IMAGEWARE SYSTEMS INC - Quarter Report: 2019 March (Form 10-Q)

  

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

 

For the quarterly period ended March 31, 2019

 

[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

 

For the transition period from _________ to _________

 

Commission file number 001-15757

 

IMAGEWARE SYSTEMS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware		33-0224167
(State or Other Jurisdiction of		(IRS Employer
Incorporation or Organization)		Identification No.)

 

13500 Evening Creek Drive N., Suite 550

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 every Interactive Data File required to be submitted 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 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:

 

Large accelerated filer	[   ]	Accelerated filer	[X]
Non-accelerated filer	[   ]	Smaller reporting company	[X]
		Emerging growth company	[   ]

 

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

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	IWSY	OTCQB Marketplace

 

The number of shares of common stock, par value $0.01 per share, outstanding on May 8, 2019 was 105,219,259.

 

 

 

 

IMAGEWARE SYSTEMS, INC.

 

INDEX

 

			Page
PART I.  FINANCIAL INFORMATION
	ITEM 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of March 31, 2019 (unaudited) and December 31, 2018	1
		Condensed Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018 (unaudited)	2
		Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2019 and 2018 (unaudited)	3
		Condensed Consolidated Statements of Shareholders Equity (Deficit) for the three months ended March 31, 2019 and 2018 (unaudited)	4
		Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018 (unaudited)	6
		Notes to unaudited Condensed Consolidated Financial Statements	7
	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	30
	ITEM 4.	Controls and Procedures	30
PART II. OTHER INFORMATION
	ITEM 1.	Legal Proceedings	31
	ITEM1A.	Risk Factors	31
	ITEM 2.	Unregistered Sales of Equity Securities	31
	ITEM 3.	Defaults Upon Senior Securities	31
	ITEM 4.	Mine Safety Disclosures	31
	ITEM 5.	Other Information	31
	ITEM 6.	Exhibits	31
SIGNATURES			32

 

 

 

 

PART I

ITEM 1.  FINANCIAL STATEMENTS

 

IMAGEWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, except for share and per share data)

 

	March 31, 2019	December 31, 2018
	(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents	$2,925	$5,694
Accounts receivable, net of allowance for doubtful accounts of $0 at March 31, 2019 and December 31, 2018.	1,119	968
Inventory, net	105	29
Other current assets	209	233
Total Current Assets	4,358	6,924
Property and equipment, net	236	244
Other assets	284	332
Operating lease right-of-use assets	2,157	—
Intangible assets, net of accumulated amortization	79	82
Goodwill	3,416	3,416
Total Assets	$10,530	$10,998
LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current Liabilities:
Accounts payable	$449	$678
Deferred revenue	1,490	1,215
Accrued expense	1,074	888
Operating lease liabilities, current portion	185	—
Derivative liabilities	1,489	1,065
Total Current Liabilities	4,687	3,846
Other long-term liabilities	118	147
Lease liabilities, net of current portion	2,032	—
Pension obligation	1,889	1,876
Total Liabilities	8,726	5,869
Mezzanine Equity:
Series C Convertible Redeemable Preferred Stock, $0.01 par value, designated 1,000 shares, 1,000 shares issued and outstanding at March 31, 2019 and December 31, 2018; liquidation preference $10,000 at March 31, 2019 and December 31, 2018.	8,342	8,156
Shareholders’ Equity (Deficit):
Preferred stock, authorized 4,000,000 shares:
Series A Convertible Redeemable Preferred Stock, $0.01 par value; designated 38,000 shares, 37,467 shares issued and outstanding at March 31, 2019 (unaudited) and December 31, 2018, respectively; liquidation preference $37,467 at March 31, 2019 (unaudited) and December 31, 2018, respectively.	—	—
Series B Convertible Redeemable Preferred Stock, $0.01 par value; designated 750,000 shares, 389,400 shares issued and 239,400 outstanding at March 31, 2019 (unaudited) and December 31, 2018, respectively; liquidation preference $620 and $607 at March 31, 2019 (unaudited) and December 31, 2018, respectively.	2	2
Common Stock, $0.01 par value, 175,000,000 shares authorized; 99,266,918 and 98,230,336 shares issued at March 31, 2019 (unaudited) and December 31, 2018, respectively, and 99,260,214 and 98,223,632 shares outstanding at March 31, 2019  (unaudited) and December 31, 2018, respectively.	992	981
Additional paid-in capital	185,300	184,130
Treasury stock, at cost 6,704 shares	(64)	(64)
Accumulated other comprehensive loss	(1,413)	(1,428)
Accumulated deficit	(191,355)	(186,648)
Total Shareholders’ Deficit	(6,538)	(3,027)
Total Liabilities, Mezzanine Equity and Shareholders’ Deficit	$10,530	$10,998

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

IMAGEWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, except share and per share amounts)

(Unaudited)

 

	Three Months Ended  March 31,
	2019	2018
Revenue:
Product	$278	$97
Maintenance	653	619
	931	716
Cost of revenue:
Product	84	26
Maintenance	120	222
Gross profit	727	468
Operating expense:
General and administrative	1,107	1,175
Sales and marketing	1,005	861
Research and development	1,774	1,799
Depreciation and amortization	19	12
	3,905	3,847
Loss from operations	(3,178)	(3,379)
Interest expense (income), net	(22)	173
Change in fair value of derivative liabilities	424	—
Other components of net periodic pension expense	32	31
Loss before income taxes	(3,612)	(3,583)
Income tax expense	—	—
Net loss	(3,612)	(3,583)
Preferred dividends and preferred stock discount accretion	(1,294)	(769)
Net loss available to common shareholders	$(4,906)	$(4,352)
Basic and diluted loss per common share - see Note 3:
Net loss	$(0.04)	$(0.04)
Preferred dividends and preferred stock discount accretion	(0.01)	(0.01)
Basic and diluted loss per share available to common shareholders	$(0.05)	$(0.05)
Basic and diluted weighted-average shares outstanding	98,398,239	94,333,663

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

  

 

 

 IMAGEWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In Thousands)

(Unaudited)

  

	Three Months Ended  March 31,
	2019	2018
Net loss	$(3,612)	$(3,583)
Other comprehensive income (loss):
Foreign currency translation adjustment	15	(27)
Comprehensive loss	$(3,597)	$(3,610)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

IMAGEWARE SYSTEMS, INC.  

	Series A Convertible,		Series B Convertible,							Accumulated
	Redeemable		Redeemable						Additional	Other
	Preferred		Preferred		Common Stock		Treasury Stock		Paid-In	Comprehensive	Accumulated
	Shares	Amount	Shares	Amount	Shares	Amount	Shares	Amount	Capital	Loss	Deficit	Total
Balance at December 31, 2018	37,467	$-	239,400	$2	98,230,336	$981	(6,704)	$(64)	$184,130	$(1,428)	$(186,648)	$(3,027)
Accretion of Series A Preferred Stock discount	-	-	-	-	-	-	-	-	(186)	-	-	(186)
Issuance of Common Stock pursuant to option exercises	-	-	-	-	286,834	3	-	-	103	-	-	106
Stock-based compensation expense	-	-	-	-	-	-	-	-	166	-	-	166
Foreign currency translation adjustment	-	-	-	-	-	-	-	-	0	15	-	15
Dividends on preferred stock	-	-	-	-	749,748	8	-	-	1,087	-	(1,095)	-
Net loss	-	-	-	-	-	-	-	-	-	-	(3,612)	(3,612)
Balance at March 31, 2019	37,467	$-	239,400	$2	99,266,918	$992	(6,704)	$(64)	$185,300	$(1,413)	$(191,355)	$(6,538)

 

 

	Series A Convertible,		Series B Convertible,							Accumulated
	Redeemable		Redeemable						Additional	Other
	Preferred		Preferred		Common Stock		Treasury Stock		Paid-In	Comprehensive	Accumulated
	Shares	Amount	Shares	Amount	Shares	Amount	Shares	Amount	Capital	Loss	Deficit	Total
Balance at December 31, 2017	31,021	$-	239,400	$2	94,174,540	$941	(6,704)	$(64)	$172,414	$(1,664)	$(170,481)	$1,148
Issuance of common stock pursuant to Series A Preferred Stock conversions	(450)	-	-	-	391,304	4	-	-	(4)	-	-	-
Cumulative effect of ASC 606 adoption	-	-	-	-	-	-	-	-	-	-	96	96
Issuance of Common Stock pursuant to option exercises	-	-	-	-	83,169	1	-	-	87	-	-	88
Recognition of beneficial conversion feature on convertible related party lines of credit	-	-	-	-	-	-	-	-	12	-	-	12
Stock-based compensation expense	-	-	-	-	-	-	-	-	335	-	-	335
Foreign currency translation adjustment	-	-	-	-	-	-	-	-	-	(27)	-	(27)
Dividends on preferred stock	-	-	-	-	472,562	4	-	-	750	-	(754)	-
Net loss	-	-	-	-	-	-	-	-	-	-	(3,583)	(3,583)
Balance at March 31, 2018	30,571	$-	239,400	$2	95,121,575	$950	(6,704)	$(64)	$173,594	$(1,691)	$(174,722)	$(1,931)

 

 

 

 

 

 

  IMAGEWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

	Three Months Ended  March 31,
	2019	2018
Cash flows from operating activities
Net loss	$(3,612)	$(3,583)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization	19	12
Amortization of debt issuance costs and beneficial conversion feature	—	59
Stock-based compensation	166	335
Change in fair value of derivative liabilities	424	—
Change in assets and liabilities:
Accounts receivable	(151)	269
Inventory	(75)	(10)
Other assets	71	(56)
Operating lease right-of-use assets	46	—
Accounts payable	(230)	(22)
Deferred revenue	275	(138)
Accrued expense	201	285
Contract costs	(29)	—
Pension obligation	13	35
Total adjustments	730	769
Net cash used in operating activities	(2,882)	(2,814)
Cash flows from investing activities
Purchase of property and equipment	(8)	(7)
Net cash used in investing activities	(8)	(7)
Cash flows from financing activities
Proceeds from exercised stock options	106	88
Net cash provided by financing activities	106	88
Effect of exchange rate changes on cash and cash equivalents	15	(26)
Net decrease in cash and cash equivalents	(2,769)	(2,759)
Cash and cash equivalents at beginning of period	5,694	7,317
Cash and cash equivalents at end of period	$2,925	$4,558
Supplemental disclosure of cash flow information:
Cash paid for interest	$—	$—
Cash paid for income taxes	$—	$—
Summary of non-cash investing and financing activities:
Beneficial conversion feature on convertible related party lines of credit	$—	$12
Stock dividends on Series A Convertible Preferred Stock	$864	$754
Stock dividends on Series C Convertible Redeemable Preferred Stock	$231	$—
Accretion of discount on Series C Convertible Redeemable Preferred Stock	$186	$—
Recognition of operating lease right-of-use assets from adoption of ASC 842	$2,265	$—
Recognition of lease liabilities from adoption of ASC 842	$(2,280)	$—
Conversion of Convertible Preferred Stock into Common Stock	$—	$4

 

  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

In May 2019, the Company completed a registered direct offering of 5,954,545 shares of its Common Stock at a price of $1.10 per share, resulting in gross proceeds to the Company of approximately $6.55 million. Net proceeds to the Company were approximately $6.125 million after payment of offering expenses. The Company intends to use the net proceeds received from the sale of the common stock for general corporate purposes.

 

The shares of common stock described above were offered by the Company pursuant to a shelf registration statement previously filed with the Securities and Exchange Commission (“SEC”) on June 28, 2018 and declared effective on July 10, 2018.

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. Our principal uses of cash have included cash used in operations, product development, and 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, 2019, we had negative working capital of approximately $329,000. Our principal sources of liquidity at March 31, 2019 consisted of approximately $2,925,000 of cash and cash equivalents.

 

Considering the common stock financing completed in May 2019, as well as 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, 2018, 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 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, 2018, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 that was filed with the SEC on March 28, 2019.

 

Operating results for the three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for the year ended December 31, 2019, or any other future periods.

 

Certain prior period amounts have been reclassified to conform with current period presentation. Pursuant to the Company’s adoption of Accounting Standards Update 2017-07 - Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”), the Company is presenting certain elements of periodic pension expense as a separate line item “Other components of net periodic pension expense” outside the loss from operations, in the Company’s condensed Consolidated Statements of Operations. 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, deferred tax asset valuation allowances, recoverability of goodwill, assumptions used in the Black-Scholes model to calculate the fair value of share based payments, fair value of financial instruments issued with and affected by the Series C Preferred Financing, assumptions used in the application of revenue recognition policies, assumptions used in the derivation of the Company’s incremental borrowing rate used in the computation of the Company’s operating lease liabilities 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.

 

Property, Equipment and Leasehold Improvements

 

Property and equipment, consisting of furniture and equipment, are stated at cost and are being depreciated on a straight-line basis over the estimated useful lives of the assets, which generally range from three to five years. Maintenance and repairs are charged to expense as incurred. Major renewals or improvements are capitalized. When assets are sold or abandoned, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized. Expenditures for leasehold improvements are capitalized. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements.

 

Fair Value of Financial Instruments

 

For certain of the Company’s financial instruments, including accounts receivable, accounts payable, accrued expense, and deferred revenue, the carrying amounts approximate fair value due to their relatively short maturities. 

 

Lease Liabilities and Operating Lease Right-of-Use Assets

 

The Company is a party to certain contractual arrangements for office space which meet the definition of leases under Accounting Standards Codification (“ASC”) Topic 842 – Leases (“ASC 842”). In accordance with ASC 842, the Company has determined that such arrangements are operating leases and accordingly the Company has, as of January 1, 2019, recorded operating lease right-of-use assets and related lease liability for the present value of the lease payments over the lease terms using the Company’s estimated weighted-average incremental borrowing rate of approximately 14.5%. The Company has utilized the practical expedient regarding lease and nonlease components and has combined such items into a single combined component. The Company has also utilized the practical expedient regarding leases of twelve months or less and has excluded such leases from its computation of lease liability and related right-of-use assets. The Company has also elected the optional transition package of practical expedients which include:

 

 A package of practical expedient to not reassess:

 

 

Revenue Recognition

 

Effective January 1, 2018, we adopted ASC 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:

 

 

 

 

 

 

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

 

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 revenue 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 $96,000. The following table sets forth our disaggregated revenue for the three months ended March 31, 2019 and 2018:

 

 

	Three Months Ended March 31,
Net Revenue	2019	2018
(dollars in thousands)
Software and royalties	$111	$84
Hardware and consumables	11	1
Services	156	12
Maintenance	653	619
Total revenue	$931	$716

 

Customer Concentration

 

For the three months ended March 31, 2019, two customers accounted for approximately 46% or $424,000 of our total revenue and had trade receivables at March 31, 2019 of $651,000.

 

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.

 

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. 2016-13. 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. 2017-11. 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 adoption of this standard did not have a material effect on the Company’s condensed consolidated financial statements.

 

FASB ASU No. 2018-07. In June 2018, the FASB issued ASU 2018-07, “Shared-Based Payment Arrangements with Nonemployees” (Topic 505), which simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such payments to nonemployees will be aligned with the requirements for share-based payments granted to employees. Under the ASU 2018-07, the measurement of equity-classified nonemployee share-based payments will be fixed on the grant date, as defined in ASC 718, and will use the term nonemployee vesting period, rather than requisite service period. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted if financial statements have not yet been issued. The adoption of this standard did not have a material effect on the Company’s condensed consolidated financial statements.

 

FASB ASU No. 2018-13. In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) —Disclosure Framework —Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). The amendments in this update improve the effectiveness of fair value measurement disclosures. ASU 2018-13 is effective for fiscal years ending after December 15, 2019. Early adoption is permitted. The adoption of this standard should be applied to all periods presented. The adoption of this standard will not have a material impact on the Company’s consolidated financial statements.

 

FASB ASU No. 2018-14. In August 2018, the FASB issued ASU 2018-14, “Compensation —Retirement Benefits —Defined Benefit Plans —General (Subtopic 715-20) —Disclosure Framework —Changes to the Disclosure Requirements for Defined Benefit Plans” (“ASU 2018-14”). The amendments in this update remove defined benefit plan disclosures that are no longer considered cost-beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. ASU 2018-14 is effective for fiscal years ending after December 15, 2020. Early adoption is permitted. The adoption of this standard should be applied to all periods presented. The adoption of this standard will not have a material impact on the Company’s consolidated financial statements. 

  

FASB ASU No. 2018-15. In August 2018, the FASB issued ASU 2018-15, “Intangibles —Goodwill and Other —Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract” (“ASU 2018-15”). The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for fiscal years ending after December 15, 2019. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s 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,
	2019	2018
Numerator for basic and diluted loss per share:
Net loss	$(3,612)	$(3,583)
Preferred dividends and preferred stock discount accretion	(1,294)	(769)
Net loss available to common shareholders	$(4,906)	$(4,352)
Denominator for basic and dilutive loss per share — weighted-average shares outstanding	98,398,239	94,333,663
Net loss	$(0.04)	$(0.04)
Preferred dividends and preferred stock discount accretion	(0.01)	(0.01)
Basic and diluted loss per share available to common shareholders	$(0.05)	$(0.05)

 

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,
	2019	2018
Related party lines of credit	—	5,325,651
Convertible redeemable preferred stock	42,626,980	26,630,458
Stock options	7,225,421	7,273,431
Warrants	1,813,856	230,000
Total potential dilutive securities	51,666,257	39,459,540

 

NOTE 4.  SELECT BALANCE SHEET DETAILS

 

Inventory

 

Inventories of $105,000 as of March 31, 2019 were comprised of work in process of $94,000 representing direct labor costs on in-process projects and finished goods of $11,000 net of reserves for obsolete and slow-moving items of $3,000.

  

Inventories of $29,000 as of December 31, 2018 were comprised of work in process of $21,000 representing direct labor costs on in-process projects and finished goods of $8,000 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 $79,000 and $82,000 as of March 31, 2019 and December 31, 2018, respectively, which includes accumulated amortization of $580,000 and $577,000 as of March 31, 2019 and December 31, 2018, respectively. Amortization expense for patent intangible assets was $3,000 for the three months ended March 31, 2019 and 2018. Patent intangible assets are being amortized on a straight-line basis over their remaining life of approximately 7.25 years. There was no impairment of the Company’s intangible assets during the three months ended March 31, 2019 and 2018.

 

 

 

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)
2019 (nine months)	$9
2020	12
2021	12
2022	12
2023	12
Thereafter	22
Totals	$79

 

Goodwill

 

The Company annually, or more frequently if events or circumstances indicate a need, tests the carrying amount of goodwill for impairment. The Company performs its annual impairment test in the fourth quarter of each year. In December 2018, the Company adopted the provisions of ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The provisions of ASU 2017-04 eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. Entities that have reporting units with zero or negative carrying amounts, will no longer be required to perform a qualitative assessment assuming they pass the simplified impairment test. The Company continues to have only one reporting unit, Identity Management which, at March 31, 2019, had a negative carrying amount of approximately $6,574,000. Based on the results of the Company’s impairment testing, the Company determined that its goodwill was not impaired during the three months ended March 31, 2019 and December 31, 2018.

 

NOTE 5.  LEASES

 

The Company is a party to certain contractual arrangements for office space which meet the definition of leases under ASC 842 – Leases. In accordance with ASC 842, the Company has determined that such arrangements are operating leases and accordingly the Company has, as of January 1, 2019, recorded operating lease right-of-use assets and related lease liability for the present value of the lease payments over the lease terms using the Company’s estimated weighted-average incremental borrowing rate of approximately 14.5%. Such assets and liabilities aggregated approximately $2,265,000 and $2,280,000 as of January 1, 2019, respectively. The Company determined that it had no arrangements representing finance leases.

 

The Company’s operating leasing arrangements are summarized below:

 

 

 

 

The above leases contain no residual value guarantees provided by the Company and there are no options to either extend or terminate the leases. The Company is not a party to any subleasing arrangements.

 

 

For the three months ended March 31, 2019 the Company recorded approximately $154,000 in lease expense using the straight-line method. Lease expense is comprised of the total lease payments under the lease plus any initial direct costs incurred less any lease incentives received by the lessor amortized ratably using the straight-line method over the lease term. The weighted-average remaining lease term of the Company’s operating leases as of March 31, 2019 is 5.16 years. Cash payments under operating leases aggregated approximately $117,000 for the three months ended March 31, 2019 and are included in operating cash flows.

 

The Company’s lease liability was computed using the present value of future lease payments. The Company has utilized the practical expedient regarding lease and non-lease components and combined such components into a single combined component in the determination of the lease liability. The Company has excluded the lease of its office space in Mexico City, Mexico in the determination of the lease liability as of January 1, 2019 as its term is less than 12 months.

 

At March 31, 2019, future minimum undiscounted lease payments are as follows:

 

($ in thousands)
2019 (9 months)	$376
2020	649
2021	642
2022	652
2023	425
Thereafter	519
Total	3,263
Short-term leases not included in lease liability	(12)
Present Value effect on future minimum undiscounted lease payments at March 31, 2019	(1,034)
Lease liability at March 31, 2019	$2,217

NOTE 6.  MEZZANINE EQUITY

 

Series C Convertible Redeemable Preferred Stock

 

On September 10, 2018, the Company filed the Certificate of Designations, Preferences, and Rights of Series C Convertible Redeemable Preferred stock (the “Series C COD”) with the Secretary of State for the State of Delaware – Division of Corporations, designating 1,000 shares of the Company’s preferred stock, par value $0.01 per share, as Series C Preferred, each share with a stated value of $10,000 per share (the “Stated Value”). Shares of Series C Preferred accrue dividends cumulatively and are payable quarterly at a rate of 8% per annum if paid in cash, or 10% per annum if paid by the issuance of shares of Common Stock. Each share of Series C Preferred has a liquidation preference equal to the greater of (i) the Stated Value plus all accrued and unpaid dividends, and (ii) such amount per share as would have been payable had each share been converted into common stock immediately prior to the occurrence of a Liquidation Event or Deemed Liquidation Event. Each share of Series C Preferred is convertible into that number of shares of the Company’s common stock (“Conversion Shares”) equal to the Stated Value, divided by $1.00, which conversion rate is subject to adjustment in accordance with the terms of the Series C COD. Holders of Series C Preferred may elect to convert shares of Series C Preferred into Conversion Shares at any time. Holders of the Series C Preferred may also require the Company to redeem all or any portion of such holder’s shares of Series C Preferred at any time from and after the third anniversary of the issuance date or in the event of the consummation of a Change of Control (as such term is defined in the Series C COD). Subject to the terms and conditions set forth in the Series C COD, in the event the volume-weighted average price of the Company’s common stock is at least $3.00 per share (subject to adjustment in accordance with the terms of the Series C COD) for at least 20 consecutive trading days, the Company may convert all, but not less than all, issued and outstanding shares of Series C Preferred into Conversion Shares. In addition, in the event of a Change of Control, the Company will have the option to redeem all, but not less than all, issued and outstanding shares of Series C Preferred for 115% of the Liquidation Preference Amount per share. Holders of Series C Preferred will have the right to vote, on an as-converted basis, with the holders of the Company’s common stock on any matter presented to the Company’s stockholders for their action or consideration. Shares of Series C Preferred rank senior to the Company’s common stock and Series A Preferred, and junior to the Company’s Series B Preferred.

 

 

 

On September 10, 2018, the Company offered and sold a total of 890 shares of Series C Preferred at a purchase price of $10,000 per share, and on September 21, 2018, the Company offered and sold an additional 110 shares of Series C Preferred at a purchase price of $10,000 per share (the “Series C Financing”). The total gross proceeds to the Company from the Series C Financing were $10,000,000. Issuance costs incurred in conjunction with the Series C Financing were approximately $1,211,000. Such costs have been recorded as a discount on the Series C Preferred stock and will be accreted to the point of earliest redemption which is the third anniversary of the Series C Financing or September 10, 2021 using the effective interest rate method. The accretion of these costs is recorded as a deemed dividend.

 

The Company had 1,000 shares of Series C Preferred outstanding as of March 31, 2019 and December 31, 2018. The Company issued the holders of Series C Preferred 157,945 shares of common stock on March 31, 2019, as payment of dividends due on that date.

 

Guidance for accounting for freestanding financial instruments that contain characteristics of both liabilities and equity are contained in ASC 480, Distinguishing Liabilities From Equity and Accounting Series Release 268 (“ASR 268”) Redeemable Preferred Stocks. The Company evaluated the provisions of the Series C Preferred and determined that the provisions of the Series C Preferred grant the holders of the Series C Preferred a redemption right whereby the holders of the Series C Preferred may, at any time after the third anniversary of the Series C Preferred issuance, require the Company to redeem in cash any or all of the holder’s outstanding Series C Preferred at an amount equal to the Liquidation Preference Amount (“Liquidation Preference Amount”). The Liquidation Preference Amount is defined as the greater of the stated value of the Series C Preferred plus any accrued unpaid interest or such amount per share as would have been payable had each such share been converted into Common Stock. In the event of a Change of Control, the holders of Series C Preferred shall have the right to require the Company to redeem in cash all or any portion of such holder’s shares at the Liquidation Preference Amount. The Company has concluded that because the redemption features of the Series C Preferred are outside of the control of the Company, the instrument is to be recorded as temporary or mezzanine equity in accordance with the provisions of ASR 268.

  

The Company noted that the Series C Preferred Stock instrument was a hybrid instrument that contains several embedded features. In November 2014, the FASB issued ASU 2014-16 to amend ASC 815, “Derivatives and Hedging,” (“ASC 815”) and require the use of the whole instrument approach (described below) to determine whether the nature of the host contract in a hybrid instrument issued in the form of a share is more akin to debt or to equity.

 

 The whole instrument approach requires an issuer or investor to consider the economic characteristics and risks of the entire hybrid instrument, including all of its stated and implied substantive terms and features. Under this approach, all stated and implied features, including the embedded feature being evaluated for bifurcation, must be considered. Each term and feature should be weighed based on the relevant facts and circumstances to determine the nature of the host contract. This approach results in a single, consistent determination of the nature of the host contract, which is then used to evaluate each embedded feature for bifurcation. That is, the host contract does not change as each feature is evaluated.

 

The revised guidance further clarifies that the existence or omission of any single feature, including an investor-held, fixed-price, noncontingent redemption option, does not determine the economic characteristics and risks of the host contract. Instead, an entity must base that determination on an evaluation of the entire hybrid instrument, including all substantive terms and features.

 

However, an individual term or feature may be weighed more heavily in the evaluation based on facts and circumstances. An evaluation of all relevant terms and features, including the circumstances surrounding the issuance or acquisition of the equity share, as well as the likelihood that an issuer or investor is expected to exercise any options within the host contract, to determine the nature of the host contract, requires judgement.

 

Using the whole instrument approach, the Company concluded that the host instrument is more akin to debt than equity as the majority of identified features contain more characteristics of debt.

 

The Company evaluated the identified embedded features of the Series C Preferred host instrument and determined that certain features meet the definition of and contained the characteristics of derivative financial instruments requiring bifurcation at fair value from the host instrument.

 

 

 

Accordingly, the Company has bifurcated from the Series C Preferred host instrument the conversion options, redemption option and participating dividend feature in accordance with the guidance in ASC 815. These bifurcated features aggregated approximately $833,000 at issuance and have been recorded as a discount to the Series C Preferred. Such amount will be accreted to the point of earliest redemption which is the third anniversary of the Series C Financing or September 10, 2021 using the effective interest rate method. The accretion of these features is recorded as a deemed dividend.

 

For the three months ended March 31, 2019, the Company recorded the accretion of debt issuance costs and derivative liabilities aggregating approximately $186,000 using the effective interest rate method. There was no Series C Preferred outstanding at any time during the three months ended March 31, 2018.

 

The Company reflected the following in Mezzanine Equity for the Series C Preferred Stock as of December 31, 2018 and March 31, 2019:

 

	Series C
	Convertible,
	Redeemable
	Preferred
(amounts in thousands, except share amounts)	Shares	Amount	Total
Total Series C Preferred Stock as of December 31, 2018	1,000	$8,156	$8,156
Accretion of discount – deemed dividend		186	186
Total Series C Preferred Stock as of March 31, 2019	1,000	$8,342	$8,342

 

NOTE 7.  DERIVATIVE LIABILITIES

 

The Company accounts for its derivative instruments under the provisions of ASC 815, “Derivatives and Hedging.” Under the provisions of ASC 815, the Company identified embedded features within the Series C Preferred host contract that qualify as derivative instruments and require bifurcation.

 

The Company determined that the conversion option, redemption option and participating dividend feature contained in the Series C Preferred host instrument required bifurcation. The Company valued the bifurcatable features at fair value. Such liabilities aggregated approximately $833,000 at inception and are classified as current liabilities on the Company’s condensed consolidated balance sheet under the caption “Derivative liabilities.” The Company revalued these features at each balance sheet date and has recorded any change in fair value in the determination of period net income or loss. Such amounts are recorded in the caption “Change in fair value of derivative liabilities” in the Company’s condensed consolidated statements of operations. During the three months ended March 31, 2019, the Company recorded an increase to these derivative liabilities using fair value methodologies of approximately $424,000. See Note 9 to these condensed consolidated financial statements for a reconciliation of amounts recorded at March 31, 2019.

 

NOTE 8.  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

 

The Company had 37,467 shares of Series A Preferred outstanding as of March 31, 2019 and December 31, 2018. At March 31, 2019 and December 31, 2018, the Company had cumulative undeclared dividends of $0. The Company issued the holders of Series A Preferred 591,803 shares of common stock on March 31, 2019 as payment of dividends due on that date.

 

Series B Convertible Preferred Stock

 

The Company had 239,400 shares of Series B Preferred stock, par value $0.01 per share (“Series B Preferred”), outstanding as of March 31, 2019 and December 31, 2018. At March 31, 2019 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, 2019 and 2018.

 

Warrants

 

The following table summarizes warrant activity for the following periods:

 

	Warrants	Weighted- Average Exercise Price
Balance at December 31, 2018	1,813,856	$0.19
Granted	—	—
Expired/Canceled	—	—
Exercised	—	—
Balance at March 31, 2019	1,813,856	$0.19

 

As of March 31, 2019, warrants to purchase 1,813,856 shares of common stock at exercise prices ranging from $0.01 to $1.46 were outstanding. All warrants are exercisable as of March 31, 2019 except for an aggregate of 1,643,856 warrants, which become exercisable only upon the attainment of specified events, and 20,000 warrants that become exercisable on June 7, 2019. Such warrants expire at various dates through September 2028. The intrinsic value of warrants outstanding at March 31, 2019 was approximately $141,000. The Company has excluded from this computation any intrinsic value of the 1,493,856 warrants issued to the Series A Preferred stockholders due to such warrants becoming exercisable only upon conversion of Series A Preferred into shares of Common Stock.

 

Stock-Based Compensation

The Company’s 1999 Stock Award Plan (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 the Company’s 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, 2019 was 445,670.

  

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 $166,000 and $273,000 for the three months ended March 31, 2019 and 2018, 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 $0 and $62,000 for the three months ended March 31, 2019 and 2018, 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, 2019 and 2018 ranged from 57% to 84%. 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 Topic 14. The expected term used by the Company during the three months ended March 31, 2019 and 2018 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. The interest rate used in the Company’s Black-Scholes calculations for the three months ended March 31, 2019 and 2018 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, 2018	7,227,248	$1.34
Granted	345,000	$0.92
Expired/Cancelled	(59,993)	$1.44
Exercised	(286,834)	$0.37
Balance at March 31, 2019	7,225,421	$1.36

   

The intrinsic value of options exercisable at March 31, 2019 was approximately $1,483,000. The aggregate intrinsic value for all options outstanding as of March 31, 2019 was approximately $1,739,000. The weighted-average grant-date per share fair value of options granted during the three months ended March 31, 2019 was $0.47. 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, 2019, the total remaining unrecognized compensation cost related to unvested stock options amounted to approximately $980,000, which will be recognized over a weighted-average period of 2.0 years.

 

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,
	2019	2018
Cost of revenue	$3	$5
General and administrative	93	216
Sales and marketing	39	60
Research and development	31	54
Total	$166	$335

 

NOTE 9.  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, 2019
($ in thousands)	Total	Level 1	Level 2	Level 3
Assets:
Pension assets	$1,699	$—	$—	$1,699
Totals	$1,699	$—	$—	$1,699
Liabilities:
Derivative liabilities	$1,489	$—	$—	$1,489
Totals	$1,489	$—	$—	$1,489

 

	Fair Value at December 31, 2018
($ in thousands)	Total	Level 1	Level 2	Level 3
Assets:
Pension assets	$1,733	$—	$—	$1,733
Totals	$1,733	$—	$—	$1,733
Liabilities:
Derivative liabilities	$1,065	$—	$—	$1,065
Totals	$1,065	$—	$—	$1,065