NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2018
Note 1: Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the
nine
months ended
June 30, 2018
are not necessarily indicative of the results that may be expected for the fiscal year ended
September 30, 2018
. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended
September 30, 2017
.
Note 2: Marketable Securities
Marketable securities consist of mutual fund investments principally in federal, state and local government debt securities of
$13,459
as of
June 30, 2018
. Such mutual fund investments are stated at market value based on quoted market prices (Level 1 inputs) and are classified as available-for-sale under the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 320, with unrealized gains and losses reported in accumulated other comprehensive loss as a component of shareholders’ equity. The cost of such securities at
June 30, 2018
was
$14,407
, with
$948
of cumulative unrealized losses reported at
June 30, 2018
.
Note 3: Accounts Receivable
Accounts receivable is stated net of an allowance for uncollectible accounts of
$713,000
and
$946,000
as of
June 30, 2018
and
September 30, 2017
, respectively.
Note 4: Loss per Share
Basic loss per share (EPS) is computed based on the weighted average number of common shares outstanding for the period. Diluted EPS reflects the maximum dilution that would have resulted from incremental common shares issuable upon the exercise of stock options and under deferred compensation agreements.
The following tables provide the components of the basic and diluted EPS computations for the three and nine month periods ended
June 30, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
June 30,
|
|
June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Basic EPS Computation
|
|
|
|
|
|
|
|
Net loss
|
$
|
(1,657,069
|
)
|
|
$
|
(1,397,439
|
)
|
|
$
|
(4,425,652
|
)
|
|
$
|
(4,602,549
|
)
|
Weighted average shares outstanding
|
17,552,623
|
|
|
9,348,388
|
|
|
16,413,221
|
|
|
9,348,388
|
|
Basic loss per share
|
$
|
(.09
|
)
|
|
$
|
(.15
|
)
|
|
$
|
(.27
|
)
|
|
$
|
(.49
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
June 30,
|
|
June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Diluted EPS Computation
|
|
|
|
|
|
|
|
Net loss
|
$
|
(1,657,069
|
)
|
|
$
|
(1,397,439
|
)
|
|
$
|
(4,425,652
|
)
|
|
$
|
(4,602,549
|
)
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
17,552,623
|
|
|
9,348,388
|
|
|
16,413,221
|
|
|
9,348,388
|
|
Stock options
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Stock compensation arrangements
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Warrants
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Diluted shares outstanding
|
17,552,623
|
|
|
9,348,388
|
|
|
16,413,221
|
|
|
9,348,388
|
|
|
|
|
|
|
|
|
|
Diluted loss per share
|
$
|
(.09
|
)
|
|
$
|
(.15
|
)
|
|
$
|
(.27
|
)
|
|
$
|
(.49
|
)
|
For the three and nine month periods ended
June 30, 2018 and 2017
, all outstanding stock options, warrants and shares issuable under stock compensation arrangements totaling
1,855,634
and
2,048,590
shares, respectively, have been omitted from the calculation of diluted EPS as their effect would have been antidilutive. The actual effect of these stock options and shares, if any, on the diluted earnings per share calculation will vary significantly depending on fluctuations in the market price of the Company's stock.
Note 5: Accumulated Other Comprehensive Loss
The Company's accumulated other comprehensive loss balances at
June 30, 2018
and
September 30, 2017
consisted of the following:
|
|
|
|
|
|
|
|
|
|
June 30, 2018
|
|
September 30, 2017
|
Foreign currency translation adjustment
|
$
|
(185,224
|
)
|
|
$
|
(155,491
|
)
|
Unrealized loss on marketable securities
|
(948
|
)
|
|
(559
|
)
|
Accumulated other comprehensive loss
|
$
|
(186,172
|
)
|
|
$
|
(156,050
|
)
|
Note 6: Stock-Based Compensation
The Company maintains stock option plans that include both incentive and non-qualified options reserved for issuance to key employees, including officers and directors. All options are issued at fair market value at the grant date and are exercisable in varying installments according to the plans. The plans allow for the payment of option exercises through the surrender of previously owned mature shares based on the fair market value of such shares at the date of surrender.
The Company follows ASC 718 (“Share-Based Payment”), which requires that all share based payments to employees, including stock options, be recognized as compensation expense in the consolidated financial statements based on their grant date fair values and over the requisite service period. For the three month periods ended
June 30, 2018
and
2017
, the Company recorded non-cash compensation expense of
$5,595
and
$10,791
, respectively (
$.00
and
$.00
per basic and diluted share, respectively), relating to stock compensation. For the nine month periods ended
June 30, 2018
and
2017
, the Company recorded non-cash compensation expense of
$18,101
and
$34,585
, respectively (
$.00
and
$.00
per basic and diluted share, respectively), relating to stock compensation.
Note 7: Recent Accounting Pronouncements
In May 2014, the FASB issued guidance on revenue from contracts with customers. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of time value of money in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved, in certain circumstances. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of
revenue and cash flows arising from an entity's contracts with customers. This guidance permits the use of either the retrospective or cumulative effect transition method and is effective for the Company beginning in fiscal 2019; early adoption is not permitted prior to the first quarter of fiscal 2018. The Company is currently evaluating the effect of implementing this guidance.
In February 2016, the FASB issued guidance on lease accounting requiring lessees to recognize a right-of-use asset and a lease liability for long-term leases. The liability will be equal to the present value of lease payments. The standard requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. This guidance must be applied using a modified retrospective transition approach to all annual and interim periods presented and is effective for the Company beginning in fiscal 2020. The Company is currently in the initial stages of evaluating the effect of implementing this guidance.
In March 2016, the FASB issued guidance on simplifying several aspects of accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance requires a mix of prospective, modified retrospective, and retrospective transition to all annual and interim periods presented and was effective for the Company beginning in fiscal 2018. The adoption of this guidance did not have a material effect on the Company's operating results or financial position.
In January 2017, the FASB issued guidance that clarifies the definition of a business, which will impact many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The new standard is intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This guidance is effective for the Company beginning in fiscal 2019 and will be considered for any future acquisitions.
Note 8: Income Taxes
Deferred tax assets and liabilities are recognized based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Deferred tax assets represent items to be used as a tax deduction or credit in future tax returns for which a tax benefit has been recorded in the income statement. The Company has a valuation allowance against its deferred tax assets due to the uncertainty of future realization. The full valuation allowance is determined to be appropriate due to the Company's operating losses since fiscal year 2010 and the inherent uncertainties of predicting future operating results in periods over which such net tax differences become deductible. At December 31, 2017, the Company had, as adjusted for the Tax Act (see below), approximately
$11.5 million
of unrecognized net deferred tax assets available, which includes approximately
$7.7 million
of tax effected U.S. and foreign net operating loss carryforwards. On August 29, 2014, the Company merged with IQinVision, Inc. In connection with this merger, the Company's ability to utilize pre-merger net operating losses and tax credit carryforwards in the future is subject to certain limitations pursuant to Section 382 of the Internal Revenue Code. The annual limitation on utilization of the Company's U.S. net operating loss carryforwards is presently estimated at $500,000. On November 7, 2017 the Company completed a rights offering that could further limit its ability to utilize prior net operating losses and tax credit carryforwards in the future pursuant to Section 382 of the Internal Revenue Code. This will not materially impact the balance sheet or statement of operations as all deferred tax assets have a full valuation allowance.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affects 2017. The Tax Act also establishes new tax laws that will affect 2018 and after, including a reduction in the U.S. federal corporate income tax rate from 34% to 21%.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740, Income Taxes. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. The Company is still evaluating whether certain tax credits will be recoverable but does not believe that it will have a material impact on the Company's operating results or financial condition.
The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company files U.S. Federal and State income tax returns and foreign tax returns in the United Kingdom, Germany and Israel. The Company is generally no longer subject to tax examinations in such jurisdictions for fiscal years prior to 2014 in the U.S. and 2011 in the U.K., Germany and Israel.
Note 9: Fair Value
The majority of the Company’s non-financial assets and liabilities are not required to be carried at fair value on a recurring basis, but the Company is required on a non-recurring basis to use fair value measurements when analyzing asset impairment as it relates to long-lived assets. The carrying amounts for trade accounts, other receivables, accounts payable and revolving credit borrowings approximate fair value due to either the short-term maturity of these instruments or the fact that the interest rate of the revolving credit borrowings is based upon current market rates.
Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Note 10: Product Warranties
The Company provides for the estimated cost of product warranties at the time revenue is recognized. While the Company engages in product quality programs and processes, including monitoring and evaluating the quality of its component suppliers, its warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from its estimates, revisions to the estimated warranty liability may be required.
Changes in the Company's warranty liability (included in accrued expenses) for the three and nine month periods ended June 30, 2018 and 2017 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Nine Months Ended June 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Balance at beginning of period
|
|
$
|
431,000
|
|
|
$
|
650,000
|
|
|
$
|
431,000
|
|
|
$
|
650,000
|
|
Provision for warranties
|
|
68,000
|
|
|
107,000
|
|
|
221,000
|
|
|
323,000
|
|
Expenses incurred
|
|
(68,000
|
)
|
|
(107,000
|
)
|
|
(221,000
|
)
|
|
(323,000
|
)
|
Balance at end of period
|
|
$
|
431,000
|
|
|
$
|
650,000
|
|
|
$
|
431,000
|
|
|
$
|
650,000
|
|
Note 11: Credit Agreement
On March 4, 2016, the Company entered into a Credit Agreement (the “Agreement”) with NIL Funding Corporation to provide a $3 million revolving line of credit for working capital purposes, which was subsequently amended and restated on two occasions as described below. The Agreement provides for a borrowing formula based upon eligible accounts receivable and is secured by a first priority security interest in substantially all of the Company’s assets. Borrowings under the Agreement bore interest at a rate of 6.75% per annum. The Agreement also provides for an unused commitment fee equal to .5% per annum. The Agreement includes provisions that are customarily found in similar financing agreements.
On August 18, 2016, the Company entered into an Amended and Restated Credit Agreement (the “Amended Agreement”) with NIL Funding Corporation which increased the $3 million revolving line of credit to $6 million. Under the Amended Agreement, the facility was to mature on October 2, 2018 and consisted of two credit lines of $4 million and $2 million which bore interest at rates of 6.95% per annum and 8.25% per annum, respectively. The $4 million line of credit was subject to a borrowing formula based upon eligible accounts receivable. The Amended Agreement also provided for an initial commitment fee of $60,000, which was paid at closing, as well as an unused commitment fee equal to .5% per annum. The Amended Agreement includes a financial covenant that requires the Company to maintain a specified minimum tangible net worth, as defined, and is otherwise substantially similar to the original Agreement with NIL Funding Corporation.
On April 20, 2017, the Company entered into the Second Amended and Restated Credit Agreement (the “Second Amended Agreement”) with NIL Funding Corporation, under which only $2 million of the $6 million facility is subject to a borrowing formula, effectively providing the Company with $2 million of additional borrowing availability. The Second Amended Agreement also extends the maturity date of the credit facility to April 2, 2019, and reduces the Company’s minimum tangible net worth requirement, but is otherwise substantially similar to the Amended Agreement. As of June 30, 2018, outstanding borrowings under the Second Amended Agreement were $5.8 million.
In connection with the Second Amended Agreement, NIL Funding was issued a three-year warrant to purchase 1.5 million shares of the Company's common stock at a price of $.40 per share. The fair value of the warrant at the date of issuance was $438,000, which is being amortized over the two-year remaining credit facility term from the date of issuance. At June 30, 2018 and September 30, 2017, there was $165,000 and $339,000, respectively, of deferred warrant issuance costs included in other assets in the accompanying balance sheets.
At June 30, 2018, the Company was in violation of the minimum tangible net worth covenant under Section 4.9 of the Second Amended Agreement. On July 27, 2018, the Company entered into an amendment (the “Amendment”) to the Second Amended Agreement with NIL Funding Corporation, which Amendment provides that, among other things, (a) from June 12, 2018 until September 1, 2018, the minimum tangible net worth covenant contained in Section 4.9 of the Second Amended Agreement will be of no force or effect, (b) from June 12, 2018 until September 2, 2018, the Company will not be permitted to borrow any additional funds under the Second Amended Agreement, and (c) NIL Funding Corporation waives any Event of Default (as defined in the Credit Agreement) with respect to Section 4.9 of the Second Amended Agreement that may have occurred prior to June 12, 2018. The Company paid NIL Funding Corporation a fee of $29,000 in connection with the Amendment.
Note 12: Going Concern and Liquidity
The accompanying financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future and, thus, do not include any adjustments relating to the recoverability and classification of assets and liabilities that may be necessary if the Company is unable to continue as a going concern. However, the Company's ability to continue as a going concern is dependent upon generating profitable operations in the future and obtaining the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due.
The Company has incurred operating losses due to depressed revenue levels and ongoing strategic investments. Since 2012, the Company has made a significant investment in the development of a completely new, and strategically critical, video management system (VMS). The initial release of this product offering was launched in January 2017, and was followed up by important system enhancements released in July 2017 and March 2018. The funding of this major development effort has contributed to the ongoing operating losses and depletion of cash reserves. Cash losses over the past several years have been financed by credit facility borrowings, the sale of the Company’s two principal operating facilities, ongoing management of working capital levels and, more recently, the Company's rights offering and related backstop funding discussed in Note 13 to the financial statements. Subsequent to quarter end, the Company launched a series of restructuring initiatives, which management expects will substantially reduce operating expenses and help improve operating efficiencies. The full impact of these initiatives are not expected to be reflected in the Company's financial statements until the onset of the quarter ending December 31, 2018.
At June 30, 2018, the Company had $2.4 million of cash reserves and was in violation of a financial covenant under the Second Amended Agreement as described above. On July 27, 2018, the Company entered into the Amendment which, among other things, provides a waiver of its default with respect to this financial covenant, and prohibits further borrowings until September 2, 2018. The Company is presently in negotiations with its lender to formalize a longer term remedy to this violation. However, there are no assurances that these negotiations will be successful. The Company currently expects to draw on its cash reserves to finance its near term working capital needs while it implements its operating cost restructuring initiatives.
Notwithstanding ongoing restructuring plans, the Company will likely require additional financing over the next twelve months to implement its planned business objectives and strategies. Accordingly, and in light of the Company's historic and continuing losses, there is substantial doubt about the Company's ability to continue as a going concern.
Note 13: Rights Offering and Investment Agreement
On November 7, 2017, the Company completed a rights offering of common stock to its existing shareholders, whereby it raised approximately $282,000 of gross proceeds for the issuance of 704,235 shares of its common stock pursuant to subscription commitments. On November 8, 2017, following the closing of the rights offering, the Company issued 7,500,000 shares of its common stock to NIL Funding Corporation, the Company's secured lender, for an aggregate purchase price of $3.0 million pursuant to an Investment Agreement between the Company and NIL Funding Corporation dated as of July 27, 2017. The net proceeds from the rights offering and Investment Agreement were used by the Company to pay down interest bearing borrowings under its Credit Agreement.
Note 14: Related Party Transactions
On August 8, 2018, the Company entered into a Research and Development Services Agreement (the “Agreement”) with Cemtrex, Inc. ("Cemtrex") to provide the Company with outsourced software development services. The Company is transitioning its principal Israeli based software development activities to Cemtrex’s India based services group, which has now assumed principal software coding and test responsibilities for the Company. The outsourcing of these activities is expected to materially reduce the Company’s software development costs and provide development efficiencies, which should help expedite its software roadmap. The terms of the Agreement, among other things, set forth the scope of services, consideration, developed technology ownership, non-disclosure and safeguard of the Company’s software code. Pursuant to an informal agreement, $122,559 of fees were billed by Cemtrex to the Company during the three and nine-month periods ended June 30, 2018 in connection with the transition of software development activities.
Cemtrex beneficially owns 46% of the Company’s common stock. In addition, the Chief Executive Officer of Cemtrex serves as the Chief Executive Officer of the Company, and the principal shareholder of Cemtrex, who serves as a director of Cemtrex, also serves as a director of the Company.