic 815)-Clarifying the Interactions
between Topic 321, Topic 323, and Topic
815”, to clarify the
interaction of the accounting for equity securities under ASC 321
and investments accounted for under the equity method of accounting
in ASC 323 and the accounting for certain forward contracts and
purchased options accounted for under ASC 815. With respect to the
interactions between ASC 321 and ASC 323, the amendments clarify
that an entity should consider observable transactions that require
it to either apply or discontinue the equity method of accounting
when applying the measurement alternative in ASC 321, immediately
before applying or upon discontinuing the equity method of
accounting. With respect to forward contracts or purchased options
to purchase securities, the amendments clarify that when applying
the guidance in ASC 815-10-15-141(a), an entity should not consider
whether upon the settlement of the forward contract or exercise of
the purchased option, individually or with existing investments,
the underlying securities would be accounted for under the equity
method in ASC 323 or the fair value option in accordance with ASC
825. The ASU is effective for interim and annual reporting periods
beginning after December 15, 2020. Early adoption is
permitted, including adoption in any interim period. The
Company does not expect the adoption of this standard to have a
material impact on its consolidated financial
statements.
FASB ASU No.
2020-06. In August 2020, the
FASB issued ASU 2020-06 “Debt—Debt with Conversion and Other
Options (Subtopic 470-20) and Derivatives and Hedging—
Contracts in Entity’s Own Equity (Subtopic 815-40):
Accounting for Convertible Instruments and Contracts in an
Entity’s Own Equity”. This ASU simplifies
accounting for convertible instruments by removing major separation
models required under current U.S. GAAP. Consequently, more
convertible debt instruments will be reported as a single liability
instrument and more convertible preferred stock as a single equity
instrument with no separate accounting for embedded conversion
features. The ASU removes certain settlement conditions that are
required for equity contracts to qualify for the derivative scope
exception, which will permit more equity contracts to qualify for
it. The ASU also simplifies the diluted earnings per share (EPS)
calculation in certain areas. This ASU is effective for public
business entities, excluding entities eligible to be smaller
reporting companies, for fiscal years beginning after December 15,
2021, including interim periods within those fiscal years. For all
other entities, the standard will be effective for fiscal years
beginning after December 15, 2023, including interim periods within
those fiscal years. Early adoption will be permitted. The Company
is currently evaluating the impact ASU 2020-06 will have on its
consolidated financial statements.
NOTE 3. NET LOSS PER COMMON SHARE
Basic
loss per common share is calculated by dividing net loss available
to common shareholders for the period by the weighted-average
number of common shares outstanding during the period. Diluted loss
per common share is calculated by dividing net loss available to
common shareholders for the period by the weighted-average number
of common shares outstanding during the period, adjusted to
include, if dilutive, potential dilutive shares consisting of
convertible preferred stock, convertible related party lines of
credit, stock options and warrants, calculated using the treasury
stock and if-converted methods. For diluted loss per share
calculation purposes, the net loss available to common shareholders
is adjusted to add back any preferred stock dividends and any
interest on convertible debt reflected in the condensed
consolidated statement of operations for the respective
periods.
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
June 30,
|
Six Months Ended
June 30,
|
|
|
|
|
|
Numerator
for basic and diluted loss per share:
|
|
|
|
|
Net
loss
|
$(2,902)
|
$(2,548)
|
$(6,027)
|
$(6,160)
|
Preferred
dividends, deemed dividends and accretion
|
(1,372)
|
(1,374)
|
(2,746)
|
(2,668)
|
Net
loss available to common shareholders
|
$(4,274)
|
$(3,922)
|
$(8,773)
|
$(8,828)
|
|
|
|
|
|
Denominator
for basic and dilutive loss per share – weighted-average
shares outstanding
|
127,065,608
|
103,431,623
|
121,630,902
|
100,928,835
|
|
|
|
|
|
Basic
and diluted loss per share available to common
shareholders
|
$(0.03)
|
$(0.04)
|
$(0.07)
|
$(0.09)
|
The
following potential dilutive securities have been excluded from the
computations of diluted weighted-average shares outstanding, as
their effect would have been antidilutive:
Potential
Dilutive Securities
|
Six
Months Ended
June
30,
|
|
|
|
Restricted stock
units
|
2,353,721
|
—
|
Convertible
redeemable preferred stock
|
44,755,071
|
42,626,028
|
Stock
options
|
1,910,000
|
7,232,346
|
Warrants
|
1,693,856
|
1,813,856
|
Total potential
dilutive securities
|
50,712,648
|
51,672,230
|
NOTE 4. SELECT BALANCE SHEET DETAILS
Inventory
Inventories of $697,000 as of June 30, 2020 were comprised of work
in process of $686,000 representing direct labor costs on
in-process projects and finished goods of $11,000 net of reserves
for obsolete and slow-moving items of $3,000.
Inventories of
$615,000 as of December 31, 2019
were comprised of work in process of $608,000, representing direct
labor costs on in-process projects and finished goods of
$7,000 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 $64,000 and $70,000 as of June 30, 2020 and December 31, 2019,
respectively, which includes accumulated amortization of $595,000
and $589,000 as of June 30, 2020 and December 31, 2019,
respectively. Amortization expense for patent intangible
assets was $3,000 and $6,000 for the three and six months ended
June 30, 2020 and 2019, respectively. Patent intangible assets are
being amortized on a straight-line basis over their remaining life
of approximately 6.0 years. There was no impairment of the
Company’s intangible assets during the three and six months
ended June 30, 2020 and 2019.
The
estimated intangible amortization expense for the next five fiscal
years is as follows:
Fiscal
Year Ended December 31,
|
Estimated
Amortization
Expense
($ in thousands)
|
2020 (six
months)
|
$6
|
2021
|
12
|
2022
|
12
|
2023
|
12
|
2024
|
12
|
Thereafter
|
10
|
Totals
|
$64
|
Goodwill
The Company annually,
or more frequently if events or circumstances indicate a need,
tests the carrying amount of goodwill for impairment. The
Company performs its annual impairment test in the fourth quarter
of each year. In December 2018, the Company adopted the provisions
of ASU 2017-04, "Intangibles
- Goodwill and Other (Topic 350): Simplifying the Test
for Goodwill Impairment". The provisions of
ASU 2017-04 eliminate the requirement to calculate the implied fair
value of goodwill to measure a goodwill impairment
charge. Instead, entities will record an impairment charge based on
the excess of a reporting unit's carrying amount over its fair
value. Entities that have reporting units with zero or negative
carrying amounts, will no longer be required to perform a
qualitative assessment assuming they pass the simplified impairment
test. The Company continues to have only one reporting unit,
Identity Management which, at June 30, 2020, had a negative
carrying amount of approximately $15,219,000. Based on the results
of the Company's impairment testing, the Company determined that
its goodwill was not impaired as of June 30, 2020 and
December 31, 2019.
Other Assets
In
conjunction with the Lincoln Park Purchase Agreement, the Company
issued to Lincoln Park, in May 2020, 2,500,000 shares of Common
Stock as consideration for entering into the Purchase Agreement.
Pursuant to this issuance, the Company recorded $400,000 as a
deferred stock issuance cost. Such deferred stock issuance costs
will be recognized as a charge against paid in capital in
proportion to securities sold under this Purchase Agreement. During
the three months ended June 30, 2020, the Company recognized
approximately $10,000 as a charge against paid in capital relating
to securities sold under the Lincoln Park Purchase
Agreement.
NOTE 5. LEASES
The
Company is a party to certain contractual arrangements for office
space which meet the definition of leases under ASC 842 –
Leases. In accordance with ASC 842, the Company has determined that
such arrangements are operating leases and accordingly the Company
has, as of January 1, 2019, recorded operating lease right-of-use
assets and related lease liability for the present value of the
lease payments over the lease terms using the Company’s
estimated weighted-average incremental borrowing rate of
approximately 14.5% as the discount rates implicit in the
Company’s leases cannot be readily determined. Such assets
and liabilities aggregated approximately $2,265,000 and $2,280,000
as of January 1, 2019, respectively and $1,906,000 and $2,089,000
as of December 31, 2019, respectively. At June 30, 2020, such
assets and liabilities aggregated approximately $1,738,000 and
$1,914,000, respectively. The Company determined that it had no
arrangements representing finance leases.
The
Company’s operating leasing arrangements are summarized
below:
●
The
Company’s corporate headquarters is located in San Diego,
California, where it occupies 8,511 square feet of office space at
an average cost of approximately $28,000 per month. This
facility’s lease was entered into by the Company in July
2018. This lease commenced on November 1, 2018 and terminates on
April 30, 2025;
●
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 $23,000
per month until the expiration of the lease on February 28, 2023;
and
●
183
square feet of office space in Mexico City, Mexico, at a cost of
approximately $2,000 per month until September 30,
2020.
The
above leases contain no residual value guarantees provided by the
Company and there are no options to either extend or terminate the
leases. The Company is not a party to any subleasing
arrangements.
For the
three and six months ended June 30, 2020 and 2019, the Company
recorded approximately $169,000 and $338,000, and $182,000 and
$349,000, respectively, in lease expense using the straight-line
method. Under the provisions of ASC 842, lease expense is comprised
of the total lease payments under the lease plus any initial direct
costs incurred less any lease incentives received by the lessor
amortized ratably using the straight-line method over the lease
term. The weighted-average remaining lease term of the
Company’s operating leases as of June 30, 2020 is 4.07 years.
Cash payments under operating leases aggregated approximately
$162,000 and $323,000, respectively, for the three and six months
ended June 30, 2020 and $116,000 and $233,000, respectively, for
the comparable periods in 2019, and are included in operating cash
flows.
The
Company’s lease liability was computed using the present
value of future lease payments. The Company has utilized the
practical expedient regarding lease and non-lease components and
combined such components into a single combined component in the
determination of the lease liability. The Company has excluded the
lease of its office space in Mexico City, Mexico in the
determination of the lease liability as of January 1, 2019 as its
term is less than 12 months.
At
June 30, 2020, future minimum undiscounted lease payments are as
follows:
($ in
thousands)
|
|
2020
(six months)
|
$333
|
2021
|
642
|
2022
|
652
|
2023
|
425
|
2024
|
387
|
Thereafter
|
132
|
Total
|
2,571
|
Short-term
leases not included in lease liability
|
(7)
|
Present
Value effect on future minimum undiscounted lease payments at June
30, 2020
|
(650)
|
Lease
liability at June 30, 2020
|
$1,914
|
Less
current portion
|
(401)
|
Non-current
lease liability at June 30, 2020
|
$1,513
|
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
Preferred (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, Series A Preferred, Series A-1
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.
There were no issuances
or conversions of Series C Preferred during the three and six
months ended June 30, 2020 or June 30, 2019. The Company issued the
holders of Series C Preferred 157,945 and 266,793 shares of Common
Stock on March 31, 2019 and June 30, 2019, respectively, as payment
of dividends due on these dates.
At
June 30, 2020 and December 31, 2019, the Company had cumulative
dividends of approximately $500,000 and $0, respectively. At June
30, 2020, the unpaid Series C Preferred dividend of $500,000 is
included as a current liability under the caption “Accrued
expense” in the Company’s condensed consolidated
balance sheet.
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.
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 six months ended June 30, 2020, the Company recorded the
accretion of debt issuance costs and derivative liabilities
aggregating approximately $175,000 and $347,000, respectively,
using the effective interest rate method. For the three and six
months ended June 30, 2019, the Company recorded the accretion of
debt issuance costs and derivative liabilities aggregating
approximately $184,000 and $370,000, respectively, using the
effective interest rate method.
There were no conversions of Series C Preferred
into Common Stock during the three and six months ended June
30, 2020 and 2019.
The
Company reflected the following in Mezzanine Equity for the Series
C Preferred Stock as of December 31, 2019 and June 30,
2020:
|
|
|
|
|
|
|
|
|
|
|
|
(amounts
in thousands, except share amounts)
|
|
|
|
|
|
Total Series C
Preferred Stock as of December 31, 2019
|
1,000
|
$8,884
|
|
|
|
Accretion of
discount – deemed dividend for the six months ended June 30,
2020
|
—
|
347
|
|
|
|
Total
Series C Preferred Stock as of June 30, 2020
|
1,000
|
$9,231
|
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 sheets 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 derivatives
liabilities” in the Company’s condensed consolidated
statements of operations. During the three and six months ended
June 30, 2020, the Company recorded an increase to these derivative
liabilities using fair value methodologies of approximately
$363,000 and $166,000, respectively. As a result of this increase,
such liabilities aggregated approximately $535,000 at June 30,
2020. During the three and six months ended June 30, 2019, the
Company recorded a decrease to these derivative liabilities using
fair value methodologies of approximately $481,000 and $57,000,
respectively. See Note 9 to these condensed consolidated financial
statements for a reconciliation of amounts recorded at June 30,
2020.
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.
On
June 9, 2020, the Company amended its Charter to increase the
number of shares of the Company’s Common Stock and the number
of shares of the Company’s Preferred Stock authorized
thereunder from an aggregate of 179 million to 350 million,
consisting of 345 million shares of Common Stock and 5 million
shares of Preferred Stock.
Series A Convertible Preferred Stock
The Company had 37,467 shares of Series A
Preferred outstanding as of June 30, 2020 and December 31,
2019. At June 30, 2020 and December 31, 2019, the Company had
cumulative dividends of approximately $1,874,000 and $0,
respectively. There were no conversions of Series A Preferred into
Common Stock during the three and six months ended June 30,
2020 and 2019. At June 30, 2020, the
unpaid Series A Preferred dividend of approximately $1,874,000 is
included as a current liability under the caption “Accrued
expense” in the Company’s condensed consolidated
balance sheet.
In conjunction with the Series A Restructuring, as
defined in Note 12 below, in July 2020, approximately $1,847,000 in
dividends payable to the Series A Holders and payable for the
quarters ended March 31, 2020 and June 30, 2020 was waived in
consideration for the issuance of Series A-1 Convertible Preferred
Stock (“Series A-1
Preferred”) in exchange
for shares of Series A Preferred.
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 June 30, 2020 and December 31, 2019. At June 30, 2020 and
December 31, 2019, the Company had cumulative undeclared dividends
of approximately $8,000. There were no conversions of Series B
Preferred into Common Stock during the three and six months
ended June 30, 2020 and 2019.
Common Stock
The following table summarizes Common
Stock activity for the six months ended June 30,
2020:
|
|
Shares
outstanding at December 31, 2019
|
113,346,472
|
Shares
issued pursuant to option exchange
|
688,695
|
Shares
issued to secure financing facility
|
2,500,000
|
Shares
issued for cash
|
12,500,000
|
Shares
outstanding at June 30, 2020
|
129,035,167
|
In
February and March of 2020, the Company sold, and Triton purchased,
an aggregate of 10,000,000 shares of the Company’s Common
Stock for cash. In February, the Company sold 4,000,000 shares of
Common Stock for $0.16 per share resulting in gross proceeds to the
Company of $640,000. In March 2020, the Company sold 6,000,000
shares of Common Stock resulting in gross proceeds to the Company
of $765,000, or a per share purchase price of $0.13 per share.
Aggregate net proceeds from this financing approximated $1,387,000
after recognition of direct offering costs.
During
May 2020, the Company sold 2,500,000 shares of its Common Stock to
Lincoln Park pursuant to the Lincoln Park Purchase Agreement for
$0.10 per share resulting in proceeds to the Company of $250,000.
Also in May 2020, the Company issued to Lincoln Park 2,500,000
shares of its Common Stock as consideration for entering into the
Purchase Agreement. The Company has recorded this issuance as a
deferred stock issuance cost in the amount of $400,000.
Such deferred stock issuance costs
will be recognized as a charge against paid in capital in
proportion to securities sold under this Purchase
Agreement.
During
the six months ended June 30, 2020, the Company issued 600,000
shares of its Common Stock pursuant to exchange agreements with
certain terminated employees whereby such employees exchanged an
aggregate 1,200,000 Common Stock purchase options for 600,000
shares of Common Stock as a component of their severance
agreement. Disclosure
of any incremental compensation expense and the related accounting
is set forth in the Stock-Based Compensation section of this
note.
During
the six months ended June 30, 2020, the Company granted 708,916
restricted stock units (“RSUs”) to certain active employees in exchange
for 1,417,832 outstanding
options held by such employees. On May 8, 2020, 88,695 shares of
RSUs vested with the remainder of such shares of Common Stock
vesting quarterly over a period of two years. Disclosure of any
incremental compensation expense and the related accounting is set
forth in the Stock-Based Compensation section of this
note.
Warrants
The
following table summarizes warrant activity for the following
periods:
|
|
Weighted-Average
Exercise
Price
|
Balance at December
31, 2019
|
1,733,856
|
$0.14
|
Granted
|
—
|
—
|
Expired/Canceled
|
(40,000)
|
1.46
|
Exercised
|
—
|
—
|
Balance at
June 30, 2020
|
1,693,856
|
$0.11
|
As of June 30, 2020, warrants to purchase
1,693,856 shares
of Common Stock at prices ranging from $0.01 to $1.14 were
outstanding. Of these warrants, 50,000 were exercisable as of June
30, 2020 and expired as of July 29, 2020 unexercised and 1,643,856
become exercisable only upon the attainment of specified events and
expire at various dates through September 2028. The intrinsic value
of warrants outstanding at June 30, 2020 was $0. The Company has
excluded from this computation any intrinsic value of the 1,493,856
warrants issued to the Series A Preferred stockholders due to the
conversion exercise contingency associated with these
warrants.
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 was authorized to 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 number of shares of the Company’s Common Stock
reserved for issuance to approximately 7.0 million. Subsequently,
in February 2018, the Company amended and restated the 1999 Plan,
whereby it increased the number of shares of the Company’s
Common Stock reserved for issuance by 2.0 million. 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 shares of the Company’s Common 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
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 of Common Stock
available for issuance under the 1999 Plan at June 30, 2020 was 0
due to the termination of the 1999 Plan.
On June 9, 2020, pursuant to authorization
obtained from the Company’s stockholders, the Company adopted
the 2020 Omnibus Stock Incentive Plan (the
”2020
Plan”). The 2020 Plan was
adopted by the Board of Directors to enhance our ability to attract
and retain highly qualified officers, non-employee directors, key
employees and consultants. Awards granted under the 2020 Plan are
designed to qualify for special tax treatment under Section 422 of
the Internal Revenue Code of 1986 (the “Code”). A total of 25.0 million shares of Common
Stock are authorized for issuance under the 2020
Plan.
The
2020 Plan supersedes and replaces the 1999 Plan and therefore no
new awards will be granted under the 1999 Plan. Any awards
outstanding under the 1999 Plan on the date of approval of the 2020
Plan will remain subject to the 1999 Plan. All shares of Common
Stock remaining authorized and available for issuance under the
1999 Plan and any shares subject to outstanding awards under the
1999 Plan that subsequently expire, terminate, or are surrendered
or forfeited for any reason without issuance of shares will
automatically become available for issuance under the 2020 Plan.
As
of June 30, 2020, 29,401,175 shares are available for issuance
under the 2020 Plan.
The Company estimates the fair value of its stock
options using a Black-Scholes option-pricing model, consistent with
the provisions of ASC 718, “Compensation – Stock
Compensation”. The fair
value of stock options granted is recognized to expense over the
requisite service period. Stock-based compensation expense for all
share-based payment awards is recognized using the straight-line
single-option method. Stock-based compensation expense is reported
in operating expense based upon the departments to which
substantially all the associated employees report and credited to
additional paid-in-capital.
ASC
718 requires the use of a valuation model to calculate the fair
value of stock-based awards. The Company has elected to use the
Black-Scholes option-pricing model, which incorporates various
assumptions including volatility, expected life, and interest
rates. The Company is required to make various assumptions in the
application of the Black-Scholes option-pricing model. The Company
has determined that the best measure of expected volatility is
based on the historical weekly volatility of the Company’s
Common Stock. Historical volatility factors utilized in the
Company’s Black-Scholes computations for the six months ended
June 30, 2020 and 2019 ranged from 66% to 57%. 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 Topic 14. The expected term
used by the Company during the six months ended June 30, 2019 was
5.17 years. The difference between the actual historical expected
life and the simplified method was immaterial. The interest rate
used is the risk-free interest rate and is based upon U.S. Treasury
rates appropriate for the expected term. Interest rates used in the
Company’s Black-Scholes calculations for the six months ended
June 30, 2020 and 2019 averaged 2.58%. Dividend yield is zero as
the Company does not expect to declare any dividends on the
Company’s common shares in the foreseeable
future.
In
addition to the key assumptions used in the Black-Scholes model,
the estimated forfeiture rate at the time of valuation is a
critical assumption. The Company has adopted the provisions of ASU
2016-09 and will continue to use an estimated 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.
A
summary of the activity under the Company’s stock option
plans is as follows:
|
|
Weighted-Average
Exercise
Price
|
Balance at December
31, 2019
|
7,204,672
|
$1.32
|
Granted
|
1,750,000
|
$0.15
|
Expired/Cancelled
|
(7,044,672)
|
$1.34
|
Exercised
|
—
|
$—
|
Balance at June 30,
2020
|
1,910,000
|
$0.22
|
During
the six months ended June 30, 2020, the Company issued 600,000
shares of its Common Stock pursuant to an exchange agreement with
certain terminated employees whereby such employees exchanged
1,200,000 Common Stock purchase options for 600,000 shares of
Common Stock as a component of their severance agreement. The
Company recorded the grant date fair value of these Common Stock
issuances as severance expense in the amount of approximately
$86,000.
The Company
periodically issues RSUs to certain employees which vest over time.
When vested, each RSU represents the right to that number of shares
of Common Stock equal to the number of RSUs granted. The grant date
fair value for RSUs is based upon the market price of the Company's
Common Stock on the date of the grant. The fair value is then
amortized to compensation expense over the requisite service period
or vesting term.
During
the six month period
ended June 30, 2020, the
Company granted 708,916 RSUs to certain employees in exchange
for options to purchase 1,417,832 shares of Common Stock
held by such employees. On May 8, 2020, 88,695 RSUs vested with the
remainder of such RSUs vesting quarterly over a period of two
years. Also, during the six months ended June 30, 2020, the Company
agreed to grant 1,733,500 RSUs to certain officers and members of
the Company’s Board of Directors in exchange for options to
purchase 3,467,000 shares of Common Stock held by such officers and
directors. However, principally due to the lack of authorized but
unissued shares of Common Stock to satisfy certain commitments of
the Company, and in lieu of pending efforts to restructure certain
issued and outstanding preferred stock and secure additional
working capital, the Company and certain officers and directors
have agreed to suspend the issuance of such RSUs in exchange for
their options.
In
addition to the aggregate 6,084,832 options exchanged or pending
exchange as disclosed above, an additional 959,840 options expired
unexercised during the six months ended June 30, 2020.
The
Company determined that the exchange agreements are a modification
of a share-based payment award under ASC 718. Accordingly, the
Company computed any incremental compensation expense as a
component of the total compensation cost to be measured at the
modification date. Aggregate incremental compensation expense
measured from the modifications of stock options was approximately
$385,000.
The intrinsic value of options exercisable and
outstanding at June 30, 2020 was $0. The aggregate
intrinsic value for all options outstanding as of June 30,
2020 was approximately $368,000. The weighted-average grant-date per share fair
value of options granted during the six months ended June 30, 2020
was $0.09 as there were no option grants during this period. At
June 30, 2020, the total remaining unrecognized compensation cost
related to unvested stock options amounted to approximately
$238,000, which will be recognized over a weighted-average period
of 1.4 years.
Stock-based
compensation expense for employees, officers and members of the
Company’s Board of Directors, related to RSUs, equity
options, and the modifications of equity options, has been
classified as follows in the accompanying condensed consolidated
statements of operations (in thousands):
|
Three Months Ended
June 30,
|
Six Months Ended
June 30,
|
|
|
|
|
|
Cost
of revenue
|
$2
|
$4
|
$5
|
$7
|
General
and administrative
|
89
|
97
|
156
|
190
|
Sales
and marketing
|
10
|
42
|
100
|
81
|
Research
and development
|
35
|
38
|
61
|
69
|
|
|
|
|
|
Total
|
$136
|
$181
|
$322
|
$347
|
NOTE
9. FAIR VALUE ACCOUNTING
The Company accounts for fair value measurements
in accordance with ASC 820, “Fair Value Measurements and
Disclosures”, which
defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands
disclosures about fair value measurements.
ASC
820 establishes a fair value hierarchy that prioritizes the inputs
to valuation techniques used to measure fair value. The hierarchy
gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements)
and the lowest priority to unobservable inputs (Level 3
measurements). The three levels of the fair value hierarchy under
ASC 820 are described below:
|
Level 1
|
Unadjusted quoted prices in active markets that are accessible at
the measurement date for identical, unrestricted assets or
liabilities.
|
|
|
|
|
Level 2
|
Applies to assets or liabilities for which there are inputs other
than quoted prices included within Level 1 that are observable for
the asset or liability such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets
or liabilities in markets with insufficient volume or infrequent
transactions (less active markets); or model-derived valuations in
which significant inputs are observable or can be derived
principally from, or corroborated by, observable market
data.
|
|
|
|
|
Level 3
|
Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable
(supported by little or no market activity).
|
The
following table sets forth the Company’s financial assets and
liabilities measured at fair value by level within the fair value
hierarchy. As required by ASC 820, assets and liabilities are
classified in their entirety based on the lowest level of input
that is significant to the fair value measurement.
|
Fair Value at June 30, 2020
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$1,711
|
$—
|
$—
|
$1,711
|
Totals
|
$1,711
|
$—
|
$—
|
$1,711
|
Liabilities:
|
|
|
|
|
Derivative
liabilities
|
$535
|
$—
|
$—
|
$535
|
Totals
|
$535
|
$—
|
$—
|
$535
|
|
Fair Value at December 31, 2019
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$1,713
|
$—
|
$—
|
$1,713
|
Totals
|
$1,713
|
$—
|
$—
|
$1,713
|
Liabilities:
|
|
|
|
|
Derivative
liabilities
|
$369
|
$—
|
$—
|
$369
|
Totals
|
$369
|
$—
|
$—
|
$369
|
The
Company’s German pension plan is funded by insurance contract
policies whereby the insurance company guarantees a fixed minimum
return. The Company has determined that the pension assets are
appropriately classified within Level 3 of the fair value hierarchy
because they are valued using actuarial valuation methodologies
which approximate cash surrender value that cannot be corroborated
with observable market data. All plan assets are managed in a
policyholder pool in Germany by outside investment managers. The
investment manager is responsible for the investment strategy of
the insurance premiums that Company submits and does not hold
individual assets per participating employer. The German Federal
Financial Supervisory oversees and supervises the insurance
contracts.
As of June 30, 2020, 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 was approximately
$535,000 and $369,000 at June 30, 2020 and December 31, 2019,
respectively, and are classified as a current liability in the
condensed consolidated balance sheets as of June 30, 2020 and
December 31, 2019. The fair value of the
Company’s derivative liabilities is classified
within Level 3 of the fair value hierarchy because they are valued
using pricing models that incorporate management assumptions that
cannot be corroborated with observable market data. The
Company uses the lattice framework, Monte-Carlo simulations and
other fair value methodologies in the determination of the fair
value of derivative liabilities.
Some
of the aforementioned fair value methodologies are affected by the
Company’s stock price as well as assumptions regarding the
expected stock price volatility over the term of the
derivative liabilities in addition to the probability of
future events. Significant assumptions used in the fair value
methodologies during the six months ended June 30, 2020 and 2019
are a risk-free rate of 0.16% to 2.22% equity volatility of 63% to
109%, effective life of 1.20 years to 4.45 years, and a preferred
stock dividend rate of 0%. Additionally, management has made
certain estimates regarding the timing of potential change of
control events.
The
Company monitors the activity within each level and any changes
with the underlying valuation techniques or inputs utilized to
recognize if any transfers between levels are
necessary. That determination is made, in part, by
working with outside valuation experts for Level 3 instruments and
monitoring market related data and other valuation inputs for Level
1 and Level 2 instruments.
The reconciliations of Level 3 pension assets
measured at fair value during the three months ended June 30, 2020
and 2019 are presented below:
($ in
thousands)
|
Three months
ended
June
30, 2020
|
Three months
ended
June
30, 2019
|
|
|
|
Pension
assets:
|
|
|
Fair value at
beginning of period
|
$1,675
|
$1,699
|
Return on plan
assets
|
16
|
15
|
Company
contributions and benefits paid, net
|
(23)
|
(19)
|
Effect of exchange
rate changes
|
43
|
26
|
Fair value at end
of period
|
$1,711
|
$1,721
|
The reconciliations of Level 3 pension assets
measured at fair value during the six months ended June 30, 2020
and 2019 are presented below:
($ in
thousands)
|
Six
months ended
June
30, 2020
|
Six
months ended
June
30, 2019
|
|
|
|
Pension
assets:
|
|
|
Fair value at
beginning of period
|
$1,713
|
$1,733
|
Return on plan
assets
|
30
|
30
|
Company
contributions and benefits paid, net
|
(33)
|
(30)
|
Effect of exchange
rate changes
|
1
|
(12)
|
Fair value at end
of period
|
$1,711
|
$1,721
|
The
reconciliations of Level 3 derivative liabilities measured at fair
value during the three months ended June 30, 2020 and 2019 are
presented below:
($ in
thousands)
|
Three months
ended
June
30, 2020
|
Three months
ended
June
30, 2019
|
Derivative
liabilities:
|
|
|
Fair value at
beginning of period
|
$172
|
$1,489
|
Change in fair
value included in earnings
|
363
|
(481)
|
Fair value at end
of period
|
$535
|
$1,008
|
The
reconciliations of Level 3 derivative liabilities measured at fair
value during the six months ended June 30, 2020 and 2019 are
presented below:
($ in
thousands)
|
Six
months ended
June
30, 2020
|
Six
months ended
June
30, 2019
|
|
|
|
Derivative
liabilities:
|
|
|
Fair value at
beginning of period
|
$369
|
$1,065
|
Change in fair
value included in earnings
|
166
|
(57)
|
Fair value at end
of period
|
$535
|
$1,008
|
NOTE 10. RELATED PARTY TRANSACTIONS
Notes Payable
On
February 12, 2020, the Company entered into a factoring agreement
with a member of the Company’s Board of Directors for
$350,000. Such amount is to be repaid with the proceeds from
certain of the Company’s trade accounts receivable
approximating $500,000 and are due no later than 21 days after
February 12, 2020. As of August 19, 2020, despite collection of the
Company’s trade accounts receivable, the borrowed amounts
have not been repaid and the Company is seeking an extension from
the Board member. Under the terms of the factoring agreement,
factored money will bear interest at the rate of 1% of the
factoring money for the first seven days, and 1% for each
additional seven days until the factoring money is paid in full. In
May 2020, the Company paid $35,000 in accrued interest to the Board
member.
In April 2020, the Company received an aggregate
amount of $550,000 from two members of the Company’s Board of
Directors. On June 29, 2020, the Company entered into promissory
notes (the "Notes") in the principal amounts of $450,000 and
$100,000, payable to the two
members of the Company's Board of Directors. The Notes are
convertible into shares of the Company’s common stock, par
value $0.01 per share, for $0.16 per share. The promissory notes
bear interest at the rate of 5% per annum, and mature on the
earlier to occur of October 13, 2020 or on such date that the
Company consummates a debt and/or equity financing resulting in net
proceeds to the Company of at least $3.0 million. As of
June 30, 2020, an aggregate of $550,000 principal amount remained
outstanding under the terms of the Notes.
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 employment agreement with our Chief Executive
Officer, executed April 10, 2020, the Chief Executive Officer will
be entitled to the following severance benefits if we terminate her
employment without cause or in the event of an involuntary
termination: (i) severance payments equal to the lesser of twelve
(12) months of salary or the remaining period prior to the
expiration of the employment period; (ii) continuation of medical
insurance for a period of twelve months.
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.
On
February 28, 2020, the employment agreement for the Company’s
Chief Technical Officer was amended to extend the term of the
employment agreement until December 31, 2020.
On
July 21, 2020, the employment agreement for the Company’s
Chief Technical Officer was terminated effective with the
Officer’s voluntary resignation on this date.
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.
12. SUBSEQUENT EVENTS
Creation of Series A-1 Convertible Preferred Stock
On July 14, 2020, the Company filed the
Certificate of Designations, Preferences, and Rights of Series A-1
Convertible Preferred Stock (“Series A-1
COD”) with the Secretary
of State for the State of Delaware – Division of
Corporations, designating 31,021 shares of the Company’s
Preferred Stock as Series A-1 Preferred. Shares of Series A-1
Preferred accrue cumulative
dividends and are payable quarterly beginning March 31, 2021 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 A-1 Preferred is convertible into that number of
shares of the Company’s Common Stock equal to that number of
shares of Series A-1 Preferred being converted multiplied by
$1,000, divided by $0.65, or the conversion price as defined in the
Series A-1 Certificate of Designation in effect as of the date the
holder delivers to the Company their notice of election to
convert.
Series A Restructuring
During July
2020, the Company entered into an Exchange Agreement, Consent and
Waiver (“Exchange
Agreement”) with certain
holders of its Series A Preferred (the "Series A
Holders"), pursuant to which
such Series A Holders agreed to exchange one-half of the Series A
Preferred beneficially owned by such Series A Holders for an
equivalent number of Series A-1 Preferred in consideration for
their waiver of approximately $1,847,000 in dividends payable to
the Series A Holders and payable for the quarters ended March 31,
2020 and June 30, 2020 (the “Series A
Restructuring”). Shares
of the Series A-1 Preferred issued to the Series A Holders pursuant
to the Exchange Agreement are convertible into shares of Common
Stock at $0.65 per share, and automatically convert into Common
Stock when the volume weighted average closing price (VWAP) of the
Company’s Common Stock for the preceding twenty trading days
is at least $1.00.
Subsequent
to June 30, 2020 and through August 19, 2020, certain Holders of
Series A-1 Preferred converted 350 shares of Series A-1 Preferred
into 538,452 shares of the Company’s Common
Stock.
Subsequent
to June 30, 2020 and through August 19, 2020, the Company sold an
aggregate 3,200,000 shares of Common Stock to Lincoln Park under
the terms of the Purchase Agreement resulting in cash proceeds to
the Company of approximately $669,000.
Subsequent
to June 30, 2020 and through August 19, 2020, the Company issued
87,198 shares of its Common Stock pursuant to share based
compensation agreements.
On
July 21, 2020, David Harding, Senior Vice President and Chief
Technical Officer submitted his resignation to the
Company.