IMAGEWARE SYSTEMS INC - Quarter Report: 2018 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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[X]
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the quarterly period ended March 31, 2018
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[ ]
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
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For the transition period from _________ to _________
Commission file number 001-15757
IMAGEWARE SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware
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33-0224167
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(State or Other Jurisdiction of Incorporation or
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(IRS Employer Identification No.)
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Organization)
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10815 Rancho Bernardo Rd., Suite 310
San Diego, CA 92127
(Address of Principal Executive Offices)
(858) 673-8600
(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 (§232.405 of this chapter)
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,
smaller reporting company or 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. (Check one):
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Large accelerated filer
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[ ]
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Accelerated filer
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[X]
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Non-accelerated filer
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[ ]
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Smaller reporting company
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[ ]
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Emerging growth company
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[ ]
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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-12 of the Exchange Act). Yes
[ ] No [X]
The number of shares of common stock, with $0.01 par value,
outstanding on May 6, 2018 was 95,166,959.
IMAGEWARE SYSTEMS,
INC.
INDEX
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IMAGEWARE SYSTEMS, INC.
(In Thousands, except for share and per share data)
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March 31,
2018
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December 31,
2017
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(Unaudited)
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ASSETS
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Current
Assets:
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Cash
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$4,558
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$7,317
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Accounts
receivable, net of allowance for doubtful accounts of $15 at March
31, 2018 and December 31, 2017.
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284
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458
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Inventory,
net
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89
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79
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Other
current assets
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217
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163
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Total
Current Assets
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5,148
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8,017
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Property
and equipment, net
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40
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43
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Other
assets
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35
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35
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Intangible
assets, net of accumulated amortization
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90
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93
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Goodwill
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3,416
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3,416
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Total Assets
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$8,729
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$11,604
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LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
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Current
Liabilities:
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Accounts
payable
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$432
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$457
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Deferred
revenue
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878
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1,016
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Accrued
expenses
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812
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658
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Accrued
interest payable to related parties
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657
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527
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Convertible
lines of credit to related parties, net of discount
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5,821
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5,774
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Total
Current Liabilities
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8,600
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8,432
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Pension
obligation
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2,060
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2,024
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Total
Liabilities
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10,660
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10,456
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Shareholders’
Equity (Deficit):
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Preferred
stock, authorized 4,000,000 shares:
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Series
A Convertible Redeemable Preferred Stock, $0.01 par value;
designated 31,021 shares, 30,571 shares and 31,021 shares issued
and outstanding at March 31, 2018 and December 31, 2017,
respectively; liquidation preference $30,571 and $31,021 at March
31, 2018 and December 31, 2017, respectively.
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—
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—
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Series
B Convertible Redeemable Preferred Stock, $0.01 par value;
designated 750,000 shares, 389,400 shares issued and 239,400 shares
outstanding at March 31, 2018 and December 31, 2017; liquidation
preference $620 at March 31, 2018 and at December 31,
2017.
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2
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2
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Common
Stock, $0.01 par value, 175,000,000 shares authorized; 95,121,575
and 94,174,540 shares issued at March 31, 2018 and December 31,
2017, respectively, and 95,114,871 and 94,167,836 shares
outstanding at March 31, 2018 and December 31, 2017,
respectively.
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950
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941
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Additional
paid-in capital
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173,595
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172,414
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Treasury
stock, at cost 6,704 shares
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(64)
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(64)
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Accumulated
other comprehensive loss
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(1,692)
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(1,664)
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Accumulated
deficit
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(174,722)
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(170,481)
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Total
Shareholders’ Equity (Deficit)
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(1,931)
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1,148
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Total Liabilities and Shareholders’ Equity
(Deficit)
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$8,729
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$11,604
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
IMAGEWARE SYSTEMS,
INC.
(In Thousands, except share and per share amounts)
(Unaudited)
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Three
Months Ended
March
31,
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2018
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2017
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Revenue:
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Product
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$97
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$273
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Maintenance
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619
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655
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716
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928
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Cost
of revenue:
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Product
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26
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54
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Maintenance
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222
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208
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Gross
profit
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468
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666
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Operating
expense:
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General and
administrative
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1,206
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967
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Sales and
marketing
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861
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761
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Research and
development
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1,799
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1,541
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Depreciation and
amortization
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12
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21
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3,878
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3,290
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Loss from
operations
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(3,410)
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(2,624)
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Interest expense,
net
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173
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100
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Other income,
net
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—
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—
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Loss before income
taxes
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(3,583)
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(2,724)
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Income tax
expense
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—
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3
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Net
loss
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(3,583)
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(2,727)
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Preferred
dividends
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(769)
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(507)
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Net loss available
to common shareholders
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$(4,352)
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$(3,234)
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Basic
and diluted loss per common share - see Note 3:
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Net
loss
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$(0.04)
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$(0.03)
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Preferred
dividends
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(0.01)
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(0.01)
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Basic and diluted
loss per share available to common shareholders
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$(0.05)
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$(0.04)
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Basic and diluted
weighted-average shares outstanding
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94,333,663
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91,864,174
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
IMAGEWARE SYSTEMS, INC.
(In Thousands)
(Unaudited)
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Three
Months Ended
March
31,
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2018
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2017
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Net
loss
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$(3,583)
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$(2,727)
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Other comprehensive
income (loss):
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Foreign currency
translation adjustment
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(27)
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(17)
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Comprehensive
loss
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$(3,610)
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$(2,744)
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
IMAGEWARE SYSTEMS,
INC.
(In Thousands)
(Unaudited)
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Three
Months Ended
March
31,
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2018
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2017
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Cash
flows from operating activities
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Net
loss
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$(3,583)
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$(2,727)
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Adjustments to
reconcile net loss to net cash used by operating
activities:
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Depreciation
and amortization
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12
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21
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Amortization
of debt issuance costs and beneficial conversion
feature
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59
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40
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Stock-based
compensation
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335
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274
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Provision
for losses on accounts receivable
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—
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15
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Change
in assets and liabilities
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Accounts
receivable
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269
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(32)
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Inventory
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(10)
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(20)
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Other
assets
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(56)
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(12)
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Accounts
payable
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(22)
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(25)
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Deferred
revenue
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(138)
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(86)
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Accrued
expense
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285
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(63)
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Pension
obligation
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35
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15
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Total
adjustments
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769
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127
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Net cash used in
operating activities
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(2,814)
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(2,600)
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Cash
flows from investing activities
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Purchase of
property and equipment
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(7)
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(1)
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Net
cash used in in investing activities
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(7)
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(1)
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Cash
flows from financing activities
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Proceeds from
exercised stock options
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88
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7
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Proceeds from line
of credit
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—
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1,500
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Net cash provided
by financing activities
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88
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1,507
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Effect of exchange
rate changes on cash
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(26)
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(17)
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Net
decrease in cash
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(2,759)
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(1,111)
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Cash at beginning
of period
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7,317
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1,586
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Cash at end of
period
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$4,558
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$475
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Supplemental
disclosure of cash flow information:
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Cash paid for
interest
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$—
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$—
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Cash paid for
income taxes
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$—
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$—
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Summary of non-cash
investing and financing activities:
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Beneficial
conversion feature on related party lines of credit
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$10
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$125
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Stock
dividends on Convertible Preferred Stock
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$756
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$494
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Conversion
of Convertible Preferred Stock into Common Stock
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$4
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$—
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The accompanying notes are an integral part of these condensed
consolidated financial statements.
IMAGEWARE SYSTEMS,
INC.
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. ORGANIZATION AND DESCRIPTION OF
BUSINESS
Overview
As
used in this Quarterly Report, “we,” “us,”
“our,” “ImageWare,” “ImageWare
Systems,” “Company” or “our Company”
refers to ImageWare Systems, Inc. and all of its subsidiaries.
ImageWare Systems, Inc. is incorporated in the state of Delaware.
The Company is a pioneer and leader in the emerging market for
biometrically enabled software-based identity management solutions.
Using those human characteristics that are unique to us all, the
Company creates software that provides a highly reliable indication
of a person’s identity. The Company’s
“flagship” product is the patented IWS Biometric
Engine®. The Company’s products are used to manage and
issue secure credentials, including national IDs, passports, driver
licenses and access control credentials. The Company’s
products also provide law enforcement with integrated mug shot,
fingerprint LiveScan and investigative capabilities. The Company
also provides comprehensive authentication security software using
biometrics to secure physical and logical access to facilities or
computer networks or internet sites. Biometric technology is now an
integral part of all markets the Company addresses, and all the
products are integrated into the IWS Biometric
Engine.
Recent Developments
On
February 8, 2018, the Company filed with the Secretary of State of
the State of Delaware a Certificate of Amendment to its Certificate
of Incorporation, as amended, to increase the authorized number of
shares of its common stock, par value $0.01 per share
(“Common
Stock”), to 175,000,000 from 150,000,000
shares.
Liquidity, Going Concern and Management’s Plan
Historically, our principal sources of cash have
included customer payments from the sale of our products, proceeds
from the issuance of common and preferred stock and proceeds from
the issuance of debt, including our Lines of Credit (defined
below). Our principal uses of cash have included cash used in
operations, product development, payments relating to purchases of
property and equipment. We expect that our principal uses of cash
in the future will be for product development, including
customization of identity management products for enterprise and
consumer applications, further development of intellectual
property, development of Software-as-a-Service
(“SaaS”) capabilities for existing products as
well as general working capital and capital expenditure
requirements. Management expects that, as our revenue grows, our
sales and marketing and research and development expenses will
continue to grow, albeit at a slower rate and, as a result, we will
need to generate significant net revenue to achieve and sustain
income from operations.
Going Concern
At
March 31, 2018, we had a working capital deficit of approximately
$3,452,000. Our principal sources of liquidity at March 31, 2018
consisted of approximately $4,558,000 of cash and $284,000 of trade
accounts receivable.
Considering
our projected cash requirements, and assuming we are unable to
generate incremental revenue, our available cash may be
insufficient to satisfy our cash requirements for the next twelve
months from the date of this filing. These factors raise
substantial doubt about our ability to continue as a going concern.
To address our working capital requirements, management may seek
additional equity and/or debt financing through the issuance of
additional debt and/or equity securities or may seek strategic or
other transactions intended to increase shareholder value. There
are currently no formal committed financing arrangements to support
our projected cash shortfall, including commitments to purchase
additional debt and/or equity securities, or other agreements, and
no assurances can be given that we will be successful in raising
additional debt and/or equity securities, or entering into any
other transaction that addresses our ability to continue as a going
concern.
In
view of the matters described in the preceding paragraph,
recoverability of a major portion of the recorded asset amounts
shown in the accompanying consolidated balance sheet is dependent
upon continued operations of the Company, which, in turn, is
dependent upon the Company’s ability to continue to raise
capital and generate positive cash flows from operations. However,
the Company operates in markets that are emerging and highly
competitive. There is no assurance that the Company will be able to
obtain additional capital, operate at a profit or generate positive
cash flows in the future.
These
condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of
recorded asset amounts and classifications of liabilities that
might be necessary should the Company be unable to continue as a
going concern.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF
PRESENTATION
Basis of Presentation
The accompanying
condensed consolidated balance sheet as of December 31, 2017, which
has been derived from audited financial statements, and the
unaudited interim condensed consolidated financial statements have
been prepared by the Company in accordance with accounting
principles generally accepted in the United States of America
(“GAAP”)
and the rules and regulations of the Securities and Exchange
Commission (“SEC”)
related to a quarterly report on Form 10-Q. Certain information and
note disclosures normally included in annual financial statements
prepared in accordance with GAAP have been condensed or omitted
pursuant to those rules and regulations, although the Company
believes that the disclosures made are adequate to make the
information not misleading. The interim financial statements
reflect all adjustments, which, in the opinion of management, are
necessary for a fair statement of the results for the periods
presented. All such adjustments are of a normal and recurring
nature. These unaudited condensed consolidated financial statements
should be read in conjunction with the Company’s audited
financial statements for the year ended December 31, 2017, which
are included in the Company’s Annual Report on Form 10-K for
the year ended December 31, 2017 that was filed with the SEC on
March 19, 2018.
Operating
results for the three months ended March 31, 2018 are not
necessarily indicative of the results that may be expected for the
year ended December 31, 2018, or any other future
periods.
Certain prior period amounts have been
reclassified to conform with current period presentation.
These reclassifications have no impact on net
loss.
Significant Accounting
Policies
Principles of Consolidation
The
consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. The Company’s
wholly-owned subsidiaries are: XImage Corporation, a California
Corporation; ImageWare Systems ID Group, Inc., a Delaware
corporation (formerly Imaging Technology Corporation): I.W. Systems
Canada Company, a Nova Scotia unlimited liability company;
ImageWare Digital Photography Systems, LLC, a Nevada limited
liability company (formerly Castleworks LLC); Digital Imaging
International GmbH, a company formed under German laws; and Image
Ware Mexico S de RL de CV, a company formed under Mexican laws. All
significant intercompany transactions and balances have been
eliminated.
Use of Estimates
The
preparation of the consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
consolidated financial statements, and the reported amounts of
revenue and expense during the reporting period. Significant
estimates include the evaluation of our ability to continue as a
going concern, the allowance for doubtful accounts receivable,
inventory carrying values, deferred tax asset valuation allowances,
accounting for loss contingencies, recoverability of goodwill and
acquired intangible assets and amortization periods, assumptions
used in the Black-Scholes model to calculate the fair value of
share based payments, fair value of Exchanged Preferred (defined
below), assumptions used in the application of revenue recognition
policies and assumptions used in the application of fair value
methodologies to calculate the fair value of pension assets and
obligations. Actual results could differ from
estimates.
Accounts Receivable
In
the normal course of business, the Company extends credit without
collateral requirements to its customers that satisfy pre-defined
credit criteria. Accounts receivable are recorded net of an
allowance for doubtful accounts. Accounts receivable are considered
delinquent when the due date on the invoice has passed. The Company
records its allowance for doubtful accounts based upon its
assessment of various factors. The Company considers historical
experience, the age of the accounts receivable balances, the credit
quality of its customers, current economic conditions and other
factors that may affect customers’ ability to pay to
determine the level of allowance required. Accounts
receivable are written off against the allowance for doubtful
accounts when all collection efforts by the Company have been
unsuccessful.
Inventories
Finished goods inventories are stated at the lower
of cost, determined using the average cost method, or net
realizable value. See Note 4, “Inventory,” below.
Fair Value of Financial Instruments
For
certain of the Company’s financial instruments, including
accounts receivable, accounts payable, accrued expense, deferred
revenue and lines of credit payable to related parties, the
carrying amounts approximate fair value due to their relatively
short maturities.
Revenue Recognition
Effective
January 1, 2018, we adopted Accounting Standards Codification
(“ASC”), Topic
606, Revenue from Contracts with Customers (“ASC 606”),
using the modified retrospective transition method.
In
accordance with ASC 606, revenue is recognized when control of the
promised goods or services is transferred to our customers, in an
amount that reflects the consideration we expect to be entitled to
in exchange for those goods or services.
The
core principle of the standard is that we should recognize revenue
to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which we expect to
be entitled in exchange for those goods or services. To achieve
that core principle, we apply the following five step
model:
1.
Identify
the contract with the customer;
2.
Identify
the performance obligation in the contract;
3.
Determine
the transaction price;
4.
Allocate
the transaction price to the performance obligations in the
contract; and
5.
Recognize
revenue when (or as) each performance obligation is
satisfied.
At
contract inception, we assess the goods and services promised in a
contract with a customer and identify as a performance obligation
each promise to transfer to the customer either: (i) a good or
service (or a bundle of goods or services) that is distinct or (ii)
a series of distinct goods or services that are substantially the
same and that have the same pattern of transfer to the customer. We
recognize revenue only when we satisfy a performance obligation by
transferring a promised good or service to a customer.
Determining
the timing of the satisfaction of performance obligations as well
as the transaction price and the amounts allocated to performance
obligations requires judgement.
We
disclose disaggregation of our customer revenue by classes of
similar products and services as follows:
●
Software licensing and royalties;
●
Sales of computer hardware and identification media;
●
Services; and
●
Post-contract customer
support.
Software licensing and royalties
Software licenses
consist of revenue from the sale of software for identity
management applications. Our software licenses are functional
intellectual property and typically provide customers with the
right to use our software in perpetuity as it exists when made
available to the customer. We recognize revenue from software
licensing at a point in time upon delivery, provided all other
revenue recognition criteria are met.
Royalties
consist of revenue from usage-based arrangements and guaranteed
minimum-based arrangements. We recognize revenue for royalty
arrangements at the later of (i) when the related sales occur, or
(ii) when the performance obligation to which some or all of the
royalty has been allocated has been satisfied.
Computer hardware and identification media
We
generate revenue from the sale of computer hardware and
identification media. Revenue for these items is recognized upon
delivery of these products to the customer, provided all other
revenue recognition criteria are met.
Services
Services
revenue is comprised primarily of software customization services,
software integration services, system installation services and
customer training. Revenue is generally recognized upon completion
of services and customer acceptance provided all other revenue
recognition criteria are met.
Post-contract customer support (“PCS”)
Post contract customer support consists of
maintenance on software and hardware for our identity management
solutions. We recognize PCS revenue from periodic maintenance
agreements. Revenue is generally recognized ratably over the
respective maintenance periods provided no significant obligations
remain. Costs related to such contracts are expensed as
incurred.
Arrangements with multiple performance obligations
A
performance obligation is a promise in a contract to transfer a
distinct good or service to the customer. In addition to selling
software licenses, hardware and identification media, services and
post-contract customer support on a standalone basis, certain
contracts include multiple performance obligations. For such
arrangements, we allocate revenues to each performance obligation
based on our best estimate of the relative standalone selling
price. The standalone selling price for a performance obligation is
the price at which we would sell a promised good or service
separately to a customer. The primary methods used to estimate
standalone selling price are as follows: (i) the expected cost-plus
margin approach, under which we forecast our expected costs of
satisfying a performance obligation and then add an appropriate
margin for that distinct good or service and (ii) the percent
discount off of list price approach.
Contract costs
We
recognize an asset for the incremental costs of obtaining a
contract with a customer if we expect the benefit of those costs to
be longer than one year. We apply a practical expedient to expense
costs as incurred for costs to obtain a contract when the
amortization period is one year or less.
Other items
We
do not offer rights of return for our products and services in the
normal course of business.
Sales
tax collected from customers is excluded from revenue.
The
adoption of ASC 606 as of January 1, 2018 resulted in a cumulative
positive adjustment to beginning accumulated deficit and accounts
receivable of approximately $95,000. For the three months ended
March 31, 2018, the adoption of ASC 606 resulted in a reduction in
royalty revenue of approximately $28,000. The following table sets
forth our disaggregated revenue for the three months ended March
31, 2018 and 2017:
|
|
Three
Months Ended
March
31,
|
|
|
Net
Revenue
|
2018
|
2017
|
|
(dollars
in thousands)
|
|
|
|
|
|
|
|
Software and
royalties
|
$84
|
$189
|
|
Hardware and
consumables
|
1
|
47
|
|
Services
|
12
|
37
|
|
Maintenance
|
619
|
655
|
|
Total
revenue
|
$716
|
$928
|
Customer Concentration
For
the three months ended March 31, 2018, two customers accounted
for approximately 38% or $275,000 of our total revenue and had
trade receivables at March 31, 2018 of $74,000.
For
the three months ended March 31, 2017, two customers accounted
for approximately 32% or $299,000 of our total revenue and had
trade receivables at March 31, 2017 of $67,000.
Recently Issued Accounting Standards
From time to time, new accounting pronouncements
are issued by the Financial Accounting Standards Board
(“FASB”), or other standard setting bodies, which
are adopted by us as of the specified effective date. Unless
otherwise discussed, the Company’s management believes the
impact of recently issued standards not yet effective will not have
a material impact on the Company’s consolidated financial
statements upon adoption.
FASB ASU No.
2016-02. In February 2016, the
FASB issued ASU No. 2016-02, “Leases.” This guidance will result in key changes to lease
accounting and will aim to bring leases onto balance sheets to give
investors, lenders, and other financial statement users a more
comprehensive view of a company’s long-term financial
obligations as well as the assets it owns versus leases. The new
leasing standard will be effective for fiscal years beginning after
December 15, 2018, and for interim periods within those fiscal
years. The Company is currently evaluating the impact this guidance
will have on our consolidated financial statements and anticipates
commencement of adoption planning in the third fiscal quarter of
2018.
FASB ASU No.
2016-13. In June 2016, the FASB
issued Accounting Standard Update No. 2016-13, Financial
Instruments—Credit Losses (Topic 326): Measurement of Credit
Losses on Financial Instruments. ASU No. 2016-13 changes the impairment model
for most financial assets and certain other instruments. For trade
and other receivables, held-to-maturity debt securities, loans and
other instruments, entities will be required to use a new
forward-looking “expected loss” model that will replace
today’s “incurred loss” model and generally will
result in the earlier recognition of allowances for losses. For
available-for-sale debt securities with unrealized losses, entities
will measure credit losses in a manner similar to current practice,
except that the losses will be recognized as an allowance. This
guidance is effective for fiscal years beginning after December 15,
2019 including interim periods within those fiscal years. The
Company is currently evaluating the potential impact of adoption of
this standard on its consolidated financial
statements.
FASB ASU No.
2017-04. In January 2017,
the FASB issued ASU No. 2017-04, Intangibles – Goodwill
and Other (Topic 350): Simplifying the Test for Goodwill
Impairment. The amendments of this
ASU eliminate step 2 from the goodwill impairment test. The annual,
or interim test is performed by comparing the fair value of a
reporting unit with its carrying amount. The amendments of this ASU
also eliminate the requirements for any reporting unit with a zero
or negative carrying amount to perform a qualitative assessment and
if it fails that qualitative test, to perform step 2 of the
goodwill impairment test. ASU No. 2017-04 is effective for fiscal
years beginning after December 15, 2019. The Company is currently evaluating the
potential impact of adoption of this standard on its consolidated
financial statements.
FASB ASU No.
2017-07. Effective January
1, 2018, we adopted ASU No. 2017-07, Compensation –
Retirement Benefits (Topic 715): Improving the Presentation of
Periodic Pension Cost and Net Periodic Postretirement Benefit
Cost issued by the FASB which
requires employers to present the service cost component of net
periodic benefit cost in the same income statement line item(s) as
other employee compensation costs arising from services rendered
during the period. The adoption of this standard did not have a
material effect on our consolidated financial
statements.
FASB ASU No. 2017-11.
In July 2017, the FASB issued ASU No
2017-11, “Earnings Per Share (Topic
260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for
Certain Financial Instruments with Down Round Features, (Part II)
Replacement of the Indefinite Deferral.” The ASU applies to issuers of financial
instruments with down-round features. It amends (1) the
classification of such instruments as liabilities or equity by
revising the guidance in ASC 815 on the evaluation of whether
instruments or embedded features with down-round provisions must be
accounted for as derivative instruments and (2) the guidance on
recognition and measurement of the value transferred upon the
trigger of a down-round feature for equity-classified instruments
by revising ASC 260. The ASU is effective for public business
entities for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2018. For all other
organizations, the amendments are effective for fiscal years
beginning after December 15, 2019, and interim periods within
fiscal years beginning after December 15, 2020. Early adoption is
permitted. The Company is
currently evaluating the potential impact of this updated guidance
on its consolidated financial statements.
NOTE 3. NET LOSS PER COMMON SHARE
Basic
loss per common share is calculated by dividing net loss available
to common shareholders for the period by the weighted-average
number of common shares outstanding during the period. Diluted loss
per common share is calculated by dividing net loss available to
common shareholders for the period by the weighted-average number
of common shares outstanding during the period, adjusted to
include, if dilutive, potential dilutive shares consisting of
convertible preferred stock, convertible related party lines of
credit, stock options and warrants, calculated using the treasury
stock and if-converted methods. For diluted loss per share
calculation purposes, the net loss available to common shareholders
is adjusted to add back any preferred stock dividends and any
interest on convertible debt reflected in the condensed
consolidated statement of operations for the respective
periods.
The
table below presents the computation of basic and diluted loss per
share:
|
(Amounts
in thousands except share and per share amounts)
|
Three Months Ended
March
31,
|
|
|
|
2018
|
2017
|
|
Numerator for basic
and diluted loss per share:
|
|
|
|
Net
loss
|
$(3,583)
|
$(2,727)
|
|
Preferred
dividends
|
(769)
|
(507)
|
|
Net loss available
to common shareholders
|
$(4,352)
|
$(3,234)
|
|
|
|
|
|
Denominator for
basic and dilutive loss per share — weighted-average shares
outstanding
|
94,333,663
|
91,864,174
|
|
Net
loss
|
$(0.04)
|
$(0.03)
|
|
Preferred
dividends
|
(0.01)
|
(0.01)
|
|
Basic and diluted
loss per share available to common shareholders
|
$(0.05)
|
$(0.04)
|
The
following potential dilutive securities have been excluded from the
computations of diluted weighted-average shares outstanding as
their effect would have been antidilutive:
|
Potential
Dilutive Securities
|
Three Months Ended
March
31,
|
|
|
|
2018
|
2017
|
|
|
|
|
|
Related party lines
of credit
|
5,325,651
|
3,450,940
|
|
Convertible
redeemable preferred stock
|
26,630,458
|
11,710,102
|
|
Stock
options
|
7,273,431
|
6,491,931
|
|
Warrants
|
230,000
|
175,000
|
|
Total potential
dilutive securities
|
39,459,540
|
21,827,973
|
NOTE 4. SELECT BALANCE SHEET DETAILS
Inventory
Inventories of $89,000 as of March 31, 2018 were comprised of work
in process of $48,000 representing direct labor costs on in-process
projects and finished goods of $41,000 net of reserves for obsolete
and slow-moving items of $3,000.
Inventories of $43,000 as of March 31, 2017 were comprised of work
in process of $37,000 representing direct labor costs on in-process
projects and finished goods of $6,000 net of reserves for obsolete
and slow-moving items of $3,000.
Intangible Assets
The
carrying amounts of the Company’s patent intangible assets
were $90,000 and $93,000 as of March 31, 2018 and December 31,
2017, respectively, which includes accumulated amortization of
$569,000 and $566,000 as of March 31, 2018 and December 31, 2017,
respectively. Amortization expense for patent intangible
assets was $3,000 for the three months ended March 31, 2018 and
2017. Patent intangible assets are being amortized on a
straight-line basis over their remaining life of approximately 7.9
years.
The
estimated acquired intangible amortization expense for the next
five fiscal years is as follows:
|
Fiscal Year Ended December 31,
|
Estimated
Amortization
Expense
($ in
thousands)
|
|
2018
(nine months)
|
$9
|
|
2019
|
12
|
|
2020
|
12
|
|
2021
|
12
|
|
2022
|
12
|
|
Thereafter
|
33
|
|
Totals
|
$90
|
Goodwill
The
Company annually, or more frequently if events or circumstances
indicate a need, tests the carrying amount of goodwill for
impairment. A two-step impairment test is used to first
identify potential goodwill impairment and then measure the amount
of goodwill impairment loss, if any. The first step was conducted
by determining and comparing the fair value, employing the market
approach, of the Company’s reporting unit to the carrying
value of the reporting unit. The Company continues to have only one
reporting unit, Identity Management. Based on the results of this
impairment test, the Company determined that its goodwill was not
impaired as of March 31, 2018 and December 31, 2017.
NOTE 5. LINES OF CREDIT WITH RELATED
PARTIES
Outstanding
lines of credit consist of the following:
|
($ in thousands)
|
March 31,
2018
|
December 31,
2017
|
|
Lines
of Credit with Related Parties
|
|
|
|
8%
convertible lines of credit. Face value of advances under lines of
credit $6,000 at March 31, 2018 and December 31, 2017. Discount on
advances under lines of credit is $179 at March 31, 2018
and $226 at December 31, 2017. Maturity date is December 31,
2018.
|
$5,821
|
$5,774
|
|
|
|
|
|
Total
lines of credit to related parties
|
5,821
|
5,774
|
|
Less
current portion
|
(5,821)
|
(5,774)
|
|
Long-term
lines of credit to related parties
|
$—
|
$—
|
Lines of Credit
In March 2013, the Company and Neal Goldman, a
member of the Company’s Board of Directors
(“Goldman”), entered into a line of credit (the
“Goldman Line of
Credit”) with available
borrowings of up to $2.5 million. In March 2014, the Goldman Line
of Credit’s borrowing was increased to an aggregate total of
$3.5 million (the “Amendment”). Pursuant to the terms and conditions of
the Amendment, Goldman had the right to convert up to $2.5 million
of the outstanding balance of the Goldman Line of Credit into
shares of the Company’s Common Stock for $0.95 per share. Any
remaining outstanding balance was convertible into shares of
the Company’s Common Stock for $2.25 per
share.
As consideration for the initial Goldman Line of
Credit, the Company issued a warrant to Goldman, exercisable for
1,052,632 shares of the Company’s Common Stock (the
“Line
of Credit Warrant”). The
Line of Credit Warrant had a term of two years from the date of
issuance and an exercise price of $0.95 per share. As
consideration for entering into the Amendment, the Company issued
to Goldman a second warrant, exercisable for 177,778 shares of the
Company’s Common Stock (the “Amendment
Warrant”). The Amendment
Warrant expired on March 27, 2015 and had an exercise price of
$2.25 per share.
The
Company estimated the fair value of the Line of Credit Warrant
using the Black-Scholes option pricing model using the following
assumptions: term of two years, a risk-free interest rate of 2.58%,
a dividend yield of 0%, and volatility of 79%. The Company recorded
the fair value of the Line of Credit Warrant as a deferred
financing fee of approximately $580,000 to be amortized over the
life of the Goldman Line of Credit. The Company estimated the fair
value of the Amendment Warrant using the Black-Scholes option
pricing model using the following assumptions: term of one year, a
risk-free interest rate of 2.58%, a dividend yield of 0% and
volatility of 74%. The Company recorded the fair value of the
Amendment Warrant as an additional deferred financing fee of
approximately $127,000 to be amortized over the life of the Goldman
Line of Credit.
During
the three months ended March 31, 2018, the Company recorded an
aggregate of approximately $2,000 in deferred financing fee
amortization expense. During the three months ended March 31, 2017,
the Company recorded an aggregate of approximately $5,000 in
deferred financing fee amortization expense. Such expense is
recorded as a component of interest expense in the Company’s
condensed consolidated statements of operations.
In April 2014, the Company and Goldman entered
into a further amendment to the Goldman Line of Credit to decrease
the available borrowings to $3.0 million (the
“Second
Amendment”). Contemporaneous with the execution
of the Second Amendment, the Company entered into a new unsecured
line of credit with Charles Crocker, a member of the
Company’s Board of Directors (“Crocker”), with available borrowings of up to
$500,000 (the “Crocker LOC”), which amount was convertible into
shares of the Company’s Common Stock for $2.25 per share. As
a result of these amendments, total available borrowings under the
lines of credit available to the Company remained unchanged an
aggregate of $3.5 million. In connection with the Second Amendment,
Goldman assigned and transferred to Crocker one-half of the
Amendment Warrant.
In December 2014, the Company and Goldman entered
into a further amendment to the Goldman Line of Credit to increase
the available borrowing to $5.0 million and extend the maturity
date of the Goldman Line of Credit to March 27, 2017 (the
“Third
Amendment”). Also, as a
result of the Third Amendment, Goldman had the right to convert up
to $2.5 million outstanding principal, plus any accrued but unpaid
interest (“Outstanding
Balance”) into shares of
the Company’s Common Stock for $0.95 per share, the next
$500,000 Outstanding Balance into shares of Common Stock for $2.25
per share and any remaining outstanding balance thereafter into
shares of Common Stock for $2.30 per share. The Third Amendment
also modified the definition of a “Qualified Financing”
to mean a debt or equity financing resulting in gross proceeds to
the Company of at least $5.0 million.
In
February 2015, as a result of the Series E Financing, the Company
issued 1,978 shares of Series E Preferred to Goldman to satisfy
$1,950,000 in principal borrowings under the Goldman Line of
Credit, plus approximately $28,000 in accrued interest. As a result
of the Series E Financing, the Company’s borrowing capacity
under the Goldman Line of Credit was reduced to $3,050,000 with the
maturity date unchanged and the Crocker LOC was terminated in
accordance with its terms.
In March 2016, the Company and Goldman entered
into a fourth amendment to the Goldman Line of Credit (the
“Fourth
Amendment”) solely to (i)
increase available borrowings to $5.0 million; (ii) extend the
maturity date to June 30, 2017, and (iii) provide for the
conversion of the outstanding balance due under the terms of the
Goldman Line of Credit into that number of fully paid and
non-assessable shares of the Company’s Common Stock as is
equal to the quotient obtained by dividing the outstanding balance
by $1.25.
Contemporaneous with the execution of the Fourth
Amendment, the Company entered into a new $500,000 line of credit
with Crocker (the “New Crocker
LOC”) with available
borrowings of up to $500,000, which replaced the original Crocker
LOC that terminated as a result of the consummation of the Series E
Financing. Similar to the Fourth Amendment, the New Crocker
LOC originally matured on June 30, 2017, and provided for the
conversion of the outstanding balance due under the terms of the
New Crocker LOC into that number of fully paid and non-assessable
shares of the Company’s Common Stock as is equal to the
quotient obtained by dividing the outstanding balance by
$1.25.
On December 27, 2016, in connection with the
consummation of the Series G Financing, the Company and Goldman
agreed to enter into the Fifth
Amendment (the “Line
of Credit Amendment”) to the Goldman
Line of Credit to provide the Company with the ability to borrow up
to $5.5 million under the terms of the Goldman Line of Credit. In
addition, the Maturity Date, as defined in the Goldman Line of
Credit, was amended to be December 31, 2017. The Line of Credit
Amendment was executed on January 23, 2017.
In addition, on January 23, 2017, the Company and Crocker amended
the New Crocker LOC to extend the maturity date thereof to December
31, 2017.
On May 10, 2017, Goldman and Crocker agreed to further extend the
maturity dates of the Goldman Line of Credit and the New Crocker
Line of Credit (collectively, the “Lines of Credit”) to December 31,
2018.
As the aforementioned amendments to the Lines of Credit resulted in
an increase to the borrowing capacity of the Lines of Credit, the
Company adjusted the amortization period of any remaining
unamortized deferred costs and note discounts to the term of the
new arrangement.
The
Company evaluated the Lines of Credit and determined that the
instruments contain a contingent beneficial conversion feature,
i.e. an embedded conversion right that enables the holder to obtain
the underlying Common Stock at a price below market value. The
beneficial conversion feature is contingent as the terms of the
conversion do not permit the Company to compute the number of
shares that the holder would receive if the contingent event occurs
(i.e. future borrowings under the Line of Credit). The Company has
considered the accounting for this contingent beneficial conversion
feature using the guidance in ASC 470, Debt. The guidance in ASC
470 states that a contingent beneficial conversion feature in an
instrument shall not be recognized in earnings until the
contingency is resolved. The beneficial conversion features of
future borrowings under the Line of Credit will be measured
using the intrinsic value calculated at the date the contingency is
resolved using the conversion price and trading value of the
Company’s Common Stock at the date the Lines of Credit were
issued (commitment date).
The Company incurred no additional borrowings
under the Lines of Credit during the three months ended March 31,
2018. During the three months ended March 31, 2018, the Company
incurred approximately $130,000 in accrued unpaid interest under
the terms of the Lines of Credit. As a result of this interest
accrual, the Company recorded an additional $10,000 in debt
discount attributable to beneficial conversion feature and
accreted
approximately $59,000 of debt discount. During the three months
ended March 31, 2017, the Company recorded approximately $125,000
in debt discount attributable to beneficial conversion feature and
accreted approximately $35,000 of the note discount.
Such expense is recorded as a
component of interest expense in the Company’s condensed
consolidated statements of operations.
NOTE 6. EQUITY
The
Company’s Certificate of Incorporation, as amended,
authorizes the issuance of two classes of stock to be designated
“Common Stock” and “Preferred Stock.” The
Preferred Stock may be divided into such number of series and with
the rights, preferences, privileges and restrictions as the Board
of Directors may determine.
Series A Convertible Preferred Stock
On September 15, 2017, the Company filed the
Certificate of Designations of the Series A Preferred with the
Delaware Secretary of State, designating 31,021 shares of the
Company’s preferred stock, par value $0.01 per share, as
Series A Preferred. Shares of Series A Preferred accrue dividends
at a rate of 8% per annum if the Company chooses to pay accrued
dividends in cash, and 10% per annum if the Company chooses to pay
accrued dividends in shares of Common Stock. Each share of Series A
Preferred has a liquidation preference of $1,000 per share and is
convertible, at the option of the holder, into that number of
shares of the Company’s Common Stock equal to the Liquidation
Preference, divided by $1.15 (“Conversion
Shares”). Each holder of
the Series A Preferred is entitled to vote on all matters, together
with the holders of Common Stock, on an as converted
basis.
Holders of Series A Preferred may elect to convert
shares of Series A Preferred into Conversion Shares at any time. In
the event the volume-weighted average price
(“VWAP”) of the Company’s Common Stock is at
least $2.15 per share for at least 20 consecutive trading days, the
Company may elect to convert one-half of the shares of Series A
Preferred issued and outstanding, on a pro-rata basis, into
Conversion Shares, or, if the VWAP of the Company’s Common
Stock is at least $2.15 for 80 consecutive trading days, the
Company may convert all issued and outstanding shares of Series A
Preferred into Conversion Shares. In addition, in the event of a
Change of Control, the Company will have the option to redeem all
issued and outstanding shares of Series A Preferred for 115% of the
Liquidation Preference per share.
On
September 18, 2017, the Company offered and sold a total of 11,000
shares of Series A Preferred at a purchase price of $1,000 per
share. The total net proceeds to the Company from the Series A
Financing were approximately $10.9 million.
Concurrently with the Series A Financing, the
Company entered into Exchange Agreements with holders of all
outstanding shares of the Company’s Series E Convertible
Preferred Stock, all outstanding shares of the Company’s
Series F Convertible Preferred Stock and all outstanding shares of
the Company's Series G Convertible Preferred Stock (collectively,
the “Exchanged
Preferred”), pursuant to
which the holders thereof agreed to cancel their respective shares
of Exchanged Preferred in exchange for shares of Series A Preferred
(the “Preferred Stock
Exchange”). As a result
of the Preferred Stock Exchange, the Company issued to the holders
of the Exchanged Preferred an aggregate total of 20,021 shares of
Series A Preferred.
The Company evaluated the Preferred Stock Exchange
and determined that the Preferred Stock Exchange was both an
induced conversion and an extinguishment transaction. Using the
guidance in ASC 260-10-S99-2, Earnings Per Share – SEC
Materials – SEC Staff Announcement: The Effect on the
Calculations of Earnings Per Share for a Period That Includes the
Redemption or Induced Conversion of Preferred Stock and
ASC 470-50, Debt – Modifications and
Extinguishments, the Company
recorded the fair value differential of the Exchanged Preferred as
adjustments within Shareholders’ Deficit and in the
computation of Net Loss Available to Common Shareholders in the
computation of basic and diluted loss per share. The Company
utilized the services an independent third-party valuation firm to
perform the computation of the fair value of the Exchanged
Preferred. Based on the fair value using these methodologies, the
Company recorded approximately $1,245,000 in fair value
differential as adjustments within Shareholders’ Deficit in
the Company’s Condensed Consolidated Balance Sheet for the
year ended December 31, 2017.
The Company had 30,571 shares and 31,021 shares of
Series A Preferred outstanding as of March 31, 2018 and December
31, 2017, respectively. At March 31, 2018 and December 31,
2017, the Company had cumulative undeclared dividends of $0.
During the three months ended March 31, 2018 certain holders of
Series A Preferred converted 450 shares of Series A Preferred into
391,304 shares of the Company’s Common Stock. The Company issued the
holders of Series A Preferred 472,562 shares of Common Stock on
March 31, 2018 as payment of dividends due on that
date.
Series B Convertible Preferred Stock
The Company had 239,400 shares of Series B
Convertible Preferred Stock (“Series B
Preferred”) outstanding
as of March 31, 2018 and December 31, 2017. At March 31, 2018 and
December 31, 2018, the Company had cumulative undeclared dividends
of approximately $21,000 and $8,000, respectively. There were no
conversions of Series B Preferred into Common Stock during the
three months ended March 31, 2018 and 2017.
Common Stock
On
February 8, 2018, the Company filed with the Secretary of the State
of Delaware a Certificate of Amendment to its Certificate of
Incorporation, as amended, to increase the authorized number of
shares of its Common Stock to 175,000,000 from 150,000,000
shares.
The
following table summarizes Common Stock activity for the three
months ended March 31, 2018:
|
|
Common Stock
|
|
Shares
outstanding at December 31, 2017
|
94,167,836
|
|
Shares
issued as payment of stock dividend on Series A
Preferred
|
472,562
|
|
Shares
issued pursuant to conversion of Series A Preferred
|
391,304
|
|
Shares
issued pursuant to option exercises
|
83,169
|
|
Shares
outstanding at March 31, 2018
|
95,114,871
|
Warrants
The
following table summarizes warrant activity for the following
periods:
|
|
Warrants
|
Weighted- Average
Exercise Price
|
|
Balance
at December 31, 2017
|
230,000
|
$0.91
|
|
Granted
|
—
|
—
|
|
Expired/Canceled
|
—
|
—
|
|
Exercised
|
—
|
—
|
|
Balance
at March 31, 2018
|
230,000
|
$0.91
|
As
of March 31, 2018, warrants to purchase 230,000 shares of Common
Stock at an exercise prices ranging from $0.80 to $1.17 were
outstanding. All warrants are exercisable as of March 31, 2018 and
expire as of September 11, 2019, except for an aggregate of 150,000
warrants, which become exercisable only upon the attainment of
specified events. The intrinsic value of warrants outstanding at
March 31, 2018 was approximately $158,000.
Stock-Based Compensation
The
1999 Plan was adopted by the Company’s Board of Directors on
December 17, 1999. Under the terms of the 1999 Plan, the Company
could, originally, issue up to 350,000 non-qualified or incentive
stock options to purchase Common Stock of the Company. During the
year ended December 31, 2014, the Company subsequently amended and
restated the 1999 Plan, whereby it increased the share reserve for
issuance to approximately 7.0 million shares of the Company’s
Common Stock. Subsequently, in February 2018, the Company amended
and restated the 1999 Plan, whereby it increased the share reserve
for issuance by an additional 2.0 million shares. The 1999
Plan prohibits the grant of stock option or stock appreciation
right awards with an exercise price less than fair market value of
Common Stock on the date of grant. The 1999 Plan also generally
prohibits the “re-pricing” of stock options or stock
appreciation rights, although awards may be bought-out for a
payment in cash or the Company’s stock. The 1999 Plan permits
the grant of stock-based awards other than stock options, including
the grant of “full value” awards such as restricted
stock, stock units and performance shares. The 1999 Plan permits
the qualification of awards under the plan (payable in either stock
or cash) as “performance-based compensation” within the
meaning of Section 162(m) of the Internal Revenue Code. The number
of options issued and outstanding and the number of options
remaining available for future issuance are shown in the table
below. The number of authorized shares available for issuance under
the plan at March 31, 2018 was 837,177.
The Company estimates the fair value of its stock
options using a Black-Scholes option-valuation model, consistent
with the provisions of ASC No. 718, Compensation – Stock
Compensation. The fair value of
stock options granted is recognized to expense over the requisite
service period. Stock-based compensation expense is reported in
general and administrative, sales and marketing, engineering and
customer service expense based upon the departments to which
substantially all of the associated employees report and credited
to additional paid-in capital. Stock-based compensation expense
related to equity options was approximately $273,000 and $274,000
for the three months ended March 31, 2018 and 2017, respectively.
Stock-based compensation expense related to options to purchase
shares of the Company’s Common Stock issued to certain
members of the Company’s Board of Directors in return for
their service (disclosed more fully below) was approximately
$62,000 and $35,000 for the three months ended March 31, 2018 and
2017, respectively.
ASC No. 718 requires the use of a valuation model
to calculate the fair value of stock-based awards. The Company has
elected to use the Black-Scholes option-valuation model, which
incorporates various assumptions including volatility, expected
life, and interest rates. The Company is required to make various
assumptions in the application of the Black-Scholes
option-valuation model. The Company has determined that the best
measure of expected volatility is based on the historical weekly
volatility of the Company’s Common Stock. Historical
volatility factors utilized in the Company’s Black-Scholes
computations for the three months ended March 31, 2018 and 2017
ranged from 58% to 64%. The Company has elected to estimate the
expected life of an award based upon the SEC approved
“simplified method” noted under the provisions of Staff
Accounting Bulletin No. 110. The expected term used by the Company
during the three months ended March 30, 2018 and 2017 was 5.17
years. The difference between the actual historical expected life
and the simplified method was immaterial. The interest rate
used is the risk-free interest rate and is based upon U.S. Treasury
rates appropriate for the expected term. Interest rates used in
the Company’s Black-Scholes calculations for the three months
ended March 31, 2018 and 2017 was 2.6%. Dividend yield is zero, as
the Company does not expect to declare any dividends on the
Company’s Common Stock in the foreseeable
future.
In
addition to the key assumptions used in the Black-Scholes model,
the estimated forfeiture rate at the time of valuation is a
critical assumption. The Company has estimated an annualized
forfeiture rate of approximately 0% for corporate officers, 4.1%
for members of the Board of Directors and 6.0% for all other
employees. The Company reviews the expected forfeiture rate
annually to determine if that percent is still reasonable based on
historical experience.
A
summary of the activity under the Company’s stock option
plans is as follows:
|
|
Options
|
Weighted-Average
Exercise Price
|
|
Balance
at December 31, 2017
|
6,093,512
|
$1.23
|
|
Granted
|
1,303,000
|
$1.76
|
|
Expired/Cancelled
|
(39,912)
|
$1.34
|
|
Exercised
|
(83,169)
|
$1.05
|
|
Balance
at March 31, 2018
|
7,273,431
|
$1.32
|
The
intrinsic value of options exercisable at March 31, 2018 was
approximately $2,409,000. The aggregate intrinsic value for
all options outstanding as of March 31, 2018 was approximately
$2,577,000. The weighted-average grant-date per share fair value of
options granted during the three months ended March 31, 2018 was
$0.99. At March 31, 2018, the total remaining unrecognized
compensation cost related to unvested stock options amounted to
approximately $1,780,000 which will be recognized over a
weighted-average period of 1.87 years.
In
January 2018, the Company issued an aggregate of 324,000 options to
purchase shares of the Company’s Common Stock to certain
members of the Company’s Board of Directors in return for
their service on the Board from January 1, 2018 through December
31, 2018. Such options vest at the rate of 27,000 options per month
on the last day of each month during the 2018 year. The options
have an exercise price of $1.75 per share and a term of 10 years.
Pursuant to this issuance, the Company recorded compensation
expense of $62,000 during the three months ended March 31, 2018
based on the grant-date fair value of the options determined using
the Black-Scholes option-valuation model.
Stock-based
compensation related to equity options, including options granted
to certain members of the Company’s Board of Directors, has
been classified as follows in the accompanying condensed
consolidated statements of operations (in thousands):
|
|
Three Months Ended
March 31,
|
|
|
|
2018
|
2017
|
|
Cost
of revenue
|
$5
|
$5
|
|
General
and administrative
|
216
|
164
|
|
Sales
and marketing
|
60
|
55
|
|
Research
and development
|
54
|
50
|
|
Total
|
$335
|
$274
|
NOTE 7. FAIR VALUE ACCOUNTING
The Company accounts for fair value measurements
in accordance with ASC 820, “Fair Value Measurements and
Disclosures,” which
defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands
disclosures about fair value measurements.
ASC
820 establishes a fair value hierarchy that prioritizes the inputs
to valuation techniques used to measure fair value. The hierarchy
gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements)
and the lowest priority to unobservable inputs (Level 3
measurements). The three levels of the fair value hierarchy under
ASC 820 are described below:
|
Level 1
|
Unadjusted quoted prices in active markets that are accessible at
the measurement date for identical, unrestricted assets or
liabilities.
|
|
Level 2
|
Applies to assets or liabilities for which there are inputs other
than quoted prices included within Level 1 that are observable for
the asset or liability such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets
or liabilities in markets with insufficient volume or infrequent
transactions (less active markets); or model-derived valuations in
which significant inputs are observable or can be derived
principally from, or corroborated by, observable market
data.
|
|
Level 3
|
Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable
(supported by little or no market activity).
|
The
following table sets forth the Company’s financial assets and
liabilities measured at fair value by level within the fair value
hierarchy. As required by ASC 820, assets and liabilities are
classified in their entirety based on the lowest level of input
that is significant to the fair value measurement.
|
|
Fair Value at March 31, 2018
|
|||
|
($ in thousands)
|
Total
|
Level 1
|
Level 2
|
Level 3
|
|
Assets:
|
|
|
|
|
|
Pension
assets
|
$1,852
|
$1,852
|
$—
|
$—
|
|
Totals
|
$1,852
|
$1,852
|
$—
|
$—
|
|
|
Fair Value at December 31, 2017
|
|||
|
($ in thousands)
|
Total
|
Level 1
|
Level 2
|
Level 3
|
|
Assets:
|
|
|
|
|
|
Pension
assets
|
$1,806
|
$1,806
|
$—
|
$—
|
|
Totals
|
$1,806
|
$1,806
|
$—
|
$—
|
NOTE 8. RELATED PARTY TRANSACTIONS
Lines of Credit
The Company has certain Lines of Credit extended
by certain members of the Company’s Board of Directors. For a
more detailed discussion of the Company’s Lines of Credit,
see Note 5, “Lines of
Credit.” As of
March 31, 2018, the Company had borrowed $5,500,000
under the terms of the Goldman LOC and $500,000 under the terms of
the New Crocker LOC. Each of Messrs. Goldman and Crocker are
members of the Board of Directors of the
Company.
Series A Financing
Messrs. Miller and Goldman, Wayne Wetherell, the Company’s
Chief Financial Officer, Robert T. Clutterbuck and Charles
Frischer, two directors appointed as members of the Company’s
Board of Directors in connection with the Series A Financing during
2017, purchased an aggregate of 1,450 Series A Preferred in
connection with the Series A Financing resulting in gross proceeds
of $1,450,000 to the Company. Messrs. Goldman, Clutterbuck and
Frischer also exchanged an aggregate 11,364 shares of Series E
Preferred, Series F Preferred and Series G Preferred for 11,364
shares of Series A Preferred in connection with the Series A
Financing.
NOTE 9. CONTINGENT LIABILITIES
Employment Agreements
The
Company has employment agreements with its Chief Executive Officer
and its Chief Technical Officer. The Company may terminate the
agreements with or without cause. Subject to the conditions and
other limitations set forth in each respective employment
agreement, each executive will be entitled to the following
severance benefits if the Company terminates the executive’s
employment without cause or in the event of an involuntary
termination (as defined in the employment agreements) by the
Company or by the executive:
Under
the terms of the agreement, the Chief Executive Officer will be
entitled to the following severance benefits if we terminate his
employment without cause or in the event of an involuntary
termination: (i) a lump sum cash payment equal to twenty-four
months’ base salary; (ii) continuation of fringe benefits and
medical insurance for a period of three years; and (iii) immediate
vesting of 50% of outstanding stock options and restricted stock
awards. In the event that the Chief Executive Officer’s
employment is terminated within six months prior to or thirteen
months following a change of control (as defined in the employment
agreements), the Chief Executive Officer is entitled to the
severance benefits described above, except that 100% of the Chief
Executive Officer’s outstanding stock options and restricted
stock awards will immediately vest.
Under
the terms of the employment agreement with our Chief Technical
Officer, this executive will be entitled to the following severance
benefits if we terminate his employment without cause or in the
event of an involuntary termination: (i) a lump sum cash payment
equal to six months of base salary; and (ii) continuation of their
fringe benefits and medical insurance for a period of six months.
In the event that his employment is terminated within six months
prior to or thirteen months following a change of control (as
defined in the employment agreements), he is entitled to the
severance benefits described above, except that 100% of his
outstanding stock options and restricted stock awards will
immediately vest.
Effective
September 15, 2017, the employment agreements for the
Company’s Chief Executive Officer and Chief Technical Officer
were amended to extend the term of each executive officer's
employment agreement until December 31, 2018.
Litigation
There
is no action, suit, proceeding, inquiry or investigation before or
by any court, public board, government agency, self-regulatory
organization or body pending or, to the knowledge of the executive
officers of the Company or any of our subsidiaries, threatened
against or affecting the Company, our Common Stock, any of our
subsidiaries or of the Company’s or our subsidiaries’
officers or directors in their capacities as such, in which an
adverse decision could have a material adverse effect.
Leases
The
Company’s corporate headquarters are located in San Diego,
California, where we occupy 9,927 square feet of office space. This
facility’s lease was renewed in September 2017 through
October 2018 at a cost of approximately $30,000 per month. In
addition to our corporate headquarters, we also occupied the
following spaces at March 31, 2018:
●
1,508 square feet in Ottawa, Province of Ontario, Canada, at a cost
of approximately $3,000 per month until the expiration of the lease
on March 31, 2021. This lease was renewed in April 2016 for a
five-year period ending on March 31, 2021. Renewal terms were
substantially unchanged from the existing lease;
●
9,720 square feet in Portland, Oregon, at a cost of approximately
$21,000 per month until the expiration of the lease on December 31,
2021. This lease was renewed in September 2017 resulting in an
additional 1,675 feet, an increase from approximately $18,000 to
approximately $21,000 per month and the extension of the term from
October 2018 to December 2021; and
●
304 square feet of office space in Mexico City, Mexico, at a cost
of approximately $3,000 per month until November 30,
2017.
At
March 31, 2018, future minimum lease payments are as
follows:
|
($ in thousands)
|
|
|
2018
(nine months)
|
$444
|
|
2019
|
283
|
|
2020
|
290
|
|
2021
|
271
|
|
2022
|
271
|
|
Thereafter
|
46
|
|
Total
|
$1,605
|
Rental
expense incurred under operating leases for the three months ended
March 31, 2018 and 2017 was approximately $171,000 and $125,000,
respectively.
NOTE 10. SUBSEQUENT EVENTS
During
April 2018, the Company issued 52,088 shares of its Common Stock
pursuant to the exercise of 52,088 options resulting in cash
proceeds to the Company of approximately $59,000.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking
statements within the meaning of Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities Exchange Act
of 1934, as amended. All forward-looking statements included in
this report are based on information available to us as of the date
hereof and we assume no obligation to update any forward-looking
statements. Forward-looking statements involve known or unknown
risks, uncertainties and other factors, which may cause our actual
results, performance or achievements, or industry results to be
materially different from any future results, performance or
achievements expressed or implied by such forward-looking
statements. Factors that could cause or contribute to such
differences include but are not limited to those items discussed
under “Risk Factors” in the Company’s Annual
Report on Form 10-K for the fiscal year ended December 31, 2017,
and in Item 1A of Part II of this Quarterly Report on Form
10-Q.
The following discussion of the financial condition and results of
operations should be read in conjunction with the condensed
consolidated financial statements included elsewhere within this
Quarterly Report. Fluctuations in annual and quarterly results may
occur as a result of factors affecting demand for our products such
as the timing of new product introductions by us and by our
competitors and our customers’ political and budgetary
constraints. Due to such fluctuations, historical results and
percentage relationships are not necessarily indicative of the
operating results for any future period.
Overview
The
Company is a pioneer and leader in the emerging market for
biometrically enabled software-based identity management solutions.
Using those human characteristics that are unique to us all, we
create software that provides a highly reliable indication of a
person’s identity. Our “flagship” product is our
patented IWS Biometric Engine®. Scalable for small city
business or worldwide deployment, our IWS Biometric Engine is a
multi-biometric software platform that is hardware and algorithm
independent, enabling the enrollment and management of unlimited
population sizes. It allows a user to utilize one or more
biometrics on a seamlessly integrated platform. Our products are
used to manage and issue secure credentials, including national
IDs, passports, driver licenses and access control credentials. Our
products also provide law enforcement with integrated mug shot,
LiveScan fingerprint and investigative capabilities. We also
provide comprehensive authentication security software using
biometrics to secure physical and logical access to facilities or
computer networks or Internet sites. Biometric technology is now an
integral part of all markets we address and all of our products are
integrated into the IWS Biometric Engine.
Recent Developments
On February 8, 2018, the Company filed with the Secretary of State
of the State of Delaware a Certificate of Amendment to its
Certificate of Incorporation, as amended, to increase the
authorized number of shares of its common stock, par value $0.01
per share (“Common
Stock”), to 175,000,000 from 150,000,000
shares.
Critical Accounting Policies and Estimates
The discussion and analysis of our consolidated
financial condition and results of operations are based on our
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States of America (“GAAP”). The preparation of these consolidated
financial statements in accordance with GAAP requires us to utilize
accounting policies and make certain estimates and assumptions that
affect the reported amounts of assets and liabilities, the
disclosure of contingencies as of the date of the consolidated
financial statements and the reported amounts of revenue and
expense during a fiscal period. The Securities and Exchange
Commission (“SEC”) considers an accounting policy to be
critical if it is important to a company’s financial
condition and results of operations, and if it requires significant
judgment and estimates on the part of management in its
application.
Significant
estimates include the evaluation of our ability to continue as a
going concern, the allowance for doubtful accounts receivable,
deferred tax asset valuation allowances, accounting for loss
contingencies, recoverability of goodwill and acquired intangible
assets and amortization periods, assumptions used in the
Black-Scholes model to calculate the fair value of share based
payments, assumptions used in the application of fair value
methodologies to calculate the fair value differential of the
Preferred Stock Exchange, assumptions used in the application of
revenue recognition policies and assumptions used in the
application of fair value methodologies to calculate the fair value
of pension assets and obligations.
Critical accounting policies are those that, in
management’s view, are most important in the portrayal of our
financial condition and results of operations. Other than the
adoption of ASC 606 “Revenue from Contracts with
Customers”, management
believes there have been no material changes during the three
months ended March 31, 2018 to the critical accounting policies
discussed in the Management’s Discussion and Analysis of
Financial Condition and Results of Operations section of our Annual
Report on Form 10-K for the year ended December 31, 2017. See Note
2 “Significant Accounting
Policies and Basis of Presentation” for a detailed discussion of this critical
accounting policy.
Results of Operations
This
management’s discussion and analysis of financial condition
and results of operations should be read in conjunction with the
condensed consolidated financial statements and related notes
contained elsewhere in this Quarterly Report.
Comparison of the Three Months Ended March 31, 2018 to the Three
Months Ended March 31, 2017
Product
Revenue
|
|
Three
Months Ended
March
31,
|
|
|
|
|
Net
Product Revenue
|
2018
|
2017
|
$
Change
|
%
Change
|
|
(dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Software and
royalties
|
$84
|
$189
|
$(105)
|
(56)%
|
|
Percentage of total
net product revenue
|
87%
|
69%
|
|
|
|
Hardware and
consumables
|
$1
|
$47
|
$(46)
|
(98)%
|
|
Percentage of total
net product revenue
|
1%
|
17%
|
|
|
|
Services
|
$12
|
$37
|
$(25)
|
(68)%
|
|
Percentage of total
net product revenue
|
12%
|
14%
|
|
|
|
Total net product
revenue
|
$97
|
$273
|
$(176)
|
(64)%
|
Software and
royalty revenue decreased 56% or approximately $105,000 during the
three months ended March 31, 2018 as compared to the corresponding
period in 2017. This decrease is attributable to lower
identification project related revenue of approximately $17,000,
lower sales of boxed identity management software sold through our
distribution channel of approximately $40,000, lower royalty
revenue of approximately $43,000 and lower law enforcement project
related revenue of approximately $5,000. The decrease in identification
project related revenue is reflective of the timing of our
completion of in-process projects. The decrease in boxed identity
management software sold through distribution channel reflects
lower procurement from two of our channel partners and the decrease
in royalty revenue results primarily from revenue recognition
timing differences due to the adoption of ASC 606 – Revenue
from Contracts with Customers effective January 1,
2018.
Revenue
from the sale of hardware and consumables decreased approximately
$46,000 during the three months ended March 31, 2018 as compared to
the corresponding period in 2017 due to a decrease in project
related solutions containing hardware and consumables and a
decrease in replacement hardware procurement by our
customers.
Services
revenue is comprised primarily of software integration services,
system installation services and customer training. Such revenue
decreased approximately $25,000 during the three months ended March
31, 2018 as compared to the corresponding period of 2017 due to a
decrease in the service element of project related work completed
during the three months ended March 31, 2018.
We
believe that the period-to-period fluctuations of identity
management software revenue in project-oriented solutions are
largely due to the timing of government procurement with respect to
the various programs we are pursuing. Although no assurances
can be given, based on management’s current visibility into
the timing of potential government procurements and potential
partnerships and current pilot programs, we believe that we will
see an increase in government procurement and implementations with
respect to identity management initiatives during 2018; however,
government procurement initiatives, implementations and pilots are
frequently delayed and extended, as was the case in the year ended
December 31, 2017, and we cannot predict the timing of such
initiatives.
During the three months ended March 31,
2018, we continued our efforts to move the Biometric Engine into
cloud and mobile markets, and expand our end-user market into
non-government sectors including commercial, consumer and
healthcare applications. Our approach to the markets we serve
is to partner with larger integrators as resellers who have both
the infrastructure and resources to sell into the worldwide market.
We rely upon these partners for guidance as to when they expect
revenue for our products to begin to ramp. In the first quarter we
saw several customers implement GoVerify ID®, our cloud based
mobile biometric authentication software as a service and
began to onboard identities on a small scale. We are being
told by our partners that we should expect to see additional
implementations throughout the year with growing numbers of
identities under management.
Maintenance Revenue
|
|
Three Months Ended
March 31,
|
|
|
|
|
Maintenance Revenue
|
2018
|
2017
|
$ Change
|
% Change
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Total
maintenance revenue
|
$619
|
$655
|
$(36)
|
(5)%
|
Maintenance
revenue was approximately $619,000 for the three months ended March
31, 2018, as compared to approximately $655,000 for the
corresponding period in 2017. Identity management maintenance
revenue generated from identification software solutions was
approximately $295,000 for the three months ended March 31, 2018 as
compared to approximately $304,000 during the comparable period in
2017. Law enforcement maintenance revenue was approximately
$324,000 and $351,000 for the three months ended March 31, 2018 and
2017, respectively. The decrease of $9,000 in identification
software maintenance revenue for the three months ended March 31,
2018 as compared to the corresponding period of 2017 and the
decrease of $27,000 in law enforcement maintenance revenue reflects
the expiration of certain maintenance contracts.
We
anticipate growth of our maintenance revenue through the retention
of existing customers combined with the expansion of our installed
base resulting from the completion of project-oriented work;
however, we cannot predict the timing of this anticipated
growth.
Cost of Product Revenue
|
|
Three Months Ended
March 31,
|
|
|
|
|
Cost of Product Revenue:
|
2018
|
2017
|
$ Change
|
% Change
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Software
and royalties
|
$5
|
$11
|
$(6)
|
(55)%
|
|
Percentage
of software and royalty product revenue
|
6%
|
6%
|
|
|
|
Hardware
and consumables
|
$6
|
$37
|
$(31)
|
(84)%
|
|
Percentage
of hardware and consumables product revenue
|
600%
|
79%
|
|
|
|
Services
|
$15
|
$6
|
$9
|
150%
|
|
Percentage
of services product revenue
|
125%
|
16%
|
|
|
|
Total
product cost of revenue
|
$26
|
$54
|
$(28)
|
(52)%
|
|
Percentage
of total product revenue
|
27%
|
20%
|
|
|
The
cost of hardware and consumable product revenue decreased
approximately $31,000 for the three months ended March 31, 2018 as
compared to the corresponding period in 2017 due primarily to lower
hardware and consumable product revenue of approximately $46,000
during the 2018 period.
The
cost of services revenue increased approximately $9,000 during the
three months ended March 31, 2018 as compared to the corresponding
period in 2017 despite lower service revenue of approximately
$25,000. This increase reflects the write-off of approximately
$15,000 in non-recoverable project costs incurred due to
implementation difficulties combined with the composition of labor
resources utilized in the completion of the service element. In
addition to changes in costs of services product revenue caused by
revenue level fluctuations, costs of services can vary as a
percentage of service revenue from period to period depending upon
both the level and complexity of professional service resources
utilized in the completion of the service element.
Cost of Maintenance Revenue
|
|
Three Months Ended
March 31,
|
|
|
|
|
Maintenance cost of revenue
|
2018
|
2017
|
$ Change
|
% Change
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Total
maintenance cost of revenue
|
$222
|
$208
|
$14
|
7%
|
|
Percentage
of total maintenance revenue
|
36%
|
32%
|
|
|
Cost
of maintenance revenue increased approximately $14,000 during the
three months ended March 31, 2018 as compared to the corresponding
period in 2017. This increase is reflective of higher replacement
hardware costs incurred during the three months ended March 31,
2018 as compared to the corresponding period in 2017 combined with
lower higher maintenance labor costs incurred during the same
period due primarily to the composition of engineering resources
used in the provision of maintenance services.
Product
Gross Profit
|
|
Three
Months Ended
March
31,
|
|
|
|
|
Product
gross profit
|
2018
|
2017
|
$
Change
|
%
Change
|
|
(dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Software and
royalties
|
$79
|
$178
|
$(99)
|
(56)%
|
|
Percentage of
software and royalty product revenue
|
94%
|
94%
|
|
|
|
Hardware and
consumables
|
$(5)
|
$10
|
$(15)
|
(150)%
|
|
Percentage of
hardware and consumables product revenue
|
(500)%
|
21%
|
|
|
|
Services
|
$(3)
|
$31
|
$(34)
|
(110)%
|
|
Percentage of
services product revenue
|
(25)%
|
84%
|
|
|
|
Total product gross
profit
|
$71
|
$219
|
$(148)
|
(68)%
|
|
Percentage of total
product revenue
|
73%
|
80%
|
|
|
Software
and royalty gross profit decreased 56% or approximately $99,000 for
the three months ended March 31, 2018 from the corresponding period
in 2017 due primarily to lower software and royalty revenue of
approximately $105,000 combined with lower software and royalty
cost of revenue of $6,000 for the same period. In addition to
changes in costs of software and royalty product revenue caused by
revenue level fluctuations, costs of products can vary as a
percentage of product revenue from period to period depending upon
level of software customization and third -party software license
content included in product sales during a given
period.
Services
gross profit decreased approximately $34,000 for the three months
ended March 31, 2018 as compared to the corresponding period in
2017 due to lower service revenue of approximately $25,000 for the
three months ended March 31, 2018 as compared to the corresponding
period in 2017, combined with higher costs of service revenue of
approximately $9,000 for the three months ended March 31, 2018 as
compared to the corresponding period in 2017. These higher costs
reflect the write-off of approximately $15,000 in non-recoverable
project costs incurred due to implementation
difficulties.
Maintenance Gross Profit
|
|
Three
Months Ended
March
31,
|
|
|
|
|
Maintenance gross profit
|
2018
|
2017
|
$ Change
|
% Change
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Total
maintenance gross profit
|
$397
|
$447
|
$(50)
|
(11)%
|
|
Percentage
of total maintenance revenue
|
70%
|
68%
|
|
|
Gross
profit related to maintenance revenue decreased 11% or
approximately $50,000 for the three months ended March 31, 2018 as
compared to the corresponding period in 2017. This decrease
reflects lower maintenance revenue of approximately $36,000 due to
the cancellation of certain contracts combined with higher cost of
maintenance revenue of approximately $14,000 due to the incurrence
of certain hardware replacement costs combined with higher
maintenance labor costs incurred during the same period due to the
composition of engineering resources used in the provision of
maintenance services.
Operating
Expense
|
|
Three
Months Ended
March
31,
|
|
|
|
|
Operating expense
|
2018
|
2017
|
$ Change
|
% Change
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative
|
$1,206
|
$967
|
$239
|
25%
|
|
Percentage
of total net revenue
|
168%
|
104%
|
|
|
|
Sales
and marketing
|
$861
|
$761
|
$100
|
13%
|
|
Percentage
of total net revenue
|
120%
|
82%
|
|
|
|
Research and
development
|
$1,799
|
$1,541
|
$258
|
17%
|
|
Percentage
of total net revenue
|
251%
|
166%
|
|
|
|
Depreciation
and amortization
|
$12
|
$21
|
$(9)
|
(43)%
|
|
Percentage
of total net revenue
|
2%
|
2%
|
|
|
General and Administrative Expense
General
and administrative expense is comprised primarily of salaries and
other employee-related costs for executive, financial, and other
infrastructure personnel. General legal, accounting and consulting
services, insurance, occupancy and communication costs are also
included with general and administrative expense. The dollar
increase of approximately $239,000 during the three months ended
March 31, 2018 as compared to the corresponding period in 2017 is
comprised of the following major components:
|
●
|
Increase
in personnel related expense of approximately $2,000;
|
|
●
|
Increases in professional services of approximately $180,000 which
includes higher Board of Director fees of approximately $27,000 due
to two additional members, higher patent-related fees of
approximately $11,000, higher auditing fees of approximately
$123,000, higher contractor fees of approximately $20,000, and
higher general corporate expenses of approximately $10,000 offset
by lower legal fees of approximately $6,000 and lower investor
relations fees of approximately $5,000;
|
|
●
|
Increase in travel, insurances, licenses, dues, rent, and office
related costs of approximately $32,000; and
|
|
●
|
Increase in stock-based compensation expense of approximately
$25,000.
|
We
continue to focus our efforts on achieving additional future
operating efficiencies by reviewing and improving upon existing
business processes and evaluating our cost structure. We believe
these efforts will allow us to continue to gradually decrease our
level of general and administrative expense expressed as a
percentage of total revenue.
Sales and Marketing
Sales
and marketing expense consists primarily of the salaries,
commissions, other incentive compensation, employee benefits and
travel expense of our sales, marketing, and business development
functions. The dollar increase of approximately $100,000 during the
three months ended March 31, 2018 as compared to the corresponding
period in 2017 is primarily comprised of the following major
components:
|
●
|
Increase in personnel related expense of approximately $122,000
driven primarily by headcount increases;
|
|
●
|
Decrease in contractor and contract services of approximately
$17,000 resulting from decreased utilization of certain sales
consultants of approximately $28,000 offset by increased marketing
dues and subscription expense and contract services of
approximately $11,000;
|
|
●
|
Increase in travel, trade show expense and office related expense
of approximately $14,000;
|
|
●
|
Decrease
in advertising expense of approximately $33,000;
|
|
●
|
Increase
in stock-based compensation expense of approximately $5,000;
and
|
|
●
|
Increase in our Mexico sales office expense and other of
approximately $9,000.
|
Research and Development
Research
and development expense consists primarily of salaries, employee
benefits and outside contractors for new product development,
product enhancements, custom integration work and related facility
costs. Such expense increased approximately $258,000 for the three
months ended March 31, 2018 as compared to the corresponding period
in 2017 due primarily to the following major
components:
|
●
|
Increase in personnel related expense of approximately $33,000 due
to headcount increases;
|
|
●
|
Increase in contractor fees and contract services of approximately
$165,000 for services related to the accelerated development of
mobile identity management applications;
|
|
●
|
Increase
in stock based-compensation expense of approximately $4,000;
and
|
|
●
|
Increase in office related expense and engineering tools and
supplies of approximately $56,000.
|
Our
level of expenditures in research and development reflects our
belief that to maintain our competitive position in markets
characterized by rapid rates of technological advancement, we must
continue to invest significant resources in new systems and
software development as well as continue to enhance existing
products.
Depreciation and Amortization
During
the three months ended March 31, 2018 and 2017, depreciation and
amortization expense was approximately $12,000 and $21,000,
respectively. The relatively small amount of depreciation and
amortization reflects the relatively small property and equipment
carrying value. The decrease is reflective of the full depreciation
of certain fixed assets.
Interest Expense, Net
For
the three months ended March 31, 2018, we recognized interest
expense of approximately $189,000 and interest income of
approximately $16,000. For the three months ended March 31, 2017,
we recognized interest expense of approximately $101,000 and
interest income of approximately $1,000. Interest expense for the
three months ended March 31, 2018 is comprised of approximately
$2,000 of amortization expense of deferred financing fees related
to the Goldman LOC, interest expense of approximately $130,000 of
coupon interest on debt outstanding under the Lines of Credit, and
approximately $57,000 related to the amortization of beneficial
conversion feature related to the Lines of Credit.
LIQUIDITY AND CAPITAL RESOURCES AND GOING CONCERN
Historically, our principal sources of cash have
included customer payments from the sale of our products, proceeds
from the issuance of common and preferred stock and proceeds from
the issuance of debt, including our Lines of Credit. Our principal
uses of cash have included cash used in operations, payments
relating to purchases of property and equipment and repayments of
borrowings. We expect that our principal uses of cash in the future
will be for product development including customization of identity
management products for enterprise and consumer applications,
further development of intellectual property, development of
Software-as-a-Service (“SaaS”) capabilities for existing products as
well as general working capital and capital expenditure
requirements. We expect that, as our revenue grows, our sales and
marketing and research and development expense will continue to
grow, albeit at a slower rate and, as a result, we will need to
generate significant net revenue to achieve and sustain income from
operations.
Series A Financing
On
September 18, 2017, the Company consummated the Series A Financing
and Preferred Stock Exchange. As a result of the Series A
Financing, the Company generated net proceeds to the Company of
approximately $10.9 million. As a result of the Preferred Stock
Exchange, the holders of all outstanding Exchanged Preferred,
agreed to cancel their Exchanged Preferred in exchange for the same
number of shares of Series A Preferred, resulting in the issuance
to the holders of Exchanged Preferred of an aggregate total of
20,021 shares of Series A Preferred.
Lines
of Credit
On March 9, 2016, the
Company and Goldman entered into the fourth amendment (the
“Fourth
Amendment”) to the
convertible promissory note and line of credit previously issued by
the Company to Goldman on March 27, 2013 (the
“Goldman
LOC”). The Fourth
Amendment (i) provides the Company with the ability to borrow up to
$5.0 million under the terms of the Goldman LOC; (ii) permits
Goldman to convert the outstanding principal, plus any accrued but
unpaid interest due under the Goldman LOC (the
“Outstanding
Balance”), into shares
of the Company’s Common Stock for $1.25 per share; and (iii)
extends the maturity date of the Goldman LOC to June 30,
2017.
In addition, on March
9, 2016, the Company and Charles Crocker, also a director of the
Company (“Crocker”),
entered into a new line of credit and promissory note (the
“New
Crocker LOC”), in the
principal amount of $500,000. The New Crocker LOC accrues interest
at a rate of 8% per annum and matures on the earlier to occur of
June 30, 2017 or such date that the Company consummates a debt
and/or equity financing resulting in net proceeds to the Company of
at least $3.5 million. All outstanding amounts due under the terms
of the New Crocker LOC are convertible into shares of the
Company’s Common Stock at $1.25 per
share.
On December 27, 2016, in connection with the
consummation of the Series G Financing, the Company and Goldman
agreed to enter into the Fifth
Amendment (the “Line
of Credit Amendment”) to the Goldman
Line of Credit to provide the Company with the ability to borrow up
to $5.5 million under the terms of the Goldman Line of Credit. In
addition, the Maturity Date, as defined in the Goldman Line of
Credit, was amended to be December 31, 2017. The Line of Credit
Amendment was executed on January 23, 2017.
In addition, on January 23, 2017, the Company and Crocker amended
the New Crocker LOC to extend the maturity date thereof to December
31, 2017.
On
May 10, 2017, Goldman and Crocker agreed to further extend the
maturity dates of the Lines of Credit to December 31,
2018.
As
of March 31, 2018, we have aggregate borrowings outstanding under
our Lines of Credit of $6,000,000 and related accrued unpaid
interest of approximately $657,000. These amounts are due on
December 31, 2018.
Going Concern
At
March 31, 2018, we had a working capital deficit of approximately
$3,452,000. Our principal sources of liquidity at March 31, 2018
consisted of cash of $4,558,000 and $284,000 of trade accounts
receivable.
Considering
our projected cash requirements, and assuming we are unable to
generate incremental revenue, our available cash may be
insufficient to satisfy our cash requirements for the next twelve
months from the date of this filing. These factors raise
substantial doubt about our ability to continue as a going concern.
To address our working capital requirements, management may seek
additional equity and/or debt financing through the issuance of
additional debt and/or equity securities, or may seek strategic or
other transactions intended to increase shareholder value. There
are currently no formal committed financing arrangements to support
our projected cash shortfall, including commitments to purchase
additional debt and/or equity securities, or other agreements, and
no assurances can be given that we will be successful in raising
additional debt and/or equity securities, or entering into any
other transaction that addresses our ability to continue as a going
concern.
In
view of the matters described in the preceding paragraph,
recoverability of a major portion of the recorded asset amounts
shown in the accompanying consolidated balance sheet is dependent
upon continued operations of the Company, which, in turn, is
dependent upon the Company’s ability to continue to raise
capital and generate positive cash flows from operations. However,
the Company operates in markets that are emerging and highly
competitive. There is no assurance that the Company will be able to
obtain additional capital, operate at a profit or generate positive
cash flows in the future.
These
condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of
recorded asset amounts and classifications of liabilities that
might be necessary should the Company be unable to continue as a
going concern.
Operating Activities
We used net cash of $2,814,000 in operating
activities for the three months ended March 31, 2018 as compared to
net cash used of $2,600,000
during the comparable period in 2017.
During the three months ended March 31, 2018, net cash used in
operating activities consisted of net loss of $3,583,000 and an
increase in working capital and other assets and liabilities of
$363,000. Those amounts were in addition to $406,000 of non-cash
costs including $335,000 in stock-based compensation, $59,000 in
debt issuance cost amortization and beneficial conversion feature
amortization and $12,000 in depreciation and amortization. During
the three months ended March 31, 2018, we generated cash of
$203,000 from reductions in current assets and generated cash of
$160,000 through increases in current liabilities and deferred
revenue, excluding debt.
Investing Activities
Net
cash used in investing activities was $7,000 for the three months
ended March 31, 2018 and $1,000 for the three months ended March
31, 2017. For the three months ended March 31, 2018, we used cash
of $7,000 to fund capital expenditures of leasehold improvements.
For the three months ended March 31, 2017, we used cash to fund
capital expenditures of computer equipment, software and furniture
and fixtures of approximately $1,000.
Financing Activities
During
the three months ended March 31, 2018, we generated cash of
approximately $88,000 from the exercise of 83,169 options resulting
in the issuance of 83,169 shares of Common Stock. For the
three months ended March 31, 2017, we generated cash of $1,500,000
from borrowings under our Lines of Credit and generated
approximately $7,000 from the exercise of 17,000 option resulting
in the issuance of 17,000 shares of Common Stock.
Debt
At March 31, 2018, the Company had $6,000,000 in
outstanding debt under the terms of the Lines of Credit, and
$657,000 in accrued but unpaid interest, as compared to $6,000,000
in outstanding debt and $527,000 in related accrued but unpaid
interest at December 31, 2017.
Contractual Obligations
Total
contractual obligations and commercial commitments as of March 31,
2018 are summarized in the following table (in
thousands):
|
|
Payment Due by Year
|
||||
|
|
Total
|
Less than
1 Year
|
1-3 Years
|
3-5 Years
|
More than
5 Years
|
|
Operating
lease obligations
|
$1,605
|
444
|
844
|
317
|
—
|
|
Lines
of credit payable to related parties
|
$6,657
|
6,657
|
—
|
—
|
—
|
|
Total
|
$8,262
|
7,101
|
844
|
317
|
—
|
Real Property Leases
The
Company’s corporate headquarters are located in San Diego,
California where we occupy 9,927 square feet of office space. This
facility’s lease was renewed in September 2017 through
October 2018 at a cost of approximately $30,000 per month. In
addition to our corporate headquarters, we also occupied the
following spaces at March 31, 2018:
|
●
|
1,508 square feet in Ottawa, Province of Ontario, Canada, at a cost
of approximately $3,000 per month until the expiration of the lease
on March 31, 2021. This lease was renewed in April 2016 for a
five-year period ending on March 31, 2021. Renewal terms were
substantially unchanged from the existing lease;
|
|
●
|
9,720 square feet in Portland, Oregon, at a cost of approximately
$21,000 per month until the expiration of the lease on December 31,
2021. This lease was renewed in September 2017 resulting in an
additional 1,675 feet, increase from approximately $18,000 to
approximately $21,000 per month and the extension of the term from
October 2018 to December 2021; and
|
|
●
|
425 square feet of office space in Mexico City, Mexico, at a cost
of approximately $3,000 per month, on a month-to-month basis until
terminated by either party.
|
At
March 31, 2018, future minimum lease payments are as
follows:
|
($ in thousands)
|
|
|
2018
(nine months)
|
$444
|
|
2019
|
$283
|
|
2020
|
$290
|
|
2021
|
$271
|
|
2022
|
$271
|
|
Thereafter
|
$46
|
|
Total
|
$1,605
|
Inflation
We
do not believe that inflation has had a material impact on our
historical operations or profitability.
Off-Balance Sheet Arrangements
At
March 31, 2018, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities
often referred to as structured finance, special purpose or
variable interest entities, which would have been established for
the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. In addition, we did not
engage in trading activities involving non-exchange traded
contracts. As a result, we are not exposed to any financing,
liquidity, market or credit risk that could arise if we had engaged
in such relationships. We do not have relationships and
transactions with persons or entities that derive benefits from
their non-independent relationship with us or our related parties
except as disclosed elsewhere in this Quarterly
Report.
Recently Issued Accounting Standards
Please
refer to the section “Recently Issued Accounting
Standards” in Note 2 of our Notes to the Condensed
Consolidated Financial Statements.
Each of our contracts requires payment in U.S.
dollars. We therefore do not engage in hedging transactions to
reduce our exposure to changes in currency exchange rates, although
in the event any future contracts are denominated in a foreign
currency, we may do so in the future. As a result, our
financial results are not affected by factors such as changes in
foreign currency exchange rates.
ITEM 4. CONTROLS AND
PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under
the supervision and with the participation of our management,
including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of the
design and operations of our disclosure controls and procedures, as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as of March 31, 2018. Based on this
evaluation, the Company’s Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and
procedures are effective to ensure that information required to be
disclosed in the reports submitted under the Securities and
Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms,
including to ensure that information required to be disclosed by
the Company is accumulated and communicated to management,
including the principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding
required disclosure.
Changes in Internal Controls Over Financial Reporting
The
Company’s Chief Executive Officer and Chief Financial Officer
have determined that there have been no changes, in the
Company’s internal control over financial reporting during
the period covered by this report identified in connection with the
evaluation described in the above paragraph that have materially
affected, or are reasonably likely to materially affect, the
Company’s internal control over financial
reporting.
PART II
None.
ITEM 1A. RISK
FACTORS
Our
results of operations and financial condition are subject to
numerous risks and uncertainties described in our Annual Report on
Form 10-K for our fiscal year ended December 31, 2017, filed on
March 19, 2018. You should carefully consider these risk factors in
conjunction with the other information contained in this Quarterly
Report. Should any of these risks materialize, our business,
financial condition and future prospects could be negatively
impacted. As of May 10, 2018, there have been no material changes
to the disclosures made in the above referenced Form
10-K.
ITEM 2. UNREGISTERED SALES OF
EQUITY SECURITIES AND USE OF PROCEEDS
None.
None.
ITEM 4. MINE SAFETY
DISCLOSURES
Not
applicable.
ITEM 5. OTHER
INFORMATION
None.
ITEM 6. EXHIBITS
|
(a)
|
|
EXHIBITS
|
|
|
|
|
|
|
Certification of the Principal Executive Officer pursuant to Rule
13a-14(a) and 15d-14(a)
|
|
|
|
Certification of the Principal Financial and Accounting Officer
pursuant to Rule 13a-14(a) and 15d-14(a)
|
|
|
|
Certification by the Principal Executive Officer and Principal
Financial and Accounting Officer pursuant to 18 U.S.C. 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
|
|
101.CAL
|
|
XBRL Taxonomy Extension Calculation Linkbase
|
|
101.DEF
|
|
XBRL Taxonomy Extension Definition Linkbase
|
|
101.LAB
|
|
XBRL Taxonomy Extension Label Linkbase
|
|
101.PRE
|
|
XBRL Taxonomy Extension Presentation Linkbase
|
SIGNATURES
In
accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
|
Date: May 10, 2018
|
|
IMAGEWARE SYTEMS, INC
|
|
|
|
|
|
|
|
By: /s/ S. James
Miller
|
|
|
|
S. James Miller
Chief Executive Officer, Chairman
and Director
(Principal Executive
Officer)
|
|
|
|
|
|
Date: May 10, 2018
|
|
By: /s/ Wayne
Wetherell
|
|
|
|
Wayne Wetherell
Chief Financial Officer
(Principal Financial and Accounting
Officer)
|
-31-