The accompanying notes are an integral part of these condensed consolidated financial statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1
–
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Condensed Consolidated Interim Financial Statements –
The accompanying unaudited condensed consolidated financial statements include the accounts of Flexpoint Sensor Systems, Inc. (the “Company”). These financial statements are condensed and, therefore, do not include all disclosures normally required by accounting principles generally accepted in the United States of America. Therefore, these statements should be read in conjunction with the most recent annual consolidated financial statements of Flexpoint Sensor Systems, Inc. for the year ended December 31, 2018 included in the Company’s Form 10-K filed with the Securities and Exchange Commission on April 1, 2019. In particular, the Company’s significant accounting principles were presented as Note 1 to the Consolidated Financial Statements in that report. In the opinion of management, all adjustments necessary for a fair presentation have been included in the accompanying condensed consolidated financial statements and consist of only normal recurring adjustments. The results of operations presented in the accompanying condensed consolidated financial statements are not necessarily indicative of the results that may be expected for the full year ending December 31, 2019.
Nature of Operations
– Flexpoint Sensor Systems, Inc. (the Company) is located in Draper, Utah. The Company’s activities to date have included acquiring equipment and enhancing technology, obtaining financing, limited production and seeking long-term manufacturing contracts. The Company’s operations are in designing, engineering, manufacturing and selling sensor technology and equipment using flexible potentiometer technology. Through June 30, 2019 the Company continued to manufacture products and sensors to fill customer orders and provide engineering and design work.
Use of Estimates –
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.
Cash and Cash Equivalents –
Cash and cash equivalents are considered to be cash and highly liquid securities with original maturities of three months or less.
Fair Value Measurements
-
The fair value of a financial instrument is the amount that could be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk, including the party’s own credit risk.
Fair value measurements do not include transaction costs. A fair value hierarchy is used to prioritize the quality and reliability of the information used to determine fair values. Categorization within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is defined into the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.
To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value
8
hierarchy within which the fair value measurement is disclosed and is determined based on the lowest level input that is significant to the fair value measurement.
The carrying value of the Company’s cash, accounts payable, short-term borrowings (including convertible notes payable), and other current assets and liabilities approximate fair value because of their short-term maturity.
The Company has classified the inputs used in valuing its derivative liabilities as Level 3 inputs. The Company valued its derivatives using the binomial lattice model. While the Company believes that its valuation methods are appropriate and consistent with other market participants, it recognizes that the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The primary assumptions that would significantly affect the fair values using the methods discussed below are that of volatility and market price of the underlying common stock of the Company.
Accounts Receivable –
Trade accounts receivable are recorded at the time product is shipped or services are provided including any shipping and handling fees. Contracts associated with design and development engineering generally require a deposit of 50% of the quoted price prior to the commencement of work. The deposit is considered deferred income until the entire project is completed and accepted by the customer, at which time the entire contract price is billed to the customer and the deposit applied. The Company has established an allowance for bad debts based on a historical experience and an analysis of risk associated with the account balances. The balance in the allowance account was $114,991 and $136,761 in the periods ended June 30, 2019 and December 31, 2018, respectively.
Inventories –
The Company does not currently have inventory. However, as production levels increase inventories will be carried on the balance sheet. Inventories will be stated at the lower of cost or market or net realizable value. Cost is determined by using the first in, first out (FIFO) method.
Property and Equipment
–
Property and equipment are stated at cost. Additions and major improvements are capitalized while maintenance and repairs are charged to operations. Upon trade-in, sale or retirement of property and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is recognized. Depreciation is computed using the straight-line method and is recognized over the estimated useful lives of the property and equipment, which range from three to ten years.
Valuation of Long-lived Assets
– The carrying values of the Company’s long-lived assets are reviewed for impairment annually and whenever events or changes in circumstances indicate that they may not be recoverable. When projections indicate that the carrying value of the long-lived asset is not recoverable, the carrying value is reduced by the estimated excess of the carrying value over the projected discounted cash flows. Under similar analysis no impairment charge was taken during the six-month period ended June 30, 2019 and during the period ended December 31, 2018. Impairment tests will be conducted on an annual basis and, should they indicate a carrying value in excess of fair value, additional impairment charges may be required.
Intangible Assets
– Costs to obtain or develop patents are capitalized and amortized over the remaining life of the patents, and technology rights are amortized over their estimated useful lives. The Company currently has the right to several patents and proprietary technology. Patents and technology are amortized from the date the Company acquires or is awarded the patent or technology right, over their estimated useful lives, which range from 5 to 15 years. An impairment charge is recognized if the carrying amount is not recoverable and the carrying amount exceeds the fair value of the intangible assets as determined by projected discounted net future cash flows. Under similar analysis there was no impairment charge taken during the six-month period ended June 30, 2019 and during year ended December 31, 2018.
Research and Development
– Research and development costs are recognized as an expense during the period incurred, which is until the conceptual formulation, design, and testing of a process is completed and the process has been determined to be commercially viable.
Lease Obligations
– While the Company has adopted ASC 842 the Company has no leases at the date of this report that are required to be reported under ASC 842. As the Company enters into such leases it will record obligations under all leases it has entered into pursuant to the reporting requirements under ASC 842, allocating such obligations between current and long term. The Company also recorded an offsetting right of use asset. The right of use asset and lease obligation will be amortized over the respective lives of the leases.
9
Goodwill
– Goodwill represents the excess of the Company’s reorganization value over the fair value of net assets of the Company upon emergence from bankruptcy. Goodwill is not amortized, but is tested for impairment annually, or at interim periods when a triggering event occurs using a fair value approach. According to Accounting Standards Codification (or “ASC”) 350-20 Intangibles – Goodwill and Other, a fair-value-based test is applied at the overall Company level. The test compares the fair value of the Company to the carrying value of its net assets. This test requires various judgments and estimates. The fair value of the Company is allocated to the Company’s assets and liabilities based upon their fair values with the excess fair value allocated to goodwill. An impairment of goodwill is measured as the excess of the carrying amount of goodwill over the determined fair value.
Revenue Recognition –
On January 1, 2018 the Company adopted ASC 606,
Revenue from Contracts with Customers
, and all of the related amendments (“new revenue standard”). We have applied the new revenue standard to all contracts as of the date of the initial adoption. The new revenue standard establishes five steps whereby a transaction is analyzed to determine if revenue has been earned and can be recognized. The adoption of the new revenue standard did not have any effect on our financial statements. The vast majority of our sales are made to order, for which orders we require a deposit of 50% of the value of the order. That amount is put in a customer deposit account until the entire order has been manufactured and shipped. At the ship date the Company has no further obligations under the contract and the revenue from the sale is recognized.
A part of our customer base is made up of international customers. The table below allocates revenue between domestic and international customers.
The following table presents Flexpoint Sensor Systems revenues disaggregated by region and product type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three months ended:
|
|
|
June 30,
|
|
|
|
June 30,
|
|
|
|
|
|
2019
|
|
|
|
|
|
2018
|
|
|
|
|
|
Consumer
|
Long-term
|
|
|
|
|
Consumer
|
Long-term
|
|
|
Segments
|
|
|
Products
|
Contract
|
Total
|
|
|
|
Products
|
Contract
|
Total
|
|
Domestic
|
|
$
|
519,103
|
-
|
519,103
|
|
|
$
|
14,525
|
-
|
14,525
|
|
International
|
|
|
53,546
|
-
|
53,546
|
|
|
|
36,633
|
-
|
36,633
|
|
|
|
$
|
572,649
|
-
|
572,649
|
|
|
$
|
51,158
|
-
|
51,158
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Components
|
|
|
54,669
|
-
|
54,669
|
|
|
|
45,684
|
-
|
45,684
|
|
Engineering Services
|
|
|
67,980
|
-
|
67,980
|
|
|
|
5,474
|
-
|
5,474
|
|
Licensing fee
|
|
|
450,000
|
-
|
450,000
|
|
|
|
-
|
-
|
-
|
|
|
|
$
|
572,649
|
-
|
572,649
|
|
|
$
|
51,158
|
-
|
51,158
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Six months ended:
|
|
|
June 30,
|
|
|
|
June 30,
|
|
|
|
|
|
2019
|
|
|
|
|
|
2018
|
|
|
|
|
|
Consumer
|
Long-term
|
|
|
|
|
Consumer
|
Long-term
|
|
|
Segments
|
|
|
Products
|
Contract
|
Total
|
|
|
|
Products
|
Contract
|
Total
|
|
Domestic
|
|
$
|
535,151
|
-
|
535,151
|
|
|
$
|
62,672
|
-
|
62,672
|
|
International
|
|
|
101,890
|
-
|
101,890
|
|
|
|
67,750
|
-
|
67,750
|
|
|
|
$
|
637,041
|
-
|
637,041
|
|
|
$
|
130,422
|
-
|
130,422
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Components
|
|
|
112,638
|
-
|
112,638
|
|
|
|
103,770
|
-
|
103,770
|
|
Engineering Services
|
|
|
74,403
|
-
|
74,403
|
|
|
|
|
|
|
|
Licensing fee
|
|
|
450,000
|
-
|
450,000
|
|
|
|
26,652
|
-
|
26,652
|
|
|
|
$
|
637,041
|
-
|
637,041
|
|
|
$
|
130,422
|
-
|
130,422
|
Basic and Diluted Loss Per Share –
Basic loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted loss per share is computed by dividing net loss by the weighted-average number of common shares and dilutive potential common shares outstanding during the period. At June 30, 2019 there were outstanding common share equivalents (options and convertible notes payable)
10
which amounted to 22,248,463 of common stock. These common share equivalents were not included in the computation of diluted earnings per share for the three and six month periods ended June 30, 2019 as their effect would have been anti-dilutive, thereby decreasing loss per common share.
Concentrations and Credit Risk -
The Company has a few major customers who represent a significant portion of revenue, accounts receivable and notes receivable. During the six month period ended June 30, 2019, two customers represented 89% of sales and two other customers represented 94% of accounts receivable. The Company has a strong ongoing relationship with this customer with scheduled delivery extending through the year and does not believe this concentration poses a significant risk, as their products are based entirely on the Company’s technologies.
Income Taxes -
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards Board Accounting Codification (ASC) 740: Income Taxes. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets will be reflected on the balance sheet when it is determined that it is more likely than not that the asset will be realized
Recent Accounting Pronouncements
- The Company has reviewed all recently issued, but not yet adopted, accounting standards in order to determine their effects, if any, on its consolidated results of operation, financial position and cash flows. Based on that review, the Company believes that none of these pronouncements will have a significant effect on its current or future earnings or operations.
NOTE 2 – GOING CONCERN
The Company continues to accumulate significant operating losses and has an accumulated deficit of $28,371,884 at June 30, 2019. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Management is seeking additional funding to provide operating capital for its operations until such time as revenues are sufficient to sustain our level of operations. However, there is no assurance that additional funding will be available on acceptable terms, if at all.
NOTE 3 – DERIVATIVE INSTRUMENTS
The derivative liability as of June 30, 2019, in the amount of $659,883 has a Level 3 fair value classification.
The following table provides a summary of changes in fair value of the Company’s Level 3 financial liabilities as of June 30, 2019 and December 31, 2018:
|
|
|
|
|
|
| |
|
|
|
|
|
Total
|
|
|
Balance, December 31, 2017
|
|
|
|
|
363,680
|
|
|
Recognition of derivative liabilities upon initial valuation
|
|
|
|
|
92,404
|
|
|
Change in fair value of derivative liabilities
|
|
|
|
|
(171,227)
|
|
|
Conversions of derivative liabilities into equity instruments
|
|
|
|
|
-
|
|
|
Balance, December 31, 2018
|
|
|
|
|
284,857
|
|
|
Recognition of derivative liabilities upon initial valuation
|
|
|
|
|
86,332
|
|
|
Change in fair value of derivative liabilities
|
|
|
|
|
288,694
|
|
|
Conversions of derivative liabilities into equity instruments
|
|
|
|
|
-
|
|
|
Balance, June 30, 2019
|
|
|
|
|
659,883
|
|
During the year ended 2018 and the six-month period ended June 30, 2019, the Company issued convertible promissory notes which are convertible into common stock. Due to the Company’s lack of authorized shares necessary to settle all convertible instruments, in accordance with ASC 815-40-25, the Company determined that the conversion features related to these notes are derivative to settle all convertible instruments. The accounting treatment of derivative financial instruments requires that the Company record fair value of the derivatives as of the inception date of debenture and to fair value as of each subsequent reporting date.
11
At June 30, 2019, the Company marked to market the fair value of the derivatives and determined a fair value of $659,883. The Company recorded a loss from change in fair value of derivatives of $288,694 for the six-month period ended June 30, 2019. The fair value of the embedded derivatives was determined using binomial lattice model based on the following assumptions: (1) dividend yield of 0%, (2) expected volatility of 137.69% to 155.86%, (3) weighted average risk-free interest rate of 2.09% to 2.50% (4) expected life of 0.50 to 1.50 years, and (5) the quoted market price of the Company’s common stock at each valuation date.
In accordance ASC 840-15-25, the Company has implemented a sequencing policy with respect to all outstanding convertible instruments. The Company evaluates its contracts based upon earliest issuance date.
As of June 30, 2019, liabilities measured at fair value on a recurring basis are summarized as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Derivative Liabilities
|
|
|
-
|
|
|
|
-
|
|
|
|
659,883
|
|
|
|
659,883
|
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
659,883
|
|
|
$
|
659,883
|
NOTE 4 – CONVERTIBLE NOTES PAYABLE
Convertible Note Payable
At June 30, 2019 there are notes outstanding with principal balances which total $930,000. Of the notes, $790,000 are convertible notes bearing a 10% annual rate of interest (with a 15% default rate) and are convertible into shares of common stock at the rate of $0.06 to $0.20 per share. $40,000 is a convertible note entered into on August 8, 2011 with a former Company Director, at a rate of $0.20 per share. That note was due on December 31, 2015, and bears a default interest rate of 10%.
On May 28, 2019 the Company issued 3,650,000 shares of restricted common stock to Empire Fund Managers and 3,200,000 shares of restricted common stock to Compass Equity Partners, LLC in consideration for two convertible notes in the amount of $300,000 and $110,574 of accrued but unpaid interest. The Company recognized a gain on extinguishment of debt of $90,325 as a result of this transaction. See Note 6.
On January 31, 2019, the Company entered into a convertible note for up to $100,000 from a third party. The note has an annual interest rate of 10% and is secured by the Company’s equipment. The note has a conversion feature for restricted common shares at $0.05 per share and a maturity date of August 31, 2018. At June 30, 2019 the Company had drawn $100,000 against this note.
Convertible Note Payable - Related Party
At June 30, 2019 there are notes outstanding with two directors of the Company with balances of $164,257 and $54,256, respectively. The notes bear an 8% annual rate of interest with a 12% default rate. There are $50,000 in notes to the first officer that had due dates of December 31, 2016 and December 31, 2017, and on which interest is being calculated at the default rate. Notes of $37,257 and $27,256 have due dates of December 31, 2018 and on which interest is being calculated at the default rate. The remaining $77,000 and $27,000 notes have due dates of December 31, 2019.
Additionally, in May 2019, the Company converted the $39,000 payable to two directors into convertible notes payable in the amounts of $22,000 and $17,000. The notes bear interest at the rate of 8%, have a default rate of 12%, are convertible into shares of common stock at a conversion price of $0.06 per share, and have a termination date of December 31, 2019. There is a debt discount of $24,037 on the balance sheet related to these notes that is being amortized over their respective terms.
All of the convertible notes issued to directors are convertible into shares of common stock with notes totaling $114,513 at the rate of $0.07 per share and notes totaling $104,000 at the rate of $0.06 per share.
NOTE 5
–
STOCK OPTION PLANS
On August 25, 2005, the Board of Directors of the Company approved and adopted the 2005 Stock Incentive Plan (the Plan). The Plan became effective upon its adoption by the Board and will continue in effect for ten years, unless terminated. This plan was approved by the stockholders of the Company at their annual meeting of shareholders on November 22, 2005. Under the Plan, the exercise price for all options issued will not be less than the average quoted closing market price of the Company’s trading common stock for the thirty day period immediately preceding the grant date plus a premium of ten percent. The maximum aggregate number of shares that may be awarded under the plan is 2,500,000 shares.
The Company continues to utilize the Black-Scholes option-pricing model for calculating the fair value of the options granted as defined by ASC Topic 718, which is an acceptable valuation approach under
12
ASC 718. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock.
On August 24, 2015, the Board of Directors approved the issuance of options to purchase 2,185,000 shares of the Company’s common stock. Of the total issued, 1,960,000 options were issued to replace options held by directors and employees which were to expire and 225,000 options were issued to new employees. Of the options issued, 640,000 have an option price of $0.14 per share, 500,000 have an option price of $0.15 per share, 995,000 have an option price of $0.20 per share, and 50,000 have an option price of $0.25 per share. Options issued as replacement shall have immediate vesting terms. Options which are not replacements shall vest over a two year four month period in equal installments on the last day of 2015, 2016 and 2017, respectively. We relied on an exemption from the registration requirements provided by Section 4(a)(2) of the Securities Act.
Projected data related to the expected volatility and expected life of stock options is based upon historical and other information, and notably, the Company's common stock has limited trading history. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore, the existing valuation models do not provide a precise measure of the fair value of the Company's employee stock options. Between August 25, 2005 and December 31, 2015, the Company granted options to employees to purchase an aggregate 3,096,000 shares of common stock at exercise prices ranging from $0.14 to $2.07 per share. The options vest over three years and expire 10 years from the date of grant. The Company used the following assumptions in estimating the fair value of the options granted:
·
Market value at the time of issuance – Range of $0.14 to 2.07
·
Expected term – Range of 3.7 years to 10.0 years
·
Risk-free interest rate – Range of 1.60% to 4.93%
·
Dividend yield – 0%
·
Expected volatility – 200% to 424%
·
Weighted-average fair value - $0.16 to $2.07
All of the options were fully vested at December 31, 2018. As a result there was no stock-based compensation expenses recorded for the three and six months ended June 30, 2019. The Company recognized no stock-based compensation expense for the three and six month periods ended June 30, 2018. There were 2,185,000 and 2,185,000 employee stock options outstanding at June 30, 2019 and December 31, 2018, respectively.
A summary of all employee options outstanding and exercisable under the plan as of June 30, 2019, and changes during the three months then ended is set forth below:
|
|
|
|
| |
|
Options
|
Shares
|
Weighted Average Exercise Price
|
Weighted Average Remaining Contractual Life (Years)
|
Aggregate Intrinsic Value
|
|
|
|
|
|
|
|
Outstanding at the beginning of period
|
2,185,000
|
$ 0.17
|
7.41
|
$ --
|
|
Granted
|
--
|
--
|
--
|
--
|
|
Expired
|
--
|
--
|
--
|
--
|
|
Forfeited
|
--
|
--
|
--
|
--
|
|
Outstanding at the end of Period
|
2,185,000
|
$ 0.17
|
7.16
|
$ --
|
|
Exercisable at the end of Period
|
2,185,000
|
$ 0.17
|
7.16
|
$ --
|
NOTE 6 – CAPITAL STOCK
Preferred Stock – There are 1,000,000 shares of preferred stock with a par value of $0.001 per share authorized. At June 30, 2019 and December 31, 2018, there were no shares of preferred stock issued or outstanding.
Common Stock – There are 100,000,000 shares of common stock with a par value of $0.001 per share authorized. At the annual meeting of stockholders held December 28, 2018, the shareholders approved increasing the number of authorized shares to 200,000,000. As of the date of this report the amendment to the Articles of Incorporation affecting such change has not been filed with the State of Delaware. During the three and six months ended June 30, 2019 the Company issued 6,850,000 shares to fulfill its obligations under two notes which totaled $300,000 and
13
accrued but unpaid interest which totaled $110,574. The notes had a conversion price of $0.06 per share. The Company recorded a gain on the extinguishment of debt of $90,325, which amount was accrued interest forgiven by the note holder.
NOTE 7 – COMMITMENTS AND CONTINGENCIES
The Company currently occupies manufacturing facility in Draper, Utah. The lease on the facility expired on December 31, 2014, at which time the Company entered into a three year extension which expired on December 31, 2017. The lease provides that on the expiration of the lease on December 31, 2017 the lease became a month to month lease at a monthly lease rate ($9,600), plus an increase of 10% on the anniversary date of each succeeding year. The Company is paying a lease rate of $11,520 per month in 2019.
NOTE 8 – RELATED PARTY TRANSACTIONS
At June 30, 2019 there were no amounts payable to officers and directors of the Company. At December 31, 2018, the Company had amounts of $10,000 payable to its Chief Executive Officer and $17,000 payable to a director for funds loaned the Company to pay of various operating expenses of the business.
In May 2019, the Company converted the amounts payable to officers to convertible notes issued notes to officers in the amounts of the amount of $22,000 and $17,000. The notes bear interest at the rate of 8% per annum with a default rate of 12%, are convertible into shares of common stock at $0.06 per share, and have a termination date of December 31, 2019.
At June 30, 2019 and December 31, 2018, the Company had outstanding notes payable to an officer in the amount of $181,257 and $147,257 respectively and outstanding notes payable to a director in the amount of $76,256 and $32,256 respectively.
NOTE 9 – SUBSEQUENT EVENTS
On July 25, 2019 the Company entered into an agreement with FGBP and Energizer Holdings, Inc. to settle debt in the amount of $91,160 by the payment of $55,000 and received a release from the remaining obligation amount. A gain on extinguishment of debt in the amount of $36,160 will be recorded in the third quarter of 2019.
In accordance with ASC 855-10 management reviewed all material events through the date of this report. There are no material subsequent events to report other than those disclosed above.
14
In this quarterly report references to “Flexpoint", "the Company," “we,” “us,” and “our” refer to Flexpoint Sensor Systems, Inc. and its
subsidiaries.
FORWARD LOOKING STATEMENTS
The U.S. Securities and Exchange Commission (“SEC”) encourages reporting companies to disclose forward-looking information so that investors can better understand future prospects and make informed investment decisions. This report contains these types of statements. Words such as “may,” “expect,” “believe,” “anticipate,” “estimate,” “project,” or “continue” or comparable terminology used in connection with any discussion of future operating results or financial performance identify forward-looking statements. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this report. All forward-looking statements reflect our present expectation of future events and are subject to a number of important factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EXECUTIVE OVERVIEW
Flexpoint Sensor Systems, Inc. is a company engaged principally in improving its unique sensor technology, expanding its suite of products, developing new sensor applications, obtaining financing and seeking long-term sustainable manufacturing contracts. Our operations have not yet commenced to a commercially sustainable level and include designing, engineering, manufacturing and selling sensor technology and products featuring our Bend Sensor
®
technology and equipment.
On June 20, 2019 the Company announced our exclusive development and licensing agreement with Audio Technology company subVo, LLC introducing a new wave of near perfect sound reproduction for everyday smart and slim devices. Tracking movement in real time, the Bend Sensor® used in the subVo® system knows the exact position of the cone at any given moment, allowing for the amplifier to calibrate, correct, and produce near-perfect sound reproduction, with zero lag time. The Bend Sensor® provides low distortion, flat frequency response, and fast impulse response. In addition to the licensing agreement the company received income for the previous work for the design and development of the system.
The Flexpoint
Bend Sensor
® technology will be utilized in subVo’s KlaraT® speaker compensation technology and software algorithm. The sensor, when added to, or printed directly onto the diaphragm of a speaker, enables perfect synergistic motion, sensing precise movements throughout the audible spectrum. The Bend Sensor works with the KlaraT proprietary software, allowing the feedback control and speaker protection algorithms to push speakers to their limits, without distortion or damage. This combined with the auto-calibration algorithm will remove all variability due to tolerances incurred in the manufacturing process, saving time and ultimately cost. The KlaraT calibration compensates for changes in temperature, humidity, and wear of the speaker itself over time.
On October 18, 2018, the Company announced it had signed a five year manufacturing and supply agreement with Counted LLC. Counted LLC conceived of a medication delivery monitoring system and dispensing monitoring system. Flexpoint designed and produced the monitoring system with Flexpoint features, Flexpoint technology and Flexpoint designed electronics to track and report the dispensing of medications in real time. The information has the potential to be transmitted to physicians, pharmacists and government agencies. Prototypes have been built and successfully tested with additional production and testing continuing through 2018 and the first quarter of 2019. The Company expects that commercial production will begin in the late third quarter of 2019, increasing throughout the balance of 2019 and beyond.
In the rapidly growing and emerging wearables space, Flexpoint has recently received additional purchase orders from multiple glove manufacturers across various market sub-segments, including medical, gaming and virtual reality. The “speed to market” commercialization plans of these companies are driving this increased order volume. Flexpoint is aggressively going after this evolving market, and expects this pattern to continue and dramatically increase throughout 2019. In aggregate, Bend Sensor
®
wearables order volumes are expected to number in the tens of thousands in 2019. The wearables market segment is clearly one where our technology is easily adapted and truly
15
illustrates our technological differentiation. Flexpoint’s willingness and ability to customize sensors for these innovative companies and deliver them at a competitive price point allows us to deliver real value to our customers.
These ground-breaking glove systems, combined with unique, leading edge software applications, also adapt to a wide range of other applications, including health rehabilitation, unmanned systems control, smartphone interaction and professional training across multiple industries. In addition to producing an array of Bend Sensors
®
, the Company is under agreement to supply integrated assemblies comprised of multiple sensor types and associated electronics.
In the VR/VA marketspace, orders of increasing size and frequency were received during the fourth quarter of 2018 and in the first quarter of 2019 from Manus VR and Neofect as they strive to fulfill production orders. Flexpoint also received orders from other global VR/AR customers during the quarter.
Finalizing long-term, constant revenue generating production contracts with our existing and other customers remains our greatest challenge because our on-going business is dependent on the types of revenues and cash flows generated by such contracts. Cash flow and cash requirement risks are closely tied to and are dependent upon our ability to attract significant long-term production contracts. We must continue to obtain funding to operate and expand our operations so that we can deliver our unique Bend Sensor
®
and Bend Sensor
®
related technologies and products to the market. Management believes that even though we are making positive strides forward with our business plan we will need to raise additional operating capital.
LIQUIDITY AND CAPITAL RESOURCES
Currently our revenue is primarily from product licensing, development, manufacturing and recurring sales with additional contributions to income from design contract, testing and limited production services for prototypes and samples, and is currently at a level to support our operations. We believe, based upon current orders and projected orders over the next twelve months, that we could be producing sensors under long-term contracts in the future that will help support our existing operations and potential future growth. Management recognizes such contracts usually go through a long negotiation process and there can be no guarantee that we will be successful in our negotiations or that such contracts will be sufficient to support our current operations in the near future.
For the twelve months previous to this quarter we have relied on the proceeds of convertible loans from existing shareholders and private placements of our common stock. During 2018 and the first six months of 2019, the Company secured additional financing to fund its operations by issuing convertible notes to First Equity Holdings Corp. and officers. The balances of all notes have a combined total of $1,148,513, net of debt discounts of $51,771, as of June 30, 2019. The notes have an annual interest rate of 8% to 10% and default rates of 12% to 15%, have various maturity dates, and are secured by the Company’s business assets.
Management believes that our current cash burn rate is approximately $60,000 per month and that proceeds from additional convertible notes and estimated revenues for manufacturing, production, engineering design and prototype products will be sufficient to fund the next twelve months of operations. Our auditors have expressed doubt about our ability to continue as a going concern and that we may not realize significant revenue or become profitable within the next twelve months. We will require additional financing to fund our short-term cash needs. We will have to rely on additional debt financing, loans from existing shareholders and private placements of common stock for additional funding. Based upon our current purchase orders and anticipated purchase orders over the next twelve months our projected revenues by the end of 2019 are anticipated to cover our projected operating expenses, based on our current burn rate. However, we cannot assure you that we will be able to obtain short-term financing, or that sources of such financing, if any, will continue to be available, and if available, that they will be on terms favorable to us. Nor is there any guarantee that the projected volume of purchase orders will meet the volumes that we anticipate.
As we enter into new agreements, we must ensure that those agreements provide adequate funding for any pre-production research and development and manufacturing costs. If we are successful in establishing agreements with adequate initial funding, management believes that our operations for the long term will be funded by revenues, licensing fees and/or royalties related to these agreements. However, we have formalized only a few agreements during the past four years and there can be no assurance that the agreements will generate sufficient revenues or be profitable in the future or that a desired technological application will be successful enough to produce the volumes and profits necessary to fund our operations.
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FINANCIAL OBLIGATIONS AND CONTINGENT LIABILITIES
Our principal commitments at June 30, 2019 consisted of our operating lease of $11,520 per month, and total liabilities of $3,471,633, which includes $1,096,742 of convertible notes payable, net of discounts of $51,771. Accrued liabilities at June 30, 2019, were $1,430,187 and were related to payroll, payroll tax liabilities, accrued professional expenses, accrued insurance expense, accrued interest expense on notes and accrued paid time off.
During the six months ending June 30, 2019, the Company has raised an additional $100,000 in operating capital through the issuance of a short-term note. On January 31, 2019, the Company entered into this convertible note for up to $100,000 from a third party. The note has an annual interest rate of 10% and a default rate of 15% annually. The note is secured by the Company’s equipment. The note has a conversion feature for restricted common shares at $0.05 per share and a maturity date of August 31, 2019. As of June 30, 2019 the Company had drawn the full $100,000 on the note.
During the year ended 2018 and the six-month period ended June 30, 2019, the Company issued convertible promissory notes which are convertible into common stock. Due to the Company’s lack of authorized shares necessary to settle all convertible instruments, we determined that the conversion features related to these notes are derivative instruments. At June 30, 2019, the Company determined a fair value of $659,833 for the derivative instruments. The Company recorded a loss from change in fair value of derivatives of $288,694 for the six-month period ended June 30, 2019.
The Company has a few major customers who represent a significant portion of revenue and accounts receivable. During the six months ended June 30, 2019, two customers represented 89% of sales and two other customers represented 94% of accounts receivable. The Company has a strong ongoing relationship with this customer with scheduled delivery extending through the year and does not believe this concentration poses a significant risk, as their products are based entirely on the Company’s technologies.
OFF-BALANCE SHEET ARRANGEMENTS
We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates of particular significance in our financial statements include goodwill and the annual tests for impairment of goodwill and long-lived assets and valuing stock option compensation.
The Company's goodwill represents the excess of its reorganization value over the fair value of the net assets upon emergence from bankruptcy. Goodwill is not amortized, therefore we test our goodwill for impairment annually or when a triggering event occur using a fair value approach. A fair value based test is applied at the overall Company level. The test compares the fair value of the Company to the carrying value of its nets assets. The test requires various judgments and estimates. During 2018 and for the six months ending June 30, 2019, the Company recorded no impairment charge to reduce the carrying value of the goodwill to its estimated fair value. As part of the impairment testing performed at December 31, 2018, the Company considered factors such as the global market volatility, variables in the economy, and the overall uncertainty in the markets which has resulted in a decline in the market price of the Company's stock price and market capitalization for a sustained period, as indicators for potential goodwill impairment.
We test long-lived assets for impairment annually or when a triggering event occurs. Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets. The amount of impairment is measured using a discounted-cash-flows model considering future revenues, operating costs and risk-adjusted discount rate and other factors. The analysis compares the present value of projected net cash flows for the remaining current year and next two years against the carrying value of the long-lived assets. If the carrying values of the long-lived assets exceed the present value of the discounted projected revenues an impairment expense would be recognized in the period and the carrying value of the assets would be adjusted accordingly. Impairment tests are conducted on an annual basis and, should they indicate a carrying value in excess of fair value, a charge may be required.
17
Financial accounting standards require that recognition of the cost of employee services received in exchange for stock options and awards of equity instruments be based on the grant-date fair value of such options and awards and is recognized as an expense in operations over the period they vest. The fair value of the options we have granted is estimated at the date of grant using the Black-Scholes American option-pricing model. Option pricing models require the input of highly sensitive assumptions, including expected stock volatility. Also, our stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. Management believes the best input assumptions available were used to value the options and that the resulting option values are reasonable. For the six month periods ended June 30, 2019 and 2018 we recognized $0 and $0, respectively, of stock-based compensation expense for our stock options and there is no additional unrecognized compensation cost related to employee stock options at the current time.
RESULTS OF OPERATIONS
The Company continues to concentrate its marketing resources on a limited number of customers that have the greatest potential to generate the most short-term revenue while still building relationships with our larger customers. Management believes this approach has the highest potential to bring long-term commercially viable products to market and will provide sustainable cash flow to fund the Company's operations in the future. Currently, overall revenues are not sufficient to sustain our operations. Management anticipates that revenues will increase as we continue to execute our long-term business plan and cultivate larger customer bases with our existing product offering. However, until a long-term production contract is in place there is no guarantee that our current customer base will order in sufficient volumes to sustain our operations. Therefore, management continues to work with larger companies and industries and is hopeful that in the near future we will sign a long-term licensing or manufacturing contract.
We received revenue from repeat orders from our existing customers, design contract, and development engineering. Revenue is recognized using the ASC 606 five step detailed in Note 1 to the financial statements. Revenue from the sale of a product is recorded at the time of shipment to the customer. Revenue from the license agreement was recognized in the period the agreement was concluded, as it is a right of use license and the Company has no further obligations to perform under the terms of the agreement. Revenue from research and development engineering contracts is recognized as the services are provided and accepted by the customer. Revenue from contracts to license technology to others is deferred until all conditions under the contract are met and then the sale is recognized as licensing royalty revenue over the remaining term of the contract.
The following discussions are based on the consolidated operations of Flexpoint Sensor Systems, Inc. and should be read in conjunction with our unaudited financial statements for the three and six months ended June 30, 2019 and 2018, included in Part I, Item 1, above, and the audited financial statements included in the Company’s annual report on Form 10-K for the years ended December 31, 2018 and 2017.
THREE MONTH PERIODS ENDED JUNE 30, 2019 AND 2018:
|
|
|
| |
|
SUMMARY OF OPERATING RESULTS
|
|
|
Three month period ended
|
|
|
June 30, 2019
|
|
June 30, 2018
|
|
Manufacturing, design, licensing and contract revenue
|
$ 572,446
|
|
$ 51,158
|
|
Total operating costs and expenses
|
220,557
|
|
213,017
|
|
Net other income (expense)
|
(244,404)
|
|
3,226
|
|
Net income (loss)
|
107,485
|
|
(158,633)
|
|
Basic and diluted loss per common share
|
0.00
|
|
(0.00)
|
For the three months ending June 30, 2019 revenue was $572,446, an increase of $521,288 when compared to the same period in 2018. The majority of the revenue for this period came from a $450,000 licensing agreement, with the remainder generated from product manufacturing and recurring sales, product engineering services, prototype and pre-production products.
Of the $220,557 and $213,017 total operating costs and expense for the three months ending June 30, 2019 and 2018, respectively, $74,306 and $81,928 were for direct research and development cost, respectively. For the three
18
months ended June 30, 2019, total operating expenses increased by $7,540 when compared to the same period in 2018.
Other expense for the three month period ended June 30, 2019 was $244,404, a $247,630 decrease compared to the same period in 2018. The decrease is attributable to a loss of $254,157 on the change in fair value of derivative liabilities recorded in 2019, offset by a $90,325 gain on extinguishment of debt while a gain of $82,091on derivative was recognized in 2018.
A net profit of $107,485 was realized for the three months ended June 30, 2019. A net loss of $158,633 was realized for the three month period ended June 30, 2018.
SIX MONTH PERIODS ENDED JUNE 30, 2019 AND 2018:
|
|
|
| |
|
SUMMARY OF OPERATING RESULTS
|
|
|
Six month period ended
|
|
|
June 30, 2019
|
|
June 30, 2018
|
|
Manufacturing, design, and contract revenue
|
$ 637,041
|
|
$ 130,422
|
|
Total operating costs and expenses
|
441,250
|
|
437,632
|
|
Net other income (expense)
|
(355,128)
|
|
45,355
|
|
Net income (loss)
|
(159,337)
|
|
(261,855)
|
|
Basic and diluted income (loss) per common share
|
(0.00)
|
|
(0.00)
|
For the six months ending June 30, 2019 revenue was $637,041, an increase of $506,619 when compared to the same period in 2018. The majority of the revenue for this period came from the $450,000 revenue recognized for the license agreement entered into, with remaining income generated from the product manufacturing and recurring sales with additional contributions to income from development engineering, prototype and pre-production products.
Of the $441,250 and $437,632 total operating costs and expense for the six months ending June 30, 2019 and 2018, respectively, $153,458 and $163,805 were for direct research and development cost, respectively. For the six months ended June 30, 2019, total operating expenses increased by $3,618 when compared to the same period in 2018, due primarily to a reduction in cost of revenue.
Other expense for the six month period ended June 30, 2019 was $355,128, a $400,483 decrease compared to the same period in 2018. The decrease is primarily attributable to the loss of $288,694 on the change in fair value of derivative liabilities and a $90,325 gain on extinguishment of debt recorded in 2019 while in 2018 a gain of $202,840 on derivative was recognized.
A net loss of $159,337 was realized for the six months ended June 30, 2019. A net loss of $261,855 was realized for the three month period ended June 30, 2018.
The chart below represents a summary of our condensed consolidated balance sheets at June 30, 2019 and December 31, 2018.