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
On
February 8, 2018, the Company filed with the Secretary of State 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, par value $0.01 per share
(“
Common
Stock
”), to 175,000,000 from 150,000,000
shares.
Liquidity, Going Concern and Management’s Plan
Historically, our principal sources of cash have
included customer payments from the sale of our products, proceeds
from the issuance of common and preferred stock and proceeds from
the issuance of debt, including our Lines of Credit (defined
below). Our principal uses of cash have included cash used in
operations, product development, payments relating to purchases of
property and equipment. 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
March 31, 2018, we had a working capital deficit of approximately
$3,452,000. Our principal sources of liquidity at March 31, 2018
consisted of approximately $4,558,000 of cash and $284,000 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 months ended March 31, 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,
inventory carrying values, deferred tax asset valuation allowances,
accounting for loss contingencies, recoverability of goodwill and
acquired intangible assets and amortization periods, assumptions
used in the Black-Scholes model to calculate the fair value of
share based payments, fair value of Exchanged Preferred (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 revenues 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 months ended
March 31, 2018, the adoption of ASC 606 resulted in a reduction in
royalty revenue of approximately $28,000. The following table sets
forth our disaggregated revenue for the three months ended March
31, 2018 and 2017:
|
Three
Months Ended
March
31,
|
Net
Revenue
|
|
|
(dollars
in thousands)
|
|
|
|
|
|
Software and
royalties
|
$
84
|
$
189
|
Hardware and
consumables
|
1
|
47
|
Services
|
12
|
37
|
Maintenance
|
619
|
655
|
|
$
716
|
$
928
|
Customer Concentration
For
the three months ended March 31, 2018, two customers accounted
for approximately 38% or $275,000 of our total revenue and had
trade receivables at March 31, 2018 of $74,000.
For
the three months ended March 31, 2017, two customers accounted
for approximately 32% or $299,000 of our total revenue and had
trade receivables at March 31, 2017 of $67,000.
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 ASU No.
2016-02
. In February 2016, the
FASB issued ASU No. 2016-02, “
Leases
.
”
This guidance will result in key changes to lease
accounting and will aim to bring leases onto balance sheets to give
investors, lenders, and other financial statement users a more
comprehensive view of a company’s long-term financial
obligations as well as the assets it owns versus leases. The new
leasing standard will be effective for fiscal years beginning after
December 15, 2018, and for interim periods within those fiscal
years. The Company is currently evaluating the impact this guidance
will have on our consolidated financial statements and anticipates
commencement of adoption planning in the third fiscal quarter of
2018.
FASB ASU No.
2016-13
. 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.
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
March
31,
|
|
|
|
Numerator for basic
and diluted loss per share:
|
|
|
Net
loss
|
$
(3,583
)
|
$
(2,727
)
|
Preferred
dividends
|
(769
)
|
(507
)
|
Net loss available
to common shareholders
|
$
(4,352
)
|
$
(3,234
)
|
|
|
|
Denominator for
basic and dilutive loss per share — weighted-average shares
outstanding
|
94,333,663
|
91,864,174
|
Net
loss
|
$
(0.04
)
|
$
(0.03
)
|
Preferred
dividends
|
(0.01
)
|
(0.01
)
|
Basic and diluted
loss per share available to common shareholders
|
$
(0.05
)
|
$
(0.04
)
|
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 Months Ended
March
31,
|
|
|
|
|
|
|
Related party lines
of credit
|
5,325,651
|
3,450,940
|
Convertible
redeemable preferred stock
|
26,630,458
|
11,710,102
|
Stock
options
|
7,273,431
|
6,491,931
|
Warrants
|
230,000
|
175,000
|
Total potential
dilutive securities
|
39,459,540
|
21,827,973
|
NOTE 4. SELECT BALANCE SHEET DETAILS
Inventory
Inventories of $89,000 as of March 31, 2018 were comprised of work
in process of $48,000 representing direct labor costs on in-process
projects and finished goods of $41,000 net of reserves for obsolete
and slow-moving items of $3,000.
Inventories of $43,000 as of March 31, 2017 were comprised of work
in process of $37,000 representing direct labor costs on in-process
projects and finished goods of $6,000 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 $90,000 and $93,000 as of March 31, 2018 and December 31,
2017, respectively, which includes accumulated amortization of
$569,000 and $566,000 as of March 31, 2018 and December 31, 2017,
respectively. Amortization expense for patent intangible
assets was $3,000 for the three months ended March 31, 2018 and
2017. Patent intangible assets are being amortized on a
straight-line basis over their remaining life of approximately 7.9
years.
The
estimated acquired intangible amortization expense for the next
five fiscal years is as follows:
Fiscal Year Ended December 31,
|
Estimated
Amortization
Expense
($ in
thousands)
|
2018
(nine months)
|
$
9
|
2019
|
12
|
2020
|
12
|
2021
|
12
|
2022
|
12
|
Thereafter
|
33
|
Totals
|
$
90
|
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 March 31, 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 $6,000 at March 31, 2018 and December 31, 2017. Discount on
advances under lines of credit is $179 at March 31, 2018
and $226 at December 31, 2017. Maturity date is December 31,
2018.
|
$
5,821
|
$
5,774
|
|
|
|
Total
lines of credit to related parties
|
5,821
|
5,774
|
Less
current portion
|
(5,821
)
|
(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 months ended March 31, 2018, the Company recorded an
aggregate of approximately $2,000 in deferred financing fee
amortization expense. During the three months ended March 31, 2017,
the Company recorded an aggregate of approximately $5,000 in
deferred financing fee amortization expense. Such expense is
recorded as a component of interest expense in the Company’s
condensed consolidated statements of operations.
In April 2014, the Company and Goldman entered
into a further amendment to the Goldman Line of Credit to decrease
the available borrowings to $3.0 million (the
“
Second
Amendment
”). Contemporaneous with the execution
of the Second Amendment, the Company entered into a new unsecured
line of credit with Charles Crocker, a member of the
Company’s Board of Directors (“
Crocker
”), with available borrowings of up to
$500,000 (the “
Crocker LOC
”), which amount was convertible into
shares of the Company’s Common Stock for $2.25 per share. As
a result of these amendments, total available borrowings under the
lines of credit available to the Company remained unchanged 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 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 contain a contingent beneficial conversion feature,
i.e. an embedded conversion right that enables the holder to obtain
the underlying Common Stock at a price below market value. The
beneficial conversion feature is contingent as the terms of the
conversion do not permit the Company to compute the number of
shares that the holder would receive if the contingent event occurs
(i.e. future borrowings under the Line of Credit). The Company has
considered the accounting for this contingent beneficial conversion
feature using the guidance in ASC 470, Debt. The guidance in ASC
470 states that a contingent beneficial conversion feature in an
instrument shall not be recognized in earnings until the
contingency is resolved. The beneficial conversion features of
future borrowings under the Line of Credit will be measured
using the intrinsic value calculated at the date the contingency is
resolved using the conversion price and trading value of the
Company’s Common Stock at the date the Lines of Credit were
issued (commitment date).
The Company incurred no additional borrowings
under the Lines of Credit during the three months ended March 31,
2018. During the three months ended March 31, 2018, the Company
incurred approximately $130,000 in accrued unpaid interest under
the terms of the Lines of Credit. As a result of this interest
accrual, the Company recorded an additional $10,000 in debt
discount attributable to beneficial conversion feature and
accreted
approximately $59,000 of debt discount. During the three months
ended March 31, 2017, the Company recorded approximately $125,000
in debt discount attributable to beneficial conversion feature and
accreted approximately $35,000 of the note discount.
Such expense is recorded as a
component of interest expense in the Company’s condensed
consolidated statements of operations.
NOTE 6. EQUITY
The
Company’s 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 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
utilized the services an independent third-party valuation firm to
perform the computation of the fair value of the Exchanged
Preferred. Based on the fair value using these methodologies, the
Company recorded approximately $1,245,000 in fair value
differential as adjustments within Shareholders’ Deficit in
the Company’s Condensed Consolidated Balance Sheet for the
year ended December 31, 2017.
The Company had 30,571 shares and 31,021 shares of
Series A Preferred outstanding as of March 31, 2018 and December
31, 2017, respectively. At March 31, 2018 and December 31,
2017, the Company had cumulative undeclared dividends of $0.
During the three months ended March 31, 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 shares of Common Stock on
March 31, 2018 as payment of dividends due on that
date.
Series B Convertible Preferred Stock
The Company had 239,400 shares of Series B
Convertible Preferred Stock (“
Series B
Preferred
”) outstanding
as of March 31, 2018 and December 31, 2017. At March 31, 2018 and
December 31, 2018, 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
three months ended March 31, 2018 and 2017.
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 175,000,000 from 150,000,000
shares.
The
following table summarizes Common Stock activity for the three
months ended March 31, 2018:
|
|
Shares
outstanding at December 31, 2017
|
94,167,836
|
Shares
issued as payment of stock dividend on Series A
Preferred
|
472,562
|
Shares
issued pursuant to conversion of Series A Preferred
|
391,304
|
Shares
issued pursuant to option exercises
|
83,169
|
Shares
outstanding at March 31, 2018
|
95,114,871
|
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
|
—
|
—
|
Expired/Canceled
|
—
|
—
|
Exercised
|
—
|
—
|
Balance
at March 31, 2018
|
230,000
|
$
0.91
|
As
of March 31, 2018, warrants to purchase 230,000 shares of Common
Stock at an exercise prices ranging from $0.80 to $1.17 were
outstanding. All warrants are exercisable as of March 31, 2018 and
expire as of September 11, 2019, except for an aggregate of 150,000
warrants, which become exercisable only upon the attainment of
specified events. The intrinsic value of warrants outstanding at
March 31, 2018 was approximately $158,000.
Stock-Based Compensation
The
1999 Plan was adopted by the Company’s Board of Directors on
December 17, 1999. Under the terms of the 1999 Plan, the Company
could, originally, issue up to 350,000 non-qualified or incentive
stock options to purchase Common Stock of the Company. During the
year ended December 31, 2014, the Company subsequently amended and
restated the 1999 Plan, whereby it increased the share reserve for
issuance to approximately 7.0 million shares of the Company’s
Common Stock. 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 March 31, 2018 was 837,177.
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 $273,000 and $274,000
for the three months ended March 31, 2018 and 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
$62,000 and $35,000 for the three months ended March 31, 2018 and
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 three months ended March 31, 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 three months ended March 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.
Interest rates used in
the Company’s Black-Scholes calculations for the three months
ended March 31, 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
|
1,303,000
|
$
1.76
|
Expired/Cancelled
|
(39,912
)
|
$
1.34
|
Exercised
|
(83,169
)
|
$
1.05
|
Balance
at March 31, 2018
|
7,273,431
|
$
1.32
|
The
intrinsic value of options exercisable at March 31, 2018 was
approximately $2,409,000. The aggregate intrinsic value for
all options outstanding as of March 31, 2018 was approximately
$2,577,000. The weighted-average grant-date per share fair value of
options granted during the three months ended March 31, 2018 was
$0.99. At March 31, 2018, the total remaining unrecognized
compensation cost related to unvested stock options amounted to
approximately $1,780,000 which will be recognized over a
weighted-average period of 1.87 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 $62,000 during the three months ended March 31, 2018
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
March 31,
|
|
|
|
Cost
of revenue
|
$
5
|
$
5
|
General
and administrative
|
216
|
164
|
Sales
and marketing
|
60
|
55
|
Research
and development
|
54
|
50
|
Total
|
$
335
|
$
274
|
NOTE 7. FAIR VALUE ACCOUNTING
The Company accounts for fair value measurements
in accordance with ASC 820, “
Fair Value Measurements and
Disclosures
,” which
defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands
disclosures about fair value measurements.
ASC
820 establishes a fair value hierarchy that prioritizes the inputs
to valuation techniques used to measure fair value. The hierarchy
gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements)
and the lowest priority to unobservable inputs (Level 3
measurements). The three levels of the fair value hierarchy under
ASC 820 are described below:
Level 1
|
Unadjusted quoted prices in active markets that are accessible at
the measurement date for identical, unrestricted assets or
liabilities.
|
Level 2
|
Applies to assets or liabilities for which there are inputs other
than quoted prices included within Level 1 that are observable for
the asset or liability such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets
or liabilities in markets with insufficient volume or infrequent
transactions (less active markets); or model-derived valuations in
which significant inputs are observable or can be derived
principally from, or corroborated by, observable market
data.
|
Level 3
|
Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable
(supported by little or no market activity).
|
The
following table sets forth the Company’s financial assets and
liabilities measured at fair value by level within the fair value
hierarchy. As required by ASC 820, assets and liabilities are
classified in their entirety based on the lowest level of input
that is significant to the fair value measurement.
|
Fair Value at March 31, 2018
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$
1,852
|
$
1,852
|
$
—
|
$
—
|
Totals
|
$
1,852
|
$
1,852
|
$
—
|
$
—
|
|
Fair Value at December 31, 2017
|
($ in thousands)
|
|
|
|
|
Assets:
|
|
|
|
|
Pension
assets
|
$
1,806
|
$
1,806
|
$
—
|
$
—
|
Totals
|
$
1,806
|
$
1,806
|
$
—
|
$
—
|
NOTE 8. RELATED PARTY TRANSACTIONS
Lines of Credit
The Company has certain Lines of Credit extended
by certain members of the Company’s Board of Directors. For a
more detailed discussion of the Company’s Lines of Credit,
see Note 5, “
Lines of
Credit
.” As of
March 31, 2018, the Company
had borrowed $5,500,000
under the terms of the Goldman LOC and $500,000 under the terms of
the New Crocker LOC. Each of Messrs. Goldman and Crocker are
members of the Board of Directors of the
Company.
Series A Financing
Messrs. Miller and Goldman, Wayne Wetherell, the Company’s
Chief Financial Officer, Robert T. Clutterbuck and Charles
Frischer, two directors appointed as members of the Company’s
Board of Directors in connection with the Series A Financing 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 9. 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 we occupy 9,927 square feet of office space. This
facility’s lease was renewed in September 2017 through
October 2018 at a cost of approximately $30,000 per month. In
addition to our corporate headquarters, we also occupied the
following spaces at March 31, 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. This lease was renewed in April 2016 for a
five-year period ending on March 31, 2021. Renewal terms were
substantially unchanged from the existing lease;
●
9,720 square feet in Portland, Oregon, at a cost of approximately
$21,000 per month until the expiration of the lease on December 31,
2021. This lease was renewed in September 2017 resulting in an
additional 1,675 feet, an increase from approximately $18,000 to
approximately $21,000 per month and the extension of the term from
October 2018 to December 2021; and
●
304 square feet of office space in Mexico City, Mexico, at a cost
of approximately $3,000 per month until November 30,
2017.
At
March 31, 2018, future minimum lease payments are as
follows:
($ in thousands)
|
|
2018
(nine months)
|
$
444
|
2019
|
283
|
2020
|
290
|
2021
|
271
|
2022
|
271
|
Thereafter
|
46
|
Total
|
$
1,605
|
Rental
expense incurred under operating leases for the three months ended
March 31, 2018 and 2017 was approximately $171,000 and $125,000,
respectively.
NOTE 10. SUBSEQUENT EVENTS
During
April 2018, the Company issued 52,088 shares of its Common Stock
pursuant to the exercise of 52,088 options resulting in cash
proceeds to the Company of approximately $59,000.