Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 1-7939

VICON INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)



New York		11-2160665
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

135 Fell Court, Hauppauge, New York		11788
(Address of principal executive offices)		(Zip Code)

(631) 952-2288

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer ¨		Accelerated filer ¨
Non-accelerated filer ¨		Smaller reporting company x
(Do not check if a smaller reporting company)		Emerging growth company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

At August 14, 2018, the registrant had outstanding 17,552,623 shares of Common Stock, $.01 par value.

VICON INDUSTRIES, INC.

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Part I. Financial Information	Page Number

Item 1. Financial Statements (unaudited)

Condensed Consolidated Statements of Operations	3

Condensed Consolidated Statements of Comprehensive Loss	4

Condensed Consolidated Balance Sheets	5

Condensed Consolidated Statements of Cash Flows	6

Notes to Condensed Consolidated Financial Statements	7

Item 2. Management's Discussion and Analysis of Financial Condition	12
and Results of Operations

Item 4. Controls and Procedures	16

Part II. Other Information

Item 1. Legal Proceedings	17

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	17

Item 3. Defaults Upon Senior Securities	17

Item 4. Mine Safety Disclosures	17

Item 5. Other Information	17

Item 6. Exhibits	17

Signatures	18

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VICON INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)



	Three Months Ended						Nine Months Ended
	6/30/2018			6/30/2017			6/30/2018			6/30/2017

Net sales	$	6,168,791		$	7,382,367		$	21,237,500		$	19,990,727
Cost of sales	3,567,853			4,538,524			12,678,223			12,328,480
Gross profit	2,600,938			2,843,843			8,559,277			7,662,247

Operating expenses:
Selling, general and administrative expense	2,890,849			2,886,799			9,001,010			8,369,195
Engineering and development expense	1,189,367			1,234,780			3,510,633			3,664,230
	4,080,216			4,121,579			12,511,643			12,033,425

Operating loss	(1,479,278		)	(1,277,736		)	(3,952,366		)	(4,371,178		)

Other income (expense):
Interest income	664			353			1,351			756
Interest expense	(178,455		)	(120,056		)	(474,637		)	(232,127		)

Loss before income taxes	(1,657,069		)	(1,397,439		)	(4,425,652		)	(4,602,549		)

Income tax expense	—			—			—			—

Net loss	$	(1,657,069	)	$	(1,397,439	)	$	(4,425,652	)	$	(4,602,549	)


Loss per share:
Basic	$	(.09	)	$	(.15	)	$	(.27	)	$	(.49	)

Diluted	$	(.09	)	$	(.15	)	$	(.27	)	$	(.49	)


Weighted average shares outstanding:

Basic	17,552,623			9,348,388			16,413,221			9,348,388

Diluted	17,552,623			9,348,388			16,413,221			9,348,388

See Accompanying Notes to Condensed Consolidated Financial Statements.

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VICON INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(UNAUDITED)



	Three Months Ended						Nine Months Ended
	6/30/2018			6/30/2017			6/30/2018			6/30/2017
Net loss	$	(1,657,069	)	$	(1,397,439	)	$	(4,425,652	)	$	(4,602,549	)
Other comprehensive income (loss):
Unrealized gain (loss) on securities	(52		)	12			(389		)	(437		)
Foreign currency translation adjustment	(139,084		)	19,532			(29,733		)	295,702
Other comprehensive income (loss)	(139,136		)	19,544			(30,122		)	295,265
Comprehensive loss	$	(1,796,205	)	$	(1,377,895	)	$	(4,455,774	)	$	(4,307,284	)

See Accompanying Notes to Condensed Consolidated Financial Statements.

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VICON INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



ASSETS	6/30/2018			9/30/2017
	(Unaudited)
CURRENT ASSETS
Cash and cash equivalents	$	2,374,125		$	2,253,952
Marketable securities	13,459			13,555
Accounts receivable, net	4,304,908			4,349,733
Inventories:
Parts, components, and materials	496,359			783,553
Work-in-process	885,458			985,934
Finished products	4,115,812			4,780,514
	5,497,629			6,550,001
Prepaid expenses and other current assets	536,095			782,128
TOTAL CURRENT ASSETS	12,726,216			13,949,369

Property, plant and equipment	6,065,029			6,038,920
Less accumulated depreciation and amortization	(5,778,252		)	(5,637,222		)
	286,777			401,698
Other assets	918,331			1,116,583
TOTAL ASSETS	$	13,931,324		$	15,467,650

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES
Revolving credit borrowings	$	5,800,000		$	—
Accounts payable	2,041,554			3,138,057
Accrued compensation and employee benefits	1,705,454			1,629,175
Accrued expenses	1,066,459			1,169,392
Unearned revenue	483,236			500,878
TOTAL CURRENT LIABILITIES	11,096,703			6,437,502

Revolving credit borrowings	—			4,950,000
Unearned revenue - non current	264,126			139,601
Other long-term liabilities	1,580,393			1,570,861
TOTAL LIABILITIES	12,941,222			13,097,964
Commitments and contingencies

SHAREHOLDERS’ EQUITY
Common stock, par value $.01 per share authorized - 25,000,000 shares issued - 18,249,062 and 10,044,827 shares, respectively	182,491			100,448
Capital in excess of par value	43,993,617			40,999,470
Accumulated deficit	(39,562,191		)	(35,136,539		)
Treasury stock at cost, 696,439 shares	(3,437,643		)	(3,437,643		)
Accumulated other comprehensive loss	(186,172		)	(156,050		)
TOTAL SHAREHOLDERS’ EQUITY	990,102			2,369,686
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	13,931,324		$	15,467,650

See Accompanying Notes to Condensed Consolidated Financial Statements.

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VICON INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)



	Nine Months Ended
	6/30/2018			6/30/2017
Cash flows from operating activities:
Net loss	$	(4,425,652	)	$	(4,602,549	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	156,593			436,781
Amortization of deferred warrant expense	173,676			—
Stock compensation expense	18,101			34,585
Change in assets and liabilities:
Accounts receivable, net	31,607			1,234,503
Inventories, net	1,038,770			191,202
Prepaid expenses and other current assets	243,025			82,545
Other assets	24,576			(18,209		)
Accounts payable	(1,079,272		)	350,578
Accrued compensation and employee benefits	78,530			178,871
Accrued expenses	(100,893		)	(85,454		)
Unearned revenue	106,883			44,284
Other liabilities	10,721			63,235
Net cash used in operating activities	(3,723,335		)	(2,089,628		)

Cash flows from investing activities:
Net increase in marketable securities	(293		)	(340		)
Capital expenditures	(41,118		)	(130,971		)
Net cash used in investing activities	(41,411		)	(131,311		)

Cash flows from financing activities:
Revolving credit borrowings	850,000			1,950,000
Net proceeds from rights offering and investment agreement	3,056,981			—
Net cash provided by financing activities	3,906,981			1,950,000
Effect of exchange rate changes on cash	(22,062		)	315,483

Net increase in cash	120,173			44,544
Cash and cash equivalents at beginning of year	2,253,952			1,954,422
Cash and cash equivalents at end of period	$	2,374,125		$	1,998,966

Non-cash investing and financing activities:
Issuance of warrants in connection with credit facility	$	—		$	438,000

See Accompanying Notes to Condensed Consolidated Financial Statements.

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VICON INDUSTRIES, INC.

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	)

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	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

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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.

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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.

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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.

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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.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements for the periods indicated, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, bad debts, product warranties, inventories, long lived assets, income taxes and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors including general market conditions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Results for the periods reported herein are not necessarily indicative of results that may be expected in future periods.

Overview

The Company designs and markets video management systems and system components for use in security, surveillance, safety and communication applications by a broad group of end users worldwide. The Company’s product line consists of various elements of a video system, including DVR's, NVR's, video encoders, decoders, servers and related video management software, data storage units, analog, digital and HD megapixel fixed and robotic cameras, virtual and analog matrix video switchers and controls, and system peripherals.

The Company sells video surveillance system components in a highly competitive worldwide marketplace principally to authorized security distributors, dealers and system integrators. Such dealers and integrators typically resell and install the Company’s products directly to end users, among other services. The Company’s sales are principally project based and are largely dependent upon winning projects, construction activities and the timing of funding. Sales will vary from period to period depending upon many factors including seasonal and geographic trends in construction activities and the timing of deliveries due to changes in project schedules and funding. The Company usually does not have a large backlog as its customer orders are typically deliverable within three months or often upon receipt of order.

The Company competes in a market of rapid technology shifts which enhance the performance capability of security systems. As a result, the Company spends a significant amount on new product development. In fiscal 2017 and 2016, the Company incurred $4.8 million and $5.2 million of engineering and development expense or 18% and 15% of net sales, respectively. The Company’s expenditures for product development are substantially less than its major competitors. Further, the Company’s sales effort requires a high level of customer service and technical support for its products. The Company routinely considers various strategic options that may augment or supplement its present product offerings and technology platforms.

The Company has a foreign sales and distribution subsidiary in Europe that conducts certain of its business in British pounds and Euros that represented approximately 18% of the Company’s consolidated sales for fiscal 2017. It also has an Israel based engineering and development subsidiary that incurs a majority of its operating expenses in Shekels that represented approximately

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23% of the Company’s operating expenses for fiscal 2017. Changes in these local foreign currency exchange rates will have a direct impact on the Company's reported financial position and results.

Results of Operations

Three Months Ended June 30, 2018 Compared with June 30, 2017

Net sales for the quarter ended June 30, 2018 decreased by $1.2 million (16%) to $6.2 million compared with $7.4 million in the year ago period. Sales in the Americas decreased $735,000 (12%) to $5.3 million compared with $6.0 million in the year ago period, while Europe, Middle East and Africa (EMEA) sales decreased $478,000 (35%) to $896,000 compared with $1.4 million in the year ago period. Order intake for the quarter ended June 30, 2018 decreased by $966,000 (14%) to $5.9 million compared with $6.9 million in the year ago period. Americas order intake decreased by $658,000 (12%) to $5.0 million compared with $5.6 million in the year ago period, while EMEA order intake decreased $308,000 (24%) to $960,000 compared with $1.3 million in the year ago period. The backlog of unfilled orders was $1.9 million at June 30, 2018 compared with $2.2 million at September 30, 2017. The Company continues to invest in the promotion of its new Valerus video management system platform and new camera line offering, which is expected to ultimately improve the Company's market competitiveness.

Gross profit margins were 42.1% for the quarter ended June 30, 2018 compared with 38.5% in the year ago period. The margin improvement reflects initial market traction from the Company's new and more cost effective camera line introductions. The Company expects to generate increasing profit margins as it continues to enhance its software solution capabilities.

Operating expenses for the third quarter of fiscal 2018 decreased $41,000 to $4.1 million compared with $4.1 million for the year ago period. Selling, general and administrative (SG&A) expenses for the current quarter remained virtually unchanged at $2.9 million compared with the year ago period. Engineering and development expenses also remained virtually unchanged at $1.2 million for the current quarter compared with the year ago period. Subsequent to quarter end, the Company initiated software development changes, which are expected to materially reduce its future expense and improve throughput efficiencies.

The Company incurred an operating loss of $1.5 million for the third quarter of fiscal 2018 compared with an operating loss of $1.3 million for the year ago period.

Interest expense increased to $178,000 for the third quarter of fiscal 2018 compared with $120,000 in the year ago period as a result of increased borrowings under the Company's revolving credit agreement. Non-cash amortization charges included in interest expense relating to warrants granted to the Company's lender in April 2017 was $57,000 for the third quarter of fiscal 2018 compared with $44,000 for the year ago period.

The Company provides for a valuation allowance against its deferred tax assets due to the uncertainty of future realization and, thus, no tax benefit has been recognized on reported pretax losses for both periods (see Note 8: Income Taxes).

As a result of the foregoing, the Company reported a net loss of $1.7 million for the third quarter of fiscal 2018 compared with a net loss of $1.4 million for the year ago period.

Results of Operations

Nine Months Ended June 30, 2018 Compared with June 30, 2017

Net sales for the nine months ended June 30, 2018 increased by $1.2 million (6%) to $21.2 million compared with $20.0 million in the year ago period. Sales in the Americas increased $1.3 million (8%) to $17.5 million compared with $16.2 million in the year ago period, while Europe, Middle East and Africa (EMEA) sales decreased $75,000 (2%) to $3.7 million compared with $3.8 million in the year ago period. Order intake for the nine months ended June 30, 2018 increased by $1.4 million (7%) to $20.9 million compared with $19.5 million in the year ago period. Americas order intake increased by $1.0 million (7%) to $17.0 million compared with $16.0 million in the year ago period, while EMEA order intake increased $330,000 (9%) to $3.9 million compared with $3.5 million in the year ago period. The Company continues to invest in the promotion of its new Valerus video management system platform and recently launched camera line offering, which is expected to ultimately improve the Company's market competitiveness.

Gross profit margins were 40.3% for the nine months ended June 30, 2018 compared with 38.3% in the year ago period. The margin improvement reflects initial market traction from the Company's new and more cost effective camera line introductions. The Company expects to generate increasing profit margins as it continues to enhance its software solution capabilities.

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Operating expenses for the nine months ended June 30, 2018 increased $478,000 to $12.5 million compared with $12.0 million for the year ago period. Selling, general and administrative (SG&A) expenses for the current period increased $632,000 to $9.0 million compared with $8.4 million in the year ago period due principally to additional sales and marketing costs in the U.S. relating to the Company's promotion of its new core product offerings. Engineering and development expenses decreased $154,000 to $3.5 million for the current period compared with $3.7 million for the year ago period as the Company eliminated certain redundant development costs. Subsequent to quarter end, the Company initiated software development changes, which are expected to materially reduce its future expense and improve throughput efficiencies.

The Company incurred an operating loss of $4.0 million for the nine months ended June 30, 2018 compared with an operating loss of $4.4 million for the year ago period.

Interest expense increased to $475,000 for the nine months ended June 30, 2018 compared with $232,000 in the year ago period as a result of increased borrowings under the Company's revolving credit agreement and non-cash amortization charges relating to warrants granted to the Company's lender in April 2017.

As a result of the foregoing, the Company reported a net loss of $4.4 million for the nine months ended June 30, 2018 compared with a net loss of $4.6 million for the year ago period.

Liquidity and Capital Resources

Net cash used in operating activities was $3.7 million for the first nine months of fiscal 2018, which included $4.1 million of net losses exclusive of non-cash charges and a $1.1 million paydown of accounts payable, offset in part by cash generated from a $1.0 million decrease in inventories. Net cash used in investing activities was $41,000 for the first nine months of fiscal 2018 consisting principally of capital expenditures. Net cash provided by financing activities was $3.9 million for the first nine months of fiscal 2018, consisting of $3.1 million of net proceeds received from a rights offering and related backstop commitment discussed below and $850,000 of additional revolving credit borrowings. As a result of the foregoing, cash (exclusive of marketable securities) increased by $120,000 for the first nine months of fiscal 2018 after the effect of exchange rate changes on the cash position of the Company.

At June 30, 2018, the Company had $2.4 million of cash reserves and was in violation of a financial covenant under its credit agreement. On July 27, 2018, the Company entered into an amendment to this agreement which, among other things, provides a waiver of 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.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet transactions, arrangements or obligations (including contingent obligations) that have, or are reasonably likely to have, a material effect on the Company’s financial condition, results of operations, liquidity, capital expenditures or capital resources.

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Critical Accounting Policies

The Company's significant accounting policies are fully described in Note 1 to the Company's consolidated financial statements included in its September 30, 2017 Annual Report on Form 10-K. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue is generally recognized when products are sold and title is passed to the customer. Advance service billings are deferred and recognized as revenues on a pro rata basis over the term of the service agreement. Pursuant to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 605-25-05, the Company evaluates multiple-element revenue arrangements for separate units of accounting, and follows appropriate revenue recognition policies for each separate unit. Elements are considered separate units of accounting provided that (i) the delivered item has stand-alone value to the customer, (ii) there is objective and reliable evidence of the fair value of the undelivered item, and (iii) if a general right of return exists relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially within the control of the Company. As applied to the Company, under arrangements involving the sale of product and the provision of services, product sales are recognized as revenue when the products are sold and title is passed to the customer, and service revenue is recognized as services are performed.

For products that include software and for separate licenses of the Company’s software products, the Company recognizes revenue in accordance with the provisions of FASB Accounting Standards Update (ASU) 2009-13, “Revenue Recognition (Topic 605) - Multiple-Deliverable Revenue Arrangements” (ASU 2009-13). ASU 2009-13 provides revenue recognition guidance for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable in the arrangement based on the fair value of the elements. The fair value for each deliverable is based on vendor-specific objective evidence ("VSOE") if available, third-party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") if neither VSOE nor TPE is available. BESP must be determined in a manner that is consistent with that used to determine the price to sell the specific elements on a standalone basis.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

The Company writes down its inventory for estimated obsolescence and slow moving inventory equal to the difference between the carrying cost of inventory and the estimated net realizable market value based upon assumptions about future demand and market conditions. Technology changes and market conditions may render some of the Company’s products obsolete and additional inventory write-downs may be required. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

The Company evaluates the establishment of technological feasibility of its software in accordance with ASC 985 ("Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed"). The Company has determined that technological feasibility for its new products is reached shortly before products are released for field testing. Costs incurred after technological feasibility has been established have not been material and are expensed as incurred.

The Company assesses the recoverability of the carrying value of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company evaluates the recoverability of such assets based upon the expectations of undiscounted cash flows from such assets. If the sum of the expected future undiscounted cash flows were less than the carrying amount of the asset, a loss would be recognized for the difference between the fair value and the carrying amount.

The Company's ability to recover the reported amounts of deferred income tax assets is dependent upon its ability to generate sufficient taxable income during the periods over which net temporary tax differences become deductible. The Company provides for a valuation allowance against all deferred tax assets due to the uncertainty of future realization. The Company plans to provide a full valuation allowance against its deferred tax assets until such time that it can achieve a sustained level of profitability or other positive evidence arises that would demonstrate an ability to recover such assets.

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The Company accrues liabilities for identified tax contingencies that result from positions that are being challenged or could be challenged by tax authorities. The Company believes that its accrual for tax liabilities is adequate for all open years, based on Management’s assessment of many factors, including its interpretations of the tax law and judgments about potential actions by tax authorities. However, it is possible that the ultimate resolution of any tax audit may be materially greater or lower than the amount accrued.

The Company is subject to proceedings, lawsuits and other claims related to labor, product and other matters. The Company assesses the likelihood of an adverse judgment or outcomes for these matters, as well as the range of potential losses. A determination of the reserves required, if any, is made after careful analysis. The required reserves may change in the future due to new developments.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

Statements in this Report on Form 10-Q that are not strictly historical facts including, without limitation, statements included under the “Management’s Discussion and Analysis” caption, are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that should be considered as subject to the many risks and uncertainties that exist in the Company's operations and business environment. The forward-looking statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause the actual results, performance and/or achievements of the Company to differ materially from any future results, performance or achievements, express or implied, by the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, and that in light of the significant uncertainties inherent in forward-looking statements, the inclusion of such statements should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. The Company assumes no obligation to publicly update or revise its forward-looking statements or to advise of changes in the assumptions and factors on which they are based.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as required by Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures. The Company identified a material weakness in controls over the approval of certain related party transactions which occurred during the quarter ended June 30, 2018. In response, the Company has established new procedures regarding the identification, approval and monitoring of specific related party transactions and plans to formalize its related party transaction policy.

Changes in Internal Controls

There were no changes in the Company's internal control over financial reporting identified in connection with the evaluation referred to above that occurred during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

None

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4 – MINE SAFETY DISCLOSURES

Not applicable

ITEM 5 - OTHER INFORMATION

None

ITEM 6 – EXHIBITS



Exhibit Number	Description
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document*
101.SCH	XBRL Taxonomy Extension Schema Document*
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB	XBRL Taxonomy Extension Label Linkbase Document*
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document*

*	In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed.”

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Signatures

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

VICON INDUSTRIES, INC.