IMAGEWARE SYSTEMS INC - Quarter Report: 2021 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, 2021

 

[ ]	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 Incorporation or Organization)		(IRS Employer Identification No.)

 

11440 West Bernardo Court, Suite 300

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	[   ]
Non-accelerated filer	[X]	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: None

 

The number of shares of common stock, par value $0.01 per share, outstanding on May 17, 2021 was 303,292,986.

 

 

 

IMAGEWARE SYSTEMS, INC.

 

INDEX

 

			Page
PART I.  FINANCIAL INFORMATION
	ITEM 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of March 31, 2021 (unaudited) and December 31, 2020	2
		Condensed Consolidated Statements of Operations for the three months ended March 31, 2021 and 2020 (unaudited)	3
		Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2021 and 2020 (unaudited)	4
		Condensed Consolidated Statements of Shareholders’ Deficit for the three months ended March 31, 2021 and 2020 (unaudited)	5
		Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020 (unaudited)	7
		Notes to unaudited Condensed Consolidated Financial Statements	8
	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	37
	ITEM 4.	Controls and Procedures	37
PART II. OTHER INFORMATION
	ITEM 1.	Legal Proceedings	38
	ITEM1A.	Risk Factors	38
	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
	ITEM 3.	Defaults Upon Senior Securities	38
	ITEM 4.	Mine Safety Disclosures	38
	ITEM 5.	Other Information	38
	ITEM 6.	Exhibits	38
SIGNATURES			39

  

 

 

 

 

Forward-Looking Statements

 

 This Quarterly Report on Form 10-Q (this "Quarterly Report") contains forward-looking statements.  The words or phrases "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements."  Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including those risks factors contained in our Annual Report on Form 10-K for the year ended December 31, 2020, previously filed with the Securities and Exchange Commission ("SEC") on April 5, 2021 is incorporated herein by reference.  Statements made herein are as of the date of the filing of this Report with the SEC and should not be relied upon as of any subsequent date.  Unless otherwise required by applicable law, we do not undertake, and specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events, or circumstances after the date of such statement.

 

 

 

 

PART I

 

ITEM 1.  FINANCIAL STATEMENTS

 

IMAGEWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

 

	March 31,	December 31,
	2021	2020
ASSETS	(Unaudited)
Current Assets:
Cash and cash equivalents	$5,056	$8,345
Accounts receivable, net of allowance for doubtful accounts of $5 at March 31, 2021 and December 31, 2020.	493	577
Inventory, net	88	40
Other current assets	625	196
Total Current Assets	6,262	9,158
Property and equipment, net	112	155
Other assets	525	458
Operating lease right-of-use assets	1,462	1,557
Intangible assets, net of accumulated amortization	55	58
Goodwill	3,416	3,416
Total Assets	$11,832	$14,802
LIABILITIES, MEZZANINE EQUITY AND SHAREHOLDERS’ DEFICIT
Current Liabilities:
Accounts payable	$974	$1,007
Deferred revenue	777	903
Accrued expense	1,006	1,130
Operating lease liabilities, current portion	435	421
Derivative liabilities	22,850	24,128
Note payable, current portion	1,107	918
Total Current Liabilities	27,149	28,507
Other long-term liabilities	65	65
Note payable, net of current portion	464	653
Lease liabilities, net of current portion	1,178	1,297
Pension obligation	2,518	2,531
Total Liabilities	31,374	33,053
Mezzanine Equity:
Series D Convertible Redeemable Preferred Stock, $0.01 par value, designated 26,000 shares, 23,111 and 22,863 shares issued at March 31, 2021 (unaudited) and December 31, 2020, respectively and 22,757 and 22,863 shares outstanding at March 31, 2021 (unaudited) and December 31, 2020, respectively; liquidation preference $22,757 and $22,863 at March 31, 2021 (unaudited) and December 31, 2020, respectively.	3,391	1,572
Shareholders’ Deficit:
Preferred stock, authorized 5,000,000 shares:
Series A Convertible Redeemable Preferred Stock, $0.01 par value; designated 38,000 shares, 37,467 shares issued at March 31, 2021 (unaudited) and December 31, 2020, and 6,149 and 14,911 shares outstanding at March 31, 2021 (unaudited) and December 31, 2020, respectively; liquidation preference $6,149 and $14,911 at March 31, 2021 (unaudited) and December 31, 2020, respectively.	—	—
Series A-1 Convertible Redeemable Preferred Stock, $0.01 par value; designated 38,000 shares, 37,467 shares issued at March 31, 2021 (unaudited) and December 31, 2020, and 5,922 and 14,782 shares outstanding at March 31, 2021 (unaudited) and December 31, 2020, respectively; liquidation preference $5,922 and $14,782 at March 31, 2021 (unaudited) and December 31, 2020, respectively.	—	—
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, 2021 (unaudited) and December 31, 2020, respectively; liquidation preference $620 and $607 at March 31, 2021 (unaudited) and December 31, 2020, respectively.	2	2
Common Stock, $0.01 par value, 1,000,000,000 shares authorized; 276,749,448 and 180,096,317 shares issued at March 31, 2021 (unaudited) and December 31, 2020, respectively, and 276,742,744 and 180,089,613 shares outstanding at March 31, 2021 (unaudited) and December 31, 2020, respectively.	2,766	1,801
Additional paid-in capital	191,585	193,652
Treasury stock, at cost 6,704 shares	(64)	(64)
Accumulated other comprehensive loss	(1,935)	(1,989)
Accumulated deficit	(215,287)	(213,225)
Total Shareholders’ Deficit	(22,933)	(19,823)
Total Liabilities, Mezzanine Equity and Shareholders’ Deficit	$11,832	$14,802

 

 

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,
	2021	2020
Revenue:
Product	$56	$150
Maintenance	677	646
	733	796
Cost of revenue:
Product	9	21
Maintenance	110	98
Gross profit	614	677
Operating expense:
General and administrative	1,347	983
Sales and marketing	724	1,058
Research and development	1,168	1,868
Depreciation and amortization	18	18
	3,257	3,927
Loss from operations	(2,643)	(3,250)
Interest (income) expense, net	—	24
(Gain) loss on change in fair value of derivative liabilities	(1,172)	(197)
Loss on extinguishment of derivative liabilities	335	—
Other (income) expense, net	25	—
Other components of net periodic pension expense	54	47
Loss before income taxes	(1,885)	(3,124)
Income tax expense	—	—
Net loss	(1,885)	(3,124)
Preferred dividends and preferred stock discount accretion	(2,255)	(1,374)
Net loss available to common shareholders	$(4,140)	$(4,498)
Basic and diluted loss per common share - see Note 3:
Basic and diluted loss per share available to common shareholders	$(0.02)	$(0.04)
Basic and diluted weighted-average shares outstanding	245,829,914	116,196,197

 

 

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,
	2021	2020
Net loss	$(1,885)	$(3,124)
Other comprehensive income (loss):
Foreign currency translation adjustment	54	31
Comprehensive loss	$(1,831)	$(3,093)

 

  

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

  

 

 

 

 

	Series A		Series A-1		Series B
	Convertible,		Convertible,		Convertible,							Accumulated
	Redeemable		Redeemable		Redeemable						Additional	Other
	Preferred		Preferred		Preferred		Common Stock		Treasury Stock		Paid-In	Comprehensive	Accumulated
	Shares	Amount	Shares	Amount	Shares	Amount	Shares	Amount	Shares	Amount	Capital	Loss	Deficit	Total
Balance at December 31, 2020	14,911	$-	14,782	$-	239,400	$2	180,096,317	$1,801	(6,704)	$(64)	$193,652	$(1,989)	$(213,225)	$(19,823)
Accretion of Preferred Stock discount	-	-	-	-	-	-	-	-	-	-	(1,817)	-	-	(1,817)
Stock-based compensation expense and issuance of RSUs	-	-	-	-	-	-	161,168	2	-	-	76	-	-	78
Issuance of common stock in lieu of cash	-	-	-	-	-	-	242,647	2	-	-	19	-	-	21
Issuance of common stock pursuant to warrant exercise	-	-	-	-	-	-	400	-	-	-	-	-	-	-
Conversion of Series A Preferred to Common Stock	(8,762)	-	-	-	-	-	43,819,500	438	-	-	(438)	-	-	-
Conversion of Series A-1 Preferred to Common Stock	-	-	(8,860)	-	-	-	44,300,000	443	-	-	(443)	-	-	-
Conversion of Series D Preferred to Common Stock	-	-	-	-	-	-	6,115,324	59	-	-	630	-	(2)	687
Foreign currency translation adjustment	-	-	-	-	-	-	-	-	-	-	-	54	-	54
Dividends on Series A Preferred stock, $(10.50)/share	-	-	-	-	-	-	1,050,826	11	-	-	81	-	(92)	-
Dividends on Series A-1 Preferred stock, $(9.75)/share	-	-	-	-	-	-	963,266	10	-	-	73	-	(83)	-
Dividends on Series D Preferred stock, $(90.90)/share	-	-	-	-	-	-	-	-	-	-	(248)	-	-	(248)
Net loss	-	-	-	-	-	-	-	-	-	-	-	-	(1,885)	(1,885)
Balance at March 31, 2021	6,149	$ -	5,922	$ -	239,400	$ 2	276,749,448	$ 2,766	(6,704)	$ (64)	$ 191,585	$ (1,935)	(215,287)	(22,933)

 

 

 

 

 

	Series A		Series B
	Convertible,		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, 2019	37,467	$-	239,400	$2	113,353,176	$1,133	(6,704)	$(64)	$195,079	$(1,741)	$(203,171)	$(8,762)
Accretion of Preferred Stock discount	-	-	-	-	-	-	-	-	(175)	-	-	(175)
Issuance of common stock net of financing costs	-	-	-	-	10,000,000	100	-	-	1,287	-	-	1,387
Stock-based compensation expense	-	-	-	-	-	-	-	-	124	-	-	124
Common stock issued in exchange for unexercised options	-	-	-	-	400,000	4	-	-	58	-	-	62
Foreign currency translation adjustment	-	-	-	-	-	-	-	-	-	31	-	31
Dividends on Series A Preferred stock, $(25.01)/share	-	-	-	-	-	-	-	-	-	-	(937)	(937)
Dividends on Series C Preferred stock, $(250.00)/share	-	-	-	-	-	-	-	-	-	-	(250)	(250)
Net loss	-	-	-	-	-	-	-	-	-	-	(3,124)	(3,124)
Balance at March 31, 2020	37,467	$-	239,400	$2	123,753,176	$1,237	(6,704)	$(64)	$196,373	$(1,710)	$(207,482)	$(11,644)

 

 

 

IMAGEWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

	Three Months Ended  March 31,
	2021	2020
Cash flows from operating activities
Net loss	$(1,885)	$(3,124)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization	18	18
Loss on disposal of fixed assets	82	—
Stock-based compensation	78	124
Issuance of common stock in exchange for unexercised options	—	62
Issuance of common stock as compensation in lieu of cash	21	—
Change in fair value of derivative liabilities	(1,172)	(197)
Loss on extinguishment of derivative liabilities	335	—
Change in assets and liabilities:
Accounts receivable	84	168
Inventory	(48)	(64)
Other assets	(495)	30
Operating lease right-of-use assets	(10)	(3)
Accounts payable	(33)	662
Deferred revenue	(129)	234
Accrued expense	(123)	102
Pension obligation	(13)	8
Total adjustments	(1,405)	1,144
Net cash used in operating activities	(3,290)	(1,980)
Cash flows from investing activities
Purchase of property and equipment	(53)	—
Net cash used in investing activities	(53)	—
Cash flows from financing activities
Proceeds from issuance of common stock, net	—	622
Proceeds from issuance of related party notes payable	—	350
Net cash provided by financing activities	—	972
Effect of exchange rate changes on cash and cash equivalents	54	31
Net decrease in cash and cash equivalents	(3,289)	(977)
Cash and cash equivalents at beginning of period	8,345	1,030
Cash and cash equivalents at end of period	$5,056	$53
Supplemental disclosure of cash flow information:
Cash paid for interest	$—	$—
Cash paid for income taxes	$—	$—
Summary of non-cash investing and financing activities:
Stock dividends on Series A Convertible Redeemable Preferred Stock	$92	$937
Stock dividends on Series A-1 Convertible Redeemable Preferred Stock	$83	$250
Stock dividends on Series D Convertible Redeemable Preferred Stock	$248	—
Accretion of discount on Series C Convertible Redeemable Preferred Stock	$—	$175
Accretion of discount on Series D Convertible Redeemable Preferred Stock	$1,817	$—
Conversion of Series A Convertible Redeemable Preferred Stock into Common Stock	$438	—
Conversion of Series A-1 Convertible Redeemable Preferred Stock into Common Stock	443	—
Stock subscription receivable	$—	765

 

 

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.  DESCRIPTION OF BUSINESS AND OPERATIONS

 

Overview

 

As used in this Quarterly Report, “we”, “us”, “our”, “ImageWare”, “ImageWare Systems” or the “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. 

 

The Company's common stock, par value $0.01 per share (the "Common Stock"), trades under the symbol "IWSY" on the OTCQB Marketplace.

 

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 requirements. Management expects 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 positive cash flows from operations. Historically the Company has not been able to generate sufficient net revenue to achieve and sustain positive cash flows from operations and management has determined that there is substantial doubt about the Company’s ability to continue as a going concern.

 

At March 31, 2021 and December 31, 2020, we had negative working capital of $20,887,000 and $19,349,000, respectively. Included in our negative working capital as of March 31, 2021 are $22,850,000 of derivative liabilities which are not required to be settled in cash except in the event of the consummation of a Change of Control or at any time after the fourth anniversary of the Series D Preferred issuance, at which time the holders of the Series D Preferred may require the Company to redeem in cash any or all of the holder’s outstanding Series D Preferred at an amount equal to the Series D Liquidation Preference Amount. At March 31, 2021 the Liquidation Preference Amount totaled $22,757,000. Considering the financings consummated in 2020, as well as our projected cash requirements, and assuming we are unable to generate incremental revenue, our available cash will be insufficient to satisfy our cash requirements for the next twelve months from the date of this filing. At May 14, 2021, cash on hand approximated $3,661,000. Based on the Company’s rate of cash consumption in the first quarter of 2021 and the last quarter of 2020, the Company estimates it will need additional capital in the third quarter of 2021 and its prospects for obtaining that capital are uncertain. As a result of the Company’s historical losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern.

 

On March 11, 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. The COVID-19 pandemic is affecting the United States and global economies and may affect the Company's operations and those of third parties on which the Company relies. Additionally, as the duration of the COVID-19 pandemic is difficult to assess or predict, the impact of the COVID-19 pandemic on the financial markets may reduce our ability to access capital, which could negatively impact the Company's short-term and long-term liquidity. These effects could have a material impact on the Company's liquidity, capital resources, operations and business and those of the third parties on which the Company relies.

 

To address our working capital requirements, management has begun instituting several cost cutting measures and may seek additional equity and/or debt financing through the issuance of additional debt and/or equity securities. Other than the Lincoln Purchase Agreement, there are currently no 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. Therefore, management’s plans do not alleviate the substantial doubt of the Company’s ability to continue as a going concern.

 

The 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.

 

 

 

Recent Developments

 

Charter Amendment

 

Our Certificate of Incorporation as of March 31, 2021 authorizes a total of 1.0 billion shares of Common Stock for issuance. Effective as of January 28, 2021 and February 16, 2021, respectively, our Board of Directors and the Majority Shareholders approved and authorized an amendment to our Certificate of Incorporation to increase the number of authorized shares of Common Stock from 1.0 billion shares to 2.0 billion shares, resulting in a total increase of 1.0 billion authorized shares of Common Stock. The increase in the number of authorized shares of Common Stock became effective upon filing the Certificate of Amendment with the Delaware Division of Corporations on April 21, 2021.

 

Coronavirus (COVID-19) Pandemic

 

On March 11, 2020, the World Health Organization declared the novel strain of coronavirus (“COVID-19”) a global pandemic and recommended containment and mitigation measures worldwide. As of May 2021, the global outbreak of COVID-19 continues to rapidly evolve, and the extent to which COVID-19 may impact our business and markets we serve will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the duration of the outbreak, travel restrictions and social distancing in the United States and other countries, business closures or business disruptions, and the effectiveness of actions taken both in the United States and other countries. We are continuing to vigilantly monitor the situation with our primary focus on health and safety of our employees and clients.

  

The Series D Financing

 

On November 12, 2020 and December 23, 2020, the Company consummated private placements of 12,060 shares of its Series D Convertible Preferred Stock, par value $0.01 per share (the "Series D Preferred"), resulting in gross proceeds to the Company of $12.06 million, less fees and expenses (the “Series D Financing”). The gross proceeds include approximately $2.2 million in principal amount due and payable under the terms of certain term loans issued by the Company on September 29, 2020 (“Bridge Notes”), which Bridge Notes were converted into Series D Preferred at Closing (the “Conversion”). The issuance of the Series D Preferred was made pursuant to securities purchase agreements, dated September 28, 2020 (the "Purchase Agreement"), by and between the Company and certain accredited investors (the "Purchasers"), for the sale of the Series D Preferred at a purchase price of $1,000 per share of Series D Preferred. The holders of Series D Preferred may voluntarily convert their shares of Series D Preferred into shares of the Company’s Common Stock at any time that is at least ninety days following the issuance date, at the conversion price calculated by dividing the Stated Value by the conversion price of $0.0583 per share of Common Stock, subject to adjustments as set forth in Section 5(e) of the Certificate of Designations, Preferences, and Rights of Series D Convertible Preferred Stock (the "Series D Certificate"). Dividends on shares of Series D Preferred will be paid prior to any junior securities and are to be paid at the rate of 4% of the Stated Value (as defined in the Series D Certificate) per share per annum in the form of shares of Series D Preferred.

 

 

 

On the fourth anniversary of the Issuance Date (as defined in the Series D Certificate), or in the event of the consummation of a Change of Control (as defined in the Series D Certificate), if any shares of Series D Preferred are outstanding, then each holder of Series D Preferred shall have the right (the “Holder Redemption Right”), at such holder’s option, to require the Company to redeem all or any portion of such holder’s shares of Series D Preferred at the Liquidation Preference Amount per share of Series D Preferred plus an amount equal to all accrued but unpaid dividends, if any, (such price, the “Holder Redemption Price”), which Holder Redemption Price shall be paid in cash.

 

In connection with the sale of the Series D Preferred, we granted certain registration rights to the Investors with respect to the Conversion Shares and Dividend Shares, pursuant to a Registration Rights Agreement by and among us and the Investors. The registration statement registering the Conversion Shares and Dividend Shares was declared effective by the United States Securities and Exchange Commission (the “SEC”) on February 12, 2021. 

 

NOTE 2.  SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of December 31, 2020, 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, 2020, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the SEC on April 5, 2021.

 

Operating results for the three months ended March 31, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021, or any other future periods.

 

Significant Accounting Policies

 

Principles of Consolidation

 

The condensed 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.

 

Operating Cycle

 

Assets and liabilities related to long-term contracts are included in current assets and current liabilities in the accompanying condensed consolidated balance sheets, although they will be liquidated in the normal course of contract completion which may take more than one operating cycle.

 

Use of Estimates

 

The preparation of the condensed 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 condensed 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, 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 D Preferred Financing, 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.

 

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, initially 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% using a capital asset pricing model. 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.

 

 

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

 

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. At March 31, 2021 and December 31, 2020, we had capitalized incremental costs of obtaining a contract with a customer of approximately $65,000. We recorded no additional contract costs during the three months ended March 31, 2021. Additionally, we recognized approximately $80,000 in revenue during the three months ended March 31, 2021 that was related to contract costs at the beginning of the period.

  

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 following table sets forth our disaggregated revenue for the three months ended March 31, 2021 and 2020:

  

	Three Months Ended March 31,
Net Revenue	2021	2020
(dollars in thousands)
Software and royalties	$39	$125
Hardware and consumables	13	14
Services	4	11
Maintenance	677	646
Total revenue	$733	$796

 

Customer Concentration

 

For the three months ended March 31, 2021, two customers accounted for approximately 45% or $333,000 of our total revenue and had trade receivables at March 31, 2021 of $249,000 of which approximately $171,000 was collected as of the date of this Quarterly Report.

 

For the three months ended March 31, 2020, one customer accounted for approximately 27% or $216,000 of our total revenue and had trade receivables at March 31, 2020 of $0.

 

 

 

 

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 Accounting Standards Update (“ASU”) No. 2020-06. In August 2020, the FASB issued ASU 2020-06 “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity”. This ASU simplifies accounting for convertible instruments by removing major separation models required under current U.S. GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The ASU also simplifies the diluted earnings per share (EPS) calculation in certain areas. This ASU is effective for public business entities, excluding entities eligible to be smaller reporting companies, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption will be permitted. The Company is currently evaluating the impact ASU 2020-06 will have 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,
	2021	2020
Numerator for basic and diluted loss per share:
Net loss	$(1,885)	$(3,124)
Preferred dividends and preferred stock discount accretion	(2,255)	(1,374)
Net loss available to common shareholders	$(4,140)	$(4,498)
Denominator for basic and dilutive loss per share — weighted-average shares outstanding	245,829,914	116,196,197
Basic and diluted loss per share available to common shareholders	$(0.02)	$(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:	Common Share Equivalents at March 31, 2021	Common Share Equivalents at December 31, 2020
Convertible redeemable preferred stock – Series A	30,743,500	74,555,000
Convertible redeemable preferred stock – Series A-1	29,610,000	73,910,000
Convertible redeemable preferred stock – Series B	46,980	46,029
Convertible redeemable preferred stock – Series D	390,348,199	392,166,023
Stock options	2,574,669	2,585,500
Restricted stock units (RSUs)	618,004	845,106
Warrants	393,589	753,775
Total Potential Dilutive Securities	454,334,941	544,861,433

 

NOTE 4.  SELECT BALANCE SHEET DETAILS

 

Inventory

 

Inventories of $88,000 as of March 31, 2021 were comprised of work in process of $78,000, representing direct labor costs on in-process projects and finished goods of $10,000 net of reserves for obsolete and slow-moving items of $3,000.

 

Inventories of $40,000 as of December 31, 2020 were comprised of work in process of $26,000, representing direct labor costs on in-process projects and finished goods of $14,000 net of reserves for obsolete and slow-moving items of $3,000.

 

Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value and required reserve levels.

 

 

 

Intangible Assets

 

The carrying amounts of the Company’s patent intangible assets were $55,000 and $58,000 as of March 31, 2021 and December 31, 2020, respectively, which includes accumulated amortization of $604,000 and $601,000 as of March 31, 2021 and December 31, 2020, respectively. Amortization expense for patent intangible assets was $3,000 for the three months ended March 31, 2021 and 2020, respectively. Patent intangible assets are being amortized on a straight-line basis over their remaining life of approximately 4.58 years. There was no impairment of the Company’s intangible assets during the three months ended March 31, 2021 and 2020.

 

The estimated intangible amortization expense for the next five fiscal years is as follows:

 

Fiscal Year Ended December 31,	Estimated Amortization Expense ($ in thousands)
2021 (nine months)	$9
2022	12
2023	12
2024	12
2025	10
Thereafter	—
Total	$55

  

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, 2021, had a negative carrying amount of approximately $22,933,000. Based on the results of the Company's impairment testing, the Company determined that its goodwill was not impaired as of March 31, 2021 and December 31, 2020.

 

Other Assets

 

 

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, initially 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% as the discount rates implicit in the Company’s leases cannot be readily determined. At December 31, 2020, such assets and liabilities aggregated approximately $1,557,000 and $1,718,000, respectively. At March 31, 2021, such assets and liabilities aggregated approximately $1,462,000 and $1,613,000, respectively. The Company determined that it had no arrangements representing finance leases.

  

 

 

Our corporate headquarters is located in San Diego, California, where we now occupy approximately 500 square feet of office space at a cost of approximately $2,000 per month. We entered into this facility’s lease in February 2021, with the new lease commencing on March 1, 2021 on a month-to-month basis. In addition to our corporate headquarters, we also occupied the following spaces at March 31, 2021:

 

 

 

 

Prior to entering into our current lease agreement in January 2021 and moving our corporate headquarters to a new location, we occupied 8,511 square feet of office space in San Diego, at a cost of approximately $28,000 per month. In January 2021, we entered in a subleasing agreement for our previously occupied corporate headquarters located in San Diego, California. The term of the sublease commenced on April 1, 2021 and expires on April 30, 2025 coterminous with the expiration of the Company’s master lease. Sublease payments due the Company approximate $26,000 per month over the term of the sublease.

 

The above leases contain no residual value guarantees provided by the Company and there are no options to either extend or terminate the leases.

    

For the three months ended March 31, 2021 and 2020, the Company recorded approximately $154,000 in lease expense using the straight-line method. Under the provisions of ASC 842, 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, 2021 is 2.0 years. Cash payments under operating leases aggregated approximately $166,000 for the three months ended March 31, 2021 and $161,000 for the comparable period in 2020 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 its term is less than 12 months.

  

At March 31, 2021, future minimum undiscounted lease payments are as follows:

 

($ in thousands)
2021 (nine months)	$491
2022	653
2023	424
2024	387
2025	128
Thereafter	—
Total	$2,083
Short-term leases not included in lease liability	(14)
Present Value effect on future minimum undiscounted lease payments at March 31, 2021	(456)
Lease liability at March 31, 2021	$1,613
Less current portion	(435)
Non-current lease liability at March 31, 2021	$1,178