BIO KEY INTERNATIONAL INC - Quarter Report: 2019 September (Form 10-Q)

 

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BIO-KEY INTERNATIONAL, INC. AND SUBSIDIARIES

  

INDEX

 

PART I. FINANCIAL INFORMATION
Item 1	Condensed Consolidated Financial Statements (unaudited):
	Balance sheets as of September 30, 2019 (unaudited) and December 31, 2018 (audited)	3
	Statements of operations for the three and nine months ended September 30, 2019 and 2018	4
	Statements of Stockholders’ Equity for the three and nine months ended September 30, 2019 and 2018	5
	Statements of cash flows for the nine months ended September 30, 2019 and 2018	7
	Notes to condensed consolidated financial statements	9
Item 2	Management’s Discussion and Analysis of Financial Conditions and Results of Operations	22
Item 4	Controls and Procedures	29
PART II. OTHER INFORMATION
Item 6	Exhibits	29
Signatures		31

 

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		September 30, 2019				December 31, 2018
		(Unaudited)
ASSETS
Cash and cash equivalents		$	78,240			$	323,943
Accounts receivable, net			773,334				1,574,032
Due from factor			50,702				56,682
Inventory			971,167				998,829
Resalable software license rights			1,125,000				1,125,000
Prepaid expenses and other			183,216				150,811
Investment – non-marketable security			512,821				-
Total current assets			3,694,480				4,229,297
Resalable software license rights, net of current portion			5,906,466				6,790,610
Equipment and leasehold improvements, net			117,644				148,608
Capitalized contract costs, net			254,957				319,199
Deposits and other assets			8,712				8,712
Operating lease right-of-use assets			611,883				-
Intangible assets, net			187,701				195,906
Total non-current assets			7,087,363				7,463,035
TOTAL ASSETS		$	10,781,843			$	11,692,332
LIABILITIES
Accounts payable		$	496,667			$	481,269
Accrued liabilities			478,541				548,232
Convertible notes payable, net of debt discount and debt issuance costs			1,859,635				-
Deferred revenue			222,721				196,609
Operating lease liabilities, current portion			178,130				-
Total current liabilities			3,235,694				1,226,110
Operating lease liabilities, net of current portion			426,879				-
Total non-current liabilities			426,879				-
TOTAL LIABILITIES			3,662,573				1,226,110
Commitments
STOCKHOLDERS’ EQUITY
Common stock — authorized, 170,000,000 shares; issued and outstanding; 14,398,701 and 13,977,868 of $.0001 par value at September 30, 2019 and December 31, 2018, respectively			1,440				1,398
Additional paid-in capital			87,310,964				85,599,140
Accumulated deficit			(80,193,134	)			(75,134,316	)
TOTAL STOCKHOLDERS’ EQUITY			7,119,270				10,466,222
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	10,781,843			$	11,692,332

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		Three months ended September 30,								Nine months ended September 30,
		2019				2018				2019				2018
Revenues
Services		$	237,372			$	225,739			$	710,975			$	777,309
License fees			98,272				210,651				241,780				467,621
Hardware			117,070				303,360				779,965				1,084,416
Total Revenues			452,714				739,750				1,732,720				2,329,346
Costs and other expenses
Cost of services			65,683				97,965				214,933				373,538
Cost of license fees			369,604				757,288				1,119,147				2,297,390
Cost of hardware			73,366				85,079				458,049				478,652
Total costs and other expenses			508,653				940,332				1,792,129				3,149,580
Gross Profit (Loss)			(55,939	)			(200,582	)			(59,409	)			(820,234	)
Operating Expenses
Selling, general and administrative			915,066				1,049,270				3,350,770				3,587,308
Research, development and engineering			300,131				391,507				975,466				1,081,294
Total operating expenses			1,215,197				1,440,777				4,326,236				4,668,602
Operating loss			(1,271,136	)			(1,641,359	)			(4,385,645	)			(5,488,836	)
Other income (expense)
Interest income			19				44				143				64
Interest expense			(558,449	)			-				(673,316	)			-
Total other income (expense), net			(558,430	)			44				(673,173	)			64
Net loss			(1,829,567	)			(1,641,315	)			(5,058,818	)			(5,488,772	)
Deemed dividend from trigger of anti-dilution provision feature			-				(1,428,966	)			-				(1,428,966	)
Convertible preferred stock dividends			-				-				-				(198,033	)
Net loss available to common stockholders		$	(1,829,567	)		$	(3,070,281	)		$	(5,058,818	)		$	(7,115,771	)
Basic and Diluted Loss per Common Share attributable to common stockholders		$	(0.13	)		$	(0.23	)		$	(0.36	)		$	(0.66	)
Weighted Average Shares Outstanding:
Basic and Diluted			14,387,467				13,145,301				14,163,120				10,810,103

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		Series A-1 Preferred Stock								Series B-1 Preferred Stock								Common Stock								Additional Paid-in				Accumulated
		Shares				Amount				Shares				Amount				Shares				Amount				Capital				Deficit				Total
Balance as of December 31, 2018			-			$	-				-			$	-				13,977,868			$	1,398			$	85,599,140			$	(75,134,316	)		$	10,466,222
Issuance of common stock for directors’ fees			-				-				-				-				13,820				1				16,505				-				16,506
Share-based compensation			-				-				-				-				-				-				509,528				-				509,528
Net loss			-				-				-				-				-				-				-				(1,803,508	)			(1,803,508	)
Balance as of March 31, 2019			-			$	-				-			$	-				13,991,688			$	1,399			$	86,125,173			$	(76,937,824	)		$	9,188,748
Issuance of common stock for directors’ fees			-				-				-				-				4,235				-				5,505				-				5,505
Issuance of common stock for commitment fees			-				-				-				-				300,000				30				449,970				-				450,000
Commitment fee adjustment			-				-				-				-				-				-				(270,000	)			-				(270,000	)
Share-based compensation			-				-				-				-				-				-				125,549				-				125,549
Net loss			-				-				-				-				-				-				-				(1,425,743	)			(1,425,743	)
Balance as of June 30, 2019			-			$	-				-			$	-				14,295,923			$	1,429			$	86,436,197			$	(78,363,567	)		$	8,074,059
Issuance of common stock for directors’ fees			-				-				-				-				6,111				1				6,500				-				6,501
Issuance of common stock for commitment fees			-				-				-				-				276,667				28				414,972				-				415,000
Commitment fee adjustment			-				-				-				-				(180,000	)			(18	)			18				-				-
Warrant debt discount valuation																											595,662				-				595,662
Legal and commitment fees			-				-				-				-				-				-				(272,985	)			-				(272,985	)
Share-based compensation			-				-				-				-				-				-				130,600				-				130,600
Net loss			-				-				-				-				-				-				-				(1,829,567	)			(1,829,567	)
Balance as of September 30, 2019			-			$	-				-			$	-				14,398,701			$	1,440			$	87,310,964			$	(80,193,134	)		$	7,119,270

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		Series A-1 Preferred Stock								Series B-1 Preferred Stock								Common Stock								Additional Paid-in				Accumulated
		Shares				Amount				Shares				Amount				Shares				Amount				Capital				Deficit				Total
Balance as of December 31, 2017			62,596			$	6				105,000			$	11				7,691,324			$	769			$	80,829,001			$	(67,076,492	)		$	13,753,295
Adoption of ASC 606			-				-				-				-				-				-				-				240,017				240,017
Issuance of common stock for directors’ fees			-				-				-				-				8,421				1				16,512				-				16,513
Dividends declared on preferred stock			-				-				-				-				-				-				(156,162	)			-				(156,162	)
Conversion of B-1 preferred stock to common stock			-				-				(60,420	)			(6	)			1,678,334				168				(162	)			-				-
Conversion of dividends payable on B-1 preferred stock			-				-				-				-				115,857				11				417,072				-				417,083
Share-based compensation			-				-				-				-				-				-				533,421				-				533,421
Net loss			-				-				-				-				-				-				-				(2,191,992	)			(2,191,992	)
Balance as of March 31, 2018			62,596			$	6				44,580			$	5				9,493,936			$	949			$	81,639,682			$	(69,028,467	)		$	12,612,175
Issuance of common stock for directors’ fees			-				-				-				-				2,683				1				6,508				-				6,509
Dividends declared on preferred stock			-				-				-				-				-				-				(41,871	)			-				(41,871	)
Conversion of A-1 preferred stock to common stock			(62,596	)			(6	)			-				-				1,738,778				174				(168	)			-				-
Conversion of dividends payable on A-1 preferred stock			-				-				-				-				98,893				10				356,005				-				356,015
Conversion of B-1 preferred stock to common stock			-				-				(44,580	)			(5	)			1,238,334				123				(118	)			-				-
Conversion of dividends payable on B-1 preferred stock			-				-				-				-				15,373				2				55,339				-				55,341
Legal fees			-				-				-				-				-				-				(15,212	)			-				(15,212	)
Share-based compensation			-				-				-				-				-				-				143,034				-				143,034
Net loss			-				-				-				-				-				-				-				(1,655,465	)			(1,655,465	)
Rounding			-				-				-				-				-				-				-				1				1
Balance as of June 30, 2018			-			$	-				-			$	-				12,587,997			$	1,259			$	82,143,199			$	(70,683,931	)		$	11,460,527
Issuance of common stock for directors’ fees			-				-				-				-				4,161				-				7,509				-				7,509
Issuance of common stock pursuant to securities purchase agreement			-				-				-				-				1,380,000				138				2,069,862				-				2,070,000
Deemed dividend related to down-round features			-				-				-				-				-				-				1,428,966				(1,428,966	)			-
Legal fees			-				-				-				-				-				-				(294,776	)			-				(294,776	)
Share-based compensation			-				-				-				-				-				-				188,837				-				188,837
Net loss			-				-				-				-				-				-				-				(1,641,315	)			(1,641,315	)
Rounding			-				-				-				-				-				1				-				(1	)			-
Balance as of September 30, 2018			-			$	-				-			$	-				13,972,158			$	1,398			$	85,543,597			$	(73,754,213	)		$	11,790,782

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		Nine Months Ended September 30,
		2019				2018
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss		$	(5,058,818	)		$	(5,488,772	)
Adjustments to reconcile net loss to cash used for operating activities:
Depreciation			59,717				69,083
Amortization of intangible assets			9,941				12,281
Amortization of resalable software license rights			843,287				1,978,349
Amortization of debt discount			288,774				-
Amortization of capitalized contract costs			102,839				90,518
Amortization of debt issuance costs			311,718				-
Share-based and warrant compensation for employees and consultants			765,677				865,291
Stock based directors’ fees			28,512				30,530
Change in operating assets and liabilities:
Accounts receivable			800,698				2,262,423
Due from factor			5,980				29,464
Operating leases right-of-use assets			(8,946	)			-
Capitalized contract costs			(38,597	)			(183,569	)
Inventory			27,662				(97,306	)
Resalable software license rights			40,857				18,111
Prepaid expenses and other			(45,000	)			(20,243	)
Accounts payable			15,398				(129,445	)
Accrued liabilities			(69,691	)			(102,422	)
Deferred revenue			26,112				(252,128	)
Operating lease liabilities			14,667				-
Net cash used for operating activities			(1,879,213	)			(917,835	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of intangible assets			(1,736	)			-
Capital expenditures			(28,753	)			(82,143	)
Purchase of investment – non-marketable security			(512,821	)			-
Net cash used for investing activities			(543,310	)			(82,143	)
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from Issuance of convertible notes			3,217,000				-
Repayment of convertible notes			(707,000	)			-
Proceeds from Issuance of common stock			-				1,875,100
Costs to issue notes, common and preferred stock			(333,180	)			(115,088	)
Net cash provided by financing activities			2,176,820				1,760,012
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS			(245,703	)			760,034
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			323,943				288,721
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	78,240			$	1,048,755

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		Nine Months Ended September 30,
		2019				2018
Cash paid for:
Interest		$	-			$	-
Income taxes		$	-			$	-
Noncash Investing and financing activities
Accrual of unpaid dividends on preferred stock		$	-			$	198,033
Conversion of A-1 preferred dividends payable to common stock		$	-			$	356,015
Conversion of A-1 preferred stock to common stock		$	-			$	6,259,600
Conversion of B-1 preferred dividends payable to common stock		$	-			$	472,426
Conversion of B-1 preferred stock to common stock		$	-			$	10,500,000
Deemed dividend from trigger of anti-dilution provision feature		$	-			$	1,428,966
Right-of-use asset addition under ASC 842		$	719,812			$	-
Operating lease liabilities under ASC 842		$	707,217			$	-
Share based loan commitment fees		$	595,000			$	-
Debt discount issued with convertible note		$	550,000			$	-
Warrant debt discount valuation		$	595,662			$	-

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1.	NATURE OF BUSINESS AND BASIS OF PRESENTATION

 

Nature of Business

 

The Company, founded in 1993, develops and markets proprietary fingerprint identification biometric technology and software solutions. The Company was a pioneer in developing automated, finger identification technology that supplements or compliments other methods of identification and verification, such as personal inspection identification, passwords, tokens, smart cards, ID cards, PKI, credit card, passports, driver’s licenses, OTP or other form of possession or knowledge-based credentialing. Additionally, advanced BIO-key® technology has been, and is, used to improve both the accuracy and speed of competing finger-based biometrics.

 

Basis of Presentation

 

The accompanying unaudited interim condensed consolidated financial statements include the accounts of BIO-key International, Inc. and its wholly-owned subsidiary (collectively, the “Company” or “BIO-key”) and are stated in conformity with accounting principles generally accepted in the United States of America, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year. Pursuant to such rules and regulations, certain financial information and note disclosures normally included in the financial statements have been condensed or omitted. Significant intercompany accounts and transactions have been eliminated in consolidation.

 

In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all necessary adjustments, consisting only of those of a recurring nature, and disclosures to present fairly the Company’s financial position and the results of its operations and cash flows for the periods presented. The balance sheet at September 30, 2019 was derived from the audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America. These unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on April 1, 2019. 

 

Updated Significant Accounting Policies

 

Leases

 

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, “Leases” (Topic 842), as amended (ASC 842).  The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months and classify as either operating or finance leases.  We adopted this standard effective January 1, 2019 using the modified retrospective approach for all leases entered into before the effective date.  Adoption of the ASC 842 had a significant effect on our balance sheet resulting in increased non-current assets and increased current and non-current liabilities.  There was no impact to retained earnings upon adoption of the new standard. We did not have any finance leases (formerly referred to as capital leases prior to the adoption of ASC 842), therefore there was no change in accounting treatment required.  For comparability purposes, the Company will continue to comply with the previous disclosure requirements in accordance with the existing lease guidance and prior periods are not restated.

 

The Company elected the package of practical expedients as permitted under the transition guidance, which allowed us: (1) to carry forward the historical lease classification; (2) not to reassess whether expired or existing contracts are or contain leases; and, (3) not to reassess the treatment of initial direct costs for existing leases.

 

In accordance with ASC 842, at the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present and the classification of the lease including whether the contract involves the use of a distinct identified asset, whether we obtain the right to substantially all the economic benefit from the use of the asset, and whether we have the right to direct the use of the asset. Leases with a term greater than one year are recognized on the balance sheet as right-of-use (ROU) assets, lease liabilities and, if applicable, long-term lease liabilities. The Company has elected not to recognize on the balance sheet leases with terms of one year or less under practical expedient in paragraph ASC 842-20-25-2. For contracts with lease and non-lease components, the Company has elected not to allocate the contract consideration and to account for the lease and non-lease components as a single lease component.

 

 

Lease liabilities and their corresponding ROU assets are recorded based on the present value of lease payments over the expected lease term. The implicit rate within our operating leases are generally not determinable and, therefore, the Company uses the incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of the Company’s incremental borrowing rate requires judgment. The Company determines the incremental borrowing rate for each lease using our estimated borrowing rate, adjusted for various factors including level of collateralization, term and currency to align with the terms of the lease. The operating lease ROU asset also includes any lease prepayments, offset by lease incentives.

 

An option to extend the lease is considered in connection with determining the ROU asset and lease liability when it is reasonably certain we will exercise that option. An option to terminate is considered unless it is reasonably certain we will not exercise the option.

 

For periods prior to the adoption of ASC 842, the Company recorded rent expense based on the term of the related lease. The expense recognition for operating leases under ASC 842 is substantially consistent with prior guidance. As a result, there are no significant differences in our results of operations presented.

 

The impact of the adoption of ASC 842 on the balance sheet was:

 

 

 

Recently Issued Accounting Pronouncements

  

In August 2018, the FASB issued ASU No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The update to the standard is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. Entities can choose to adopt the ASU 2018-15 prospectively or retrospectively. The Company is currently assessing the impact ASU 2018-15 will have on its consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), referred to herein as ASU 2016-13, which significantly changes how entities will account for credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. ASU 2016-13 replaces the existing incurred loss model with an expected credit loss model that requires entities to estimate an expected lifetime credit loss on most financial assets and certain other instruments. Under ASU 2016-13 credit impairment is recognized as an allowance for credit losses, rather than as a direct write-down of the amortized cost basis of a financial asset. The impairment allowance is a valuation account deducted from the amortized cost basis of financial assets to present the net amount expected to be collected on the financial asset. Once the new pronouncement is adopted by the Company, the allowance for credit losses must be adjusted for management’s current estimate at each reporting date. The new guidance provides no threshold for recognition of impairment allowance. Therefore, entities must also measure expected credit losses on assets that have a low risk of loss. For instance, trade receivables that are either current or not yet due may not require an allowance reserve under currently generally accepted accounting principles, but under the new standard, the Company will have to estimate an allowance for expected credit losses on trade receivables under ASU 2016-13. ASU 2016-13 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted. The Company is currently assessing the impact ASU 2016-13 will have on its condensed consolidated financial statements.

 

Management does not believe that any other recently issued, but not yet effective, accounting standard if currently adopted would have a material effect on the accompanying consolidated financial statements.

 

Reclassification

 

Reclassifications occurred to certain prior year amounts in order to conform to the current year classifications including segregating the hardware revenues. The reclassifications have no effect on the reported net loss.

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2.	GOING CONCERN

 

The Company has incurred significant losses to date and at September 30, 2019 had an accumulated deficit of approximately $80 million. In addition, broad commercial acceptance of the Company’s technology is critical to the Company’s success and ability to generate future revenues. At September 30, 2019, the Company’s total cash and cash equivalents were approximately $78,000, as compared to approximately $324,000 at December 31, 2018.

 

The Company has financed operations in the past through access to the capital markets by issuing secured and convertible debt securities, convertible preferred stock, common stock, and through factoring receivables. The Company estimates that it currently requires approximately $537,000 per month to conduct operations, a monthly amount that it has been unable to achieve consistently through revenue generation.

 

If the Company is unable to generate sufficient revenue to meet its goals, it will need to obtain additional third-party financing to (i) conduct the sales, marketing and technical support necessary to execute its plan to substantially grow operations, increase revenue, and serve a significant customer base; and (ii) provide working capital. No assurance can be given that any form of additional financing will be available on terms acceptable to the Company, that adequate financing will be obtained by the Company, in order to meet its needs, or that such financing would not be dilutive to existing shareholders.

 

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"), which contemplate continuation of the Company as a going concern, and assumes continuity of operations, realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The matters described in the preceding paragraphs raise substantial doubt about the Company’s ability to continue as a going concern. Recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, and become profitable in its future operations. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

 

3.	REVENUE FROM CONTRACTS WITH CUSTOMERS

 

The Company adopted ASC 606 on January 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. In accordance with ASC 606, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. To achieve this core principle, the Company applies the following five steps:

 

●

Identify the contract with a customer

●

Identify the performance obligations in the contract

●

Determine the transaction price

●

Allocate the transaction price to performance obligations in the contract

●

Recognize revenue when or as the Company satisfies a performance obligation

 

 

Disaggregation of Revenue

 

The following table summarizes revenue from contracts with customers for the three month periods ended:

 

 

 

 

 

The following table summarizes revenue from contracts with customers for the nine month periods ended:

 

 

 

 

*EMEA – Europe, Middle East, Africa

 

All of the Company's performance obligations, and associated revenue, are generally transferred to customers at a point in time, with the exception of support and maintenance, and professional services, which are generally transferred to the customer over time.

 

Software licenses

Software license revenue consist of fees for perpetual software licenses for one or more of the Company’s biometric fingerprint solutions. Revenue is recognized at a point in time once the software is available to the customer for download. Software license contracts are generally invoiced in full on execution of the arrangement.

 

 

Hardware

Hardware revenue consists of fees for associated equipment sold with or without a software license arrangement, such as servers, locks and fingerprint readers. Customers are not obligated to buy third party hardware from the Company, and may procure these items from a number of suppliers. Revenue is recognized at a point in time once the hardware is shipped to the customer. Hardware items are generally invoiced in full on execution of the arrangement.

 

Support and Maintenance

Support and maintenance revenue consists of fees for unspecified upgrades, telephone assistance and bug fixes. The Company satisfies its support and maintenance performance obligation by providing “stand-ready” assistance as required over the contract period. The Company records deferred revenue (contract liability) at time of invoice until the contracts term occurs. Revenue is recognized over time on a ratable basis over the contract term. Support and maintenance contracts are up to one year in length and are generally invoiced either annually or quarterly in advance.

 

Professional Services

Professional services revenues consist primarily of fees for deployment and optimization services, as well as training. The majority of the Company’s consulting contracts are billed on a time and materials basis, and revenue is recognized based on the amount billable to the customer in accordance with practical expedient ASC 606-10-55-18. For other professional services contracts, the Company utilizes an input method and recognizes revenue based on labor hours expended to date relative to the total labor hours expected to be required to satisfy its performance obligation.

 

Contracts with Multiple Performance Obligations

Some contracts with customers contain multiple performance obligations. For these contracts, the Company accounts for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis.  The standalone selling prices are determined based on overall pricing objectives, taking into consideration market conditions and other factors, including the value of the contracts, the cloud applications sold, customer demographics, geographic locations, and the number and types of users within the contracts.

 

The Company considered several factors in determining that control transfers to the customer upon shipment of hardware and availability of download of software.  These factors include that legal title transfers to the customer, the Company has a present right to payment, and the customer has assumed the risks and rewards of ownership.

 

Accounts receivable from customers are typically due within 30 days of invoicing.  The Company does not record a reserve for product returns or warranties as amounts are deemed immaterial based on historical experience.

 

Costs to Obtain and Fulfill a Contract

Costs to obtain and fulfill a contract are predominantly sales commissions earned by the sales force and are considered incremental and recoverable costs of obtaining a contract with a customer. These costs are deferred and then amortized over a period of benefit determined to be four years. These costs are included as capitalized contract costs on the balance sheet. The period of benefit was determined by taking into consideration customer contracts, technology, and other factors based on historical evidence. Amortization expense is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.

 

Revenue recognized during the three and nine months ended September 30, 2019 from amounts included in deferred revenue at the beginning of the period was approximately $89,000 and $200,000, respectively. The Company did not recognize any revenue from performance obligations satisfied in prior periods. Total deferred revenue (contract liability) was $222,721 and $196,609 at September 30, 2019 and December 31, 2018, respectively.

 

Transaction Price Allocated to the Remaining Performance Obligations

ASC 606 requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as at September 30, 2019. The guidance provides certain practical expedients that limit this requirement, which the Company’s contracts meet as follows:

 

●

The performance obligation is part of a contract that has an original expected duration of one year or less, in accordance with ASC 606-10-50-14.

 

At September 30, 2019 deferred revenue represents our remaining performance obligations related to support and maintenance, all of which is expected to be recognized within one year.

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4.	ACCOUNTS RECEIVABLE

 

Accounts receivable are carried at original amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful receivables by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history, and current economic conditions. Accounts receivable are written off when deemed uncollectible. As a result of the payment delays for a large customer, the Company has reserved $1,720,000 at September 30, 2019 and December 31, 2018, which represents 100% of the remaining balance owed under the contract, respectively. Recoveries of accounts receivable previously written off are recorded when received. Accounts receivable at September 30, 2019 and December 31, 2018 consisted of the following: 

 

 

5.	SHARE BASED COMPENSATION

  

The following table presents share-based compensation expenses for continuing operations included in the Company’s unaudited interim condensed consolidated statements of operations:

 

 

 

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6.

FACTORING

 

Due from factor consisted of the following as of: 

 

 

 

The Company entered into an accounts receivable factoring arrangement with a financial institution (the “Factor”) which has been extended to October 31, 2020. Pursuant to the terms of the arrangement, the Company, from time to time, sells to the Factor a minimum of $150,000 per quarter of certain of its accounts receivable balances on a non-recourse basis for credit approved accounts. The Factor remits 35% of the foreign and 75% of the domestic accounts receivable balance to the Company (the “Advance Amount”), with the remaining balance, less fees, forwarded to the Company once the Factor collects the full accounts receivable balance from the customer. In addition, the Company, from time to time, receives over advances from the Factor. Factoring fees range from 2.75% to 15% of the face value of the invoice factored, and are determined by the number of days required for collection of the invoice. The cost of factoring is included in selling, general and administrative expenses. The cost of factoring was as follows: 

 

 

7.

INVENTORY

 

Inventory is stated at the lower of cost, determined on a first in, first out basis, or net realizable value and consists primarily of fabricated assemblies and finished goods. Inventory is comprised of the following as of: 

 

 

8.	RESALABLE SOFTWARE LICENSE RIGHTS

 

On November 11, 2015, the Company entered into a license agreement for the rights to all software and documentation regarding the technology currently known as or offered under the FingerQ name. The license agreement grants the Company the exclusive right to reproduce, create derivative works and distribute copies of the FingerQ software and documentation, create new FingerQ related products, and grant sub-licenses of the licensed technology to end users. The license rights have been granted to the Company in perpetuity, with a stated number of end-user resale sub-licenses allowed under the contract for a total of $12,000,000. The cost of sub-license rights expected to be amortized in the following 12 months is $1,125,000 and is classified as current, with remainder as non-current.

 

The Company originally determined the software license rights to be a finite lived intangible asset, and estimated that the software license rights shall be economically used over a 10 year period, with a weighting towards the beginning years of that time-frame. The license rights were acquired during the fourth quarter of 2015, but the usage of such rights in the Company’s products was not generally available until January 2017. Accordingly, amortization began in the first quarter of 2017.

 

Through 2018, the remaining license rights were amortized over the greater of the following amounts: 1) an estimate of the economic use of such license rights, 2) the amount calculated by the straight line method over ten years or 3) the actual cost basis of sales usage of such rights. The Company believes that the economic use model was front-end focused as a majority of the expected up-take of the FingerQ technology was predicted to occur during the first 4-5 years of the 10-year life cycle of the product. Based on current sales trends, the Company now believes future transactions will be more evenly dispersed over the remaining life cycle of the product, indicating that the greater of the straight-line methodology or actual unit cost per license sold will more closely align the expense with the remaining useful life of the product. The change in amortization was effective beginning on January 1, 2019 based on the net remaining software license rights balance. The Company believes categorizing the amortization expense under Cost of Sales more closely reflects the nature of the license right arrangement and the use of the technology.

 

 

A total of $281,250 and $660,000 was charged to cost of sales during the three-month periods ended September 30, 2019 and 2018, respectively, and of this amount $113 and $210, represent the cost basis of the actual sales, respectively. A total of $843,750 and $1,980,000 was charged to cost of sales during the nine-month periods ended September 30, 2019 and 2018, respectively and of this amount $463 and $1,651 represent the cost basis of the actual sales, respectively.  Since the license purchase, a cumulative amount of $5,042,346 has been charged to cost of sales, with a carrying balance of $6,957,654 as of September 30, 2019.

 

The Company's change in methodology was determined to be a change in accounting estimate that is effected by a change in accounting principle.  Pursuant to ASC 250-10-45-17 guidance, this accounting change will not be accounted for as a cumulative effect adjustment on the statement of operations in the period of change and there will be no retroactive application or restatement of prior periods.  Instead, the Company allocates the remaining unamortized balance over the remaining life of the assets using the newly adopted method.

 

The following compares line items on the statement of operations had the change in amortization methodology not been made:

 

 

 

On December 31, 2015, the Company purchased third-party software licenses in the amount of $180,000 in anticipation of a large pending deployment that has yet to materialize. The Company is amortizing the total cost over the same methodology described above with the greatest of the two approaches being the actual unit cost per license sold. A total of $5,701 and $8,358 was expensed during the three month periods ended September 30, 2019 and 2018, respectively. A total of $40,394 and $16,460 (net of credits of $14,400) was expensed during the nine-month periods ended September 30, 2019 and 2018, respectively. Since the license purchase, the actual per unit cost (actual usage) of such license rights in the cumulative amount of $106,188 has been charged to cost of sales, with a carrying balance of $73,812 as of September 30, 2019. The Company has classified the balance as non-current until a larger deployment occurs. Software license rights is comprised of the following as of:

   

 

9.	investments

 

During the quarter, the Company purchased a 4,000,000 Hong Kong dollar Bond Certificate with a financial institution in Hong Kong. The Bond Certificate translates to $512,821 U.S. Dollars. The bond has a one-year maturity and 5% interest rate. The Company can invest up to a 20,000,000 Hong Kong dollars under the terms of the certificate.  The bond is recorded on the balance sheet as an investment – non-marketable security. The investment is recorded at amortized cost which approximates fair value, and is currently planned to be held to maturity.

 

10.	Related Party

 

During the nine months ended September 30, 2019, the Company received a series of non-interest-bearing advances from an executive officer/director, the Company's principal stockholder, to pay current liabilities. The balance of the advance as at September 30, 2019 was paid in full.

 

11.	Convertible NOTES PAYABLE

 

On April 4, 2019, the Company issued a $550,000 secured convertible debenture which had a maturity date of November 15, 2019 and was convertible into common stock at a conversion price of $1.50 per share. The note was redeemable at any time by payment of a premium to the principal balance starting at 5% and increasing to 25%.  The note was issued at approximately 7% ($40,000) original issue discount.  Subject to the mutual agreement of the Company and the investor, the Company could issue two additional $550,000 principal amount notes on the same terms after 45 day intervals from the prior issuance, for additional net proceeds of $1,020,000.  The convertible note contained anti-dilution protections if the Company issued shares of common stock for less than the conversion price. The convertible note was secured by substantially all the assets of the Company.  At the closing, the Company issued 80,000 shares of common stock in payment of a $120,000 commitment fee and was obligated to issue 10,000 shares of common stock monthly in payment of a monthly commitment fee of $15,000 until the earlier of November 1, 2019 or the repayment or conversion of the note.

 

 

On June 14, 2019, the Company issued a $157,000 secured 10% convertible redeemable note which had a maturity date of November 14, 2019 and was convertible into common stock at a conversion price of $1.50 per share. The convertible redeemable note contained anti-dilution protections if the Company offered a conversion discount or other more favorable conversion terms while the note was outstanding.  The note was redeemable within the first five months by payment of a premium to the principal balance starting at 10% and increasing to 30% of principal plus interest.  At the closing, the Company agreed to issue 200,000 shares of common stock in lieu of payment of a $30,000 commitment fee which would be reduced to 20,000 shares if the note was repaid prior to the maturity date.

 

Both notes were repaid in full on July 10, 2019.

 

For the two notes issued during the second quarter of 2019, the Company agreed to issue a total of 310,000 shares of common stock, amounting to $465,000 in commitment fees. Of these amounts, $195,000 was recorded as an offset to notes payable – debt issuance costs and was amortized over the life of the loan.   The reduction of the commitment fee in amount of $270,000 (180,000 shares) was recorded as a reduction in additional paid in capital and the shares were returned to the Company on July 10, 2019. The Company also incurred $17,000 of legal fees withheld from proceeds which was also recorded as an offset to notes payable – debt issuance costs and was amortized over the life of the loan. Amortization of the debt issuance costs and debt discount are included in interest expense on the statement of operations. 

  

Securities Purchase Agreement dated July 10, 2019

 

On July 10, 2019, the Company issued a $3,060,000 principal amount senior secured convertible note (the “Note”). At closing, a total of $2,550,000 was funded. The original issue discount was $510,000. The principal amount due of the Note is due and payable as follows: $918,000 is due 180 days after funding, $1,071,000 is due 270 days after funding, and the remaining balance is due 12 months after the date of funding. Upon the occurrence of standard and customary events of default and expiration of any applicable cure periods, repayment of the outstanding principal amount due under the Note is subject to acceleration in the discretion of the Investor in which event, interest will accrue at the higher of 18% per annum or the maximum amount permitted by applicable law and the Company will become obligated to pay an amount equal to 20% of the then outstanding principal amount due under the Note.  

 

The Note is secured by a lien on substantially all of the Company’s assets and properties and is convertible at the option of the Investor into shares of common stock at a fixed conversion price of $1.50 per share. The Company has the right to prepay the Note in full at any time without penalty in which event, the Investor will have the option of converting 25% of the outstanding principal amount of the Note into shares of common stock.

 

In connection with the closing, the Company issued a five year warrant to the Investor to purchase 2,000,000 shares of common stock at a fixed exercise price of $1.50 per share, paid a $50,000 commitment fee, and issued 266,667 shares of common stock in payment of a $400,000 due diligence fee. The Company also paid banker fees of $193,500 and legal fees of $71,330. The valuation of the warrant of $595,662 was recorded to debt discount and is amortized over the life of the Note. The fees associated with the agreement were allocated to debt issuance costs and additional paid-in capital based on the respective ratio of the valuation of the note and warrant. Amortization of the debt issuance costs and debt discount are included in interest expense on the statement of operations.

 

Until the second anniversary of the closing, the Investor has the right to purchase up to 20% of the securities the Company issues in any future private placement, subject to certain exceptions for, among other things, strategic investments.

 

Secured convertible note payable, net of unamortized debt discount and debt issuance costs at September 30, 2019 consisted of:

 

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12.

LEASES

 

The Company’s leases office space in New Jersey, Hong Kong and Minnesota with lease termination dates of 2023, 2020, and 2022, respectively. The leases include non-lease components with variable payments. The following tables present the components of lease expense and supplemental balance sheet information related to the operating leases, were:

 

 

Supplemental cash flow information related to leases were as follows, for the nine months ended September 30, 2019:

 

 

Maturities of operating lease liabilities were as follows:

 

 

13.	EARNINGS (LOSS) PER SHARE - COMMON STOCK (“EPS”)

 

The Company’s basic EPS is calculated using net loss available to common shareholders and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants and the assumed conversion of convertible notes and preferred stock.

  

The reconciliation of the numerators of the basic and diluted EPS calculations was as follows for both of the following three and nine month periods ended September 30, 2019 and 2018:

 

 

 

Items excluded from the diluted per share calculation because the exercise price was greater than the average market price of the common shares:

 

 

 

The following table summarizes the weighted average securities that were excluded from the diluted per share calculation because the effect of including these potential shares was antidilutive due to the net losses for the periods:

 

 

14.	STOCKHOLDERS’ EQUITY

 

Preferred Stock

 

Within the limits and restrictions provided in the Company’s Certificate of Incorporation, the Board of Directors has the authority, without further action by the shareholders, to issue up to 5,000,000 shares of preferred stock, $.0001 par value per share, in one or more series, and to fix, as to any such series, any dividend rate, redemption price, preference on liquidation or dissolution, sinking fund terms, conversion rights, voting rights, and any other preference or special rights and qualifications. As of September 30, 2019, 100,000 shares of preferred stock have been designated as Series A-1 Convertible Preferred Stock ("Series A-1 Stock"), of which 90,000 were issued in 2015 and 0 remain outstanding, and 105,000 shares of preferred stock have been designated as Series B-1 Convertible Preferred Stock ("Series B-1 Stock"), of which 105,000 were issued in 2015 and 0 remain outstanding.

 

Series A-1 Convertible Preferred Stock

  

On October 22 and 29, 2015, the Company issued 84,500 shares of Series A-1 Stock at a purchase price of $100.00 per share, for aggregate gross proceeds of $8,450,000. On November 11, 2015, 5,500 additional shares of Series A-1 Stock were issued at a purchase price of $100.00 per share, for gross cash proceeds of $550,000.

 

Between September 22, 2017 and May 31, 2018, the holder of the Series A-1 Stock converted all shares of Series A-1 Stock into an aggregate of 2,500,000 shares of common stock and purchased an aggregate of 248,893 shares of common stock in consideration of the conversion of $896,015 of accrued dividends payable on the Series A-1 Stock.

 

As a result of the forgoing conversions, as of September 30, 2019 there are no longer any issued and outstanding shares of Series A-1 Stock.

 

Overall balances and conversion of Series A-1 Stock and accrued dividends into common stock has been as follows:

 

 

 

Series B-1 Convertible Preferred Stock

 

On November 11, 2015, the Company issued 105,000 shares of Series B-1 Stock at a purchase price of $100.00 per share, for gross proceeds of $10,500,000.  

 

Between March 23, 2018 and May 23, 2018, holders of shares of Series B-1 Stock converted all shares of Series B-1 Stock into an aggregate of 2,916,668 shares of common stock and purchased an aggregate of 131,229 shares of common stock in consideration of the conversion of $472,426 of accrued dividends payable on the Series B-1 Stock.

 

As a result of the forgoing conversions, as of September 30, 2019 there are no longer any issued and outstanding shares of Series B-1 Stock.

 

Overall balances and conversion of Series B-1 Stock and accrued dividends into common stock has been as follows:

 

  

 

Common Stock

 

On March 21 and 28, 2019, the Company issued 13,820 shares of common stock to its directors in payment of board and board committee fees valued at $16,506. 

 

On May 14, 2019, the Company issued 4,235 shares of common stock to its directors in payment of board and board committee fees, valued at $5,505.

 

On August 8 and 14, 2019, the Company issued 6,111 shares of common stock to its directors in payment of board and board committee fees valued at $6,501. 

 

See Note 11 for common stock issued as commitment fees for notes payable in for the three and nine months ending September 30, 2019. 

 

Securities Purchase Agreement dated November 13, 2014

 

Pursuant to a Securities Purchase Agreement, dated November 13, 2014, by and between the Company and a number of private and institutional investors, the Company issued to certain private investors 664,584 shares of common stock and warrants to purchase an additional 996,877 shares of common stock for aggregate gross proceeds of $1,595,000.

 

The warrants have a term of five years and an initial exercise price of $3.60 per share, and have been fully exercisable since February 2015. The warrants have customary anti-dilution protections including a “full ratchet” anti-dilution adjustment provision which are triggered in the event the Company sells or grants any additional shares of common stock, options, warrants or other securities that are convertible into common stock at a price lower than $3.60 per share, The anti-dilution adjustment provision is not triggered by certain “exempt issuances” which among other issuances, includes the issuance of shares of common stock, options or other securities to officers, employees, directors, consultants or service providers.

 

On August 24, 2018 the Company issued Common Stock and Warrants to investors at a purchase price of $1.50 per unit which triggered the anti-dilution protection provision under this Securities Purchase Agreement. As a result, the total number of outstanding and fully vested warrants was increased from 996,877 to 2,392,502, and the exercise price was reduced from $3.60 to $1.50 per share. The Company recognized a non-cash deemed dividend of $1,288,139 in 2018 in connection with these adjustments.

 

 

Securities Purchase Agreement dated September 23, 2015

 

On September 23, 2015, the Company issued a warrant to purchase 69,445 shares of common stock in connection with the issuance of a promissory note. The warrants are immediately exercisable at an initial exercise price of $3.60 per share and have a term of five years. 

 

The warrants have customary anti-dilution protections including a "full ratchet" anti-dilution adjustment provision which are triggered in the event the Company sells or grants any additional shares of common stock, options, warrants or other securities that are convertible into common stock at a price lower than $3.60 per share. The anti-dilution adjustment provision is not triggered by certain "exempt issuances" which among other issuances, includes the issuance of shares of common stock, options or other securities to officers, employees, directors, consultants or service providers.

 

On August 24, 2018 the Company issued Common Stock and Warrants to the investors at a purchase price of $1.50 per unit which triggered the anti-dilution protection provision under this Securities Purchase Agreement. As a result, the total number of outstanding and fully vested warrants was increased from 69,445 to 166,668, and the exercise price was reduced from $3.60 to $1.50 per share. The Company recognized a non-cash deemed dividend of $140,827 in 2018 in connection with these adjustments. 

 

Issuances of Stock Options

 

4,000 options were granted during the quarter ended September 30, 2019.  The options have a three year vesting period, seven year term, and exercise price of $1.13.  The fair value of the options at date of issuance was estimated on the date of grant at $3,956 using the Black-Scholes option-pricing model with the following assumptions: risk free interest rate: 1.55%, expected life of options in years: 4.5, expected dividends: 0, volatility of stock price: 83%.