WIDEPOINT CORP - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

 

☑	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2018
or
☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from __________________ to ___________________

 

Commission File Number: 001-33035

WidePoint Corporation

(Exact name of Registrant as specified in its charter)

 

Delaware		52-2040275
(State or other jurisdiction of		(I.R.S. employer
incorporation or organization)		identification no.)

 

7926 Jones Branch Drive, Suite 520, McLean, Virginia 22102

(Address of principal executive offices) (Zip Code)

 

(703) 349-2577

(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 ☑ No ⬜

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files): Yes ☑ No ⬜

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the 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 ☐ (Do not check if a smaller reporting company)		Smaller reporting company ☑ Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ☐ No ☑

 

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

 

As of November 14, 2018, there were 84,062,446 shares of the registrant’s Common Stock issued and 83,762,448 shares outstanding.

 

WIDEPOINT CORPORATION

 

INDEX

 

	Page No.
Part I.       FINANCIAL INFORMATION
Item 1.      Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017 (unaudited)	2
Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 2018 and 2017 (unaudited)	3
Condensed Consolidated Statements of Comprehensive Loss for the three and nine month periods ended September 30, 2018 and 2017 (unaudited)	4
Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2018 and 2017 (unaudited)	5
Notes to Condensed Consolidated Financial Statements (unaudited)	7
Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.     Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.     Controls and Procedures	28
Part II.      OTHER INFORMATION
Item 1.       Legal Proceedings	28
Item 1A.    Risk Factors	28
Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.       Default Upon Senior Securities	28
Item 4.       Mine Safety Disclosures	28
Item 5.       Other Information	28
Item 6.       Exhibits	28
SIGNATURES	29
CERTIFICATIONS

 

 

 

 

 

WIDEPOINT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$3,950,106	$5,272,457
Accounts receivable, net of allowance for doubtful accounts
of $96,846 and $107,618 in 2018 and 2017, respectively	8,022,377	8,131,025
Unbilled accounts receivable	7,803,572	8,131,448
Other current assets	963,649	767,944
Total current assets	20,739,704	22,302,874
NONCURRENT ASSETS
Property and equipment, net	1,058,786	1,318,420
Intangibles, net	3,284,626	3,671,506
Goodwill	18,555,578	18,555,578
Other long-term assets	145,477	44,553
Total assets	$43,784,171	$45,892,931
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable	$6,080,686	$7,266,212
Accrued expenses	9,064,369	9,796,350
Deferred revenue	2,689,038	2,348,578
Current portion of capital leases	105,712	101,591
Current portion of other term obligations	107,109	203,271
Total current liabilities	18,046,914	19,716,002
NONCURRENT LIABILITIES
Capital leases, net of current portion	151,037	232,109
Other term obligations, net of current portion	64,006	78,336
Deferred revenue	410,310	264,189
Deferred tax liability	393,975	392,229
Total liabilities	19,066,242	20,682,865
STOCKHOLDERS' EQUITY
Preferred stock, $0.001 par value; 10,000,000 shares
authorized; 2,045,714 shares issued and none outstanding	-	-
Common stock, $0.001 par value; 110,000,000 shares
authorized; 84,062,446 and 83,031,595 shares
issued; 83,762,446 and 83,031,595 shares
outstanding, respectively	83,763	83,032
Additional paid-in capital	94,814,580	94,200,237
Accumulated other comprehensive loss	(185,317)	(122,461)
Accumulated deficit	(69,995,097)	(68,950,742)
Total stockholders’ equity	24,717,929	25,210,066
Total liabilities and stockholders’ equity	$43,784,171	$45,892,931

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

 

 

WIDEPOINT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

	THREE MONTHS ENDED		NINE MONTHS ENDED
	SEPTEMBER 30,		SEPTEMBER 30,
	2018	2017	2018	2017
	(Unaudited)
REVENUES	$21,294,360	$18,463,872	$58,918,317	$55,956,617
COST OF REVENUES (including amortization and depreciation
of $248,009, $318,461, $802,174, and $895,088, respectively)	17,609,287	15,087,567	48,134,084	45,859,532
GROSS PROFIT	3,685,073	3,376,305	10,784,233	10,097,085
OPERATING EXPENSES
Sales and marketing	387,407	532,714	1,366,989	1,709,892
General and administrative expenses (including share-based
compensation of $272,737, ($81,043), $593,075 and
$138,036, respectively)	3,257,262	3,046,148	10,037,904	10,668,368
Product development	-	11,342	-	219,141
Depreciation and amortization	104,914	69,935	312,763	212,874
Total operating expenses	3,749,583	3,660,139	11,717,656	12,810,275
LOSS FROM OPERATIONS	(64,510)	(283,834)	(933,423)	(2,713,190)
OTHER (EXPENSE) INCOME
Interest income	936	1,971	6,339	11,564
Interest expense	(21,644)	(13,985)	(71,531)	(36,402)
Other income (expense)	2	(1,541)	3	1,758
Total other expense	(20,706)	(13,555)	(65,189)	(23,080)
LOSS BEFORE INCOME TAX PROVISION	(85,216)	(297,389)	(998,612)	(2,736,270)
INCOME TAX PROVISION	24,795	17,212	45,743	32,723
NET LOSS	$(110,011)	$(314,601)	$(1,044,355)	$(2,768,993)
BASIC LOSS PER SHARE	$(0.00)	$(0.00)	$(0.01)	$(0.03)
BASIC WEIGHTED-AVERAGE SHARES OUTSTANDING	83,177,804	82,946,847	83,100,832	82,878,287
DILUTED LOSS PER SHARE	$(0.00)	$(0.00)	$(0.01)	$(0.03)
DILUTED WEIGHTED-AVERAGE SHARES OUTSTANDING	83,177,804	82,946,847	83,100,832	82,878,287

 

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

 

 

WIDEPOINT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

 

	THREE MONTHS ENDED		NINE MONTHS ENDED
	SEPTEMBER 30,		SEPTEMBER 30,
	2018	2017	2018	2017
	(Unaudited)
NET LOSS	$(110,011)	$(314,601)	$(1,044,355)	$(2,768,993)
Other comprehensive income:
Foreign currency translation adjustments, net of tax	(27,459)	45,673	(62,856)	173,705
Other comprehensive (loss) income	(27,459)	45,673	(62,856)	173,705
COMPREHENSIVE LOSS	$(137,470)	$(268,928)	$(1,107,211)	$(2,595,288)

 

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

 

 

WIDEPOINT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

	NINE MONTHS ENDED
	SEPTEMBER 30,
	2018	2017
	(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$(1,044,355)	$(2,768,993)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Deferred income tax benefit	-	(10,173)
Depreciation expense	414,507	295,798
(Recovery of) provision for doubtful accounts	(6,149)	31,187
Amortization of intangibles	700,430	812,164
Amortization of deferred financing costs	16,054	9,485
Share-based compensation expense	593,075	138,036
Gain on sale of assets held for sale	-	(66,683)
Loss on disposal of fixed assets	-	172,472
Changes in assets and liabilities:
Accounts receivable and unbilled receivables	390,672	(612,010)
Inventories	(61,778)	(189,607)
Prepaid expenses and other current assets	(236,532)	(245,637)
Other assets	(108,742)	(10,849)
Accounts payable and accrued expenses	(1,890,395)	(552,531)
Income tax payable	16,289	85,891
Deferred revenue and other liabilities	505,619	281,168
Net cash used in operating activities	(711,305)	(2,630,282)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment	(164,573)	(573,400)
Software development costs	(230,101)	(360,685)
Proceeds from sale of assets held for sale	-	236,451
Proceeds from the sale of property and equipment	-	53,861
Net cash used in investing activities	(394,674)	(643,773)
CASH FLOWS FROM FINANCING ACTIVITIES
Advances on bank line of credit	14,048,741	11,599,343
Repayments of bank line of credit advances	(14,048,741)	(11,046,604)
Principal repayments of long-term debt	-	(82,440)
Principal repayments under capital lease obligations	(75,785)	(25,562)
Contingent consideration payment	(100,000)	-
Restricted stock award tax liability payment	-	(60,614)
Proceeds from exercise of stock options	22,000	17,100
Net cash (used in) provided by financing activities	(153,785)	401,223
Net effect of exchange rate on cash and equivalents	(62,587)	173,308
NET DECREASE IN CASH	(1,322,351)	(2,699,524)
CASH AND CASH EQUIVALENTS, beginning of period	5,272,457	9,123,498
CASH AND CASH EQUIVALENTS, end of period	$3,950,106	$6,423,974

 

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

 

 

WIDEPOINT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

	NINE MONTHS ENDED
	SEPTEMBER 30,
	2018	2017
	(Unaudited)
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest	$51,032	$23,656
Cash paid for income taxes	$14,418	$8,787
Cash received from income tax refund	$-	$2,674
NONCASH INVESTING AND FINANCING ACTIVITIES
Fair value of contingent consideration paid in connection
with software asset purchase (Note 3)	$-	$50,000
Insurance policies financed by short term notes payable	$76,979	$68,488
Acquisition of assets under capital lease obligation (Notes 7 and 9)	$-	$93,301

 

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

 

 

WIDEPOINT CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Organization

 

WidePoint Corporation (“WidePoint” or the “Company”) was incorporated in Delaware on May 30, 1997 and conducts operations through its wholly-owned operating subsidiaries throughout the continental United States, Ireland, the Netherlands and the United Kingdom. The Company’s principal executive and administrative headquarters is located in McLean, Virginia.

 

Nature of Operations

 

The Company is a leading provider of trusted mobility management (TM2) solutions to the government and commercial sectors. The Company’s TM2 solutions are internally hosted and are accessible on-demand through a secure portal that provides its customers with a set of streamlined mobile communications management, identity management, and consulting solutions. The Company’s TM2 framework is a set of state-of-the-art integrated workflow solution that meets Federal Information Security Management Act requirements for data security and other recognized industry compliance certifications related to system processing controls and privacy which enables its customers to focus its valuable resources on managing, analyzing and protecting access to and use of their valuable communication assets. Additionally, the Company’s TM2 platform received an Authorization to Operate by the U.S. Department of Homeland Security (DHS) and the General Service Administration (GSA).

 

The Company derives a significant amount of its revenues from contracts funded by federal government agencies for which WidePoint’s subsidiaries act in the capacity as the prime contractor, or as a subcontractor. The Company believes that contracts with federal government agencies, will be the primary source of revenues for the foreseeable future. External factors outside of the Company’s control such as delays and/or a changes in government administrations, budgets and other political matters that may impact the timing and commencement of such work and could result in variations in operating results and directly affect the Company’s financial performance. Successful contract performance and variation in the volume of activity as well as in the number of contracts commenced or completed during any quarter may cause significant variations in operating results from quarter to quarter.

 

A significant portion of the Company’s expenses, such as personnel and facilities costs, are fixed in the short term and may be not be easily modified to manage through changes in the Company’s market place that may create pressure on pricing and/or costs to deliver its services.

 

The Company has periodic capital expense requirements to maintain and upgrade its internal technology infrastructure tied to its hosted solutions and other such costs may be significant when incurred in any given quarter.

 

Basis of Presentation

 

The unaudited condensed consolidated financial statements as of September 30, 2018 and for each of the three and nine month periods ended September 30, 2018 and 2017, respectively, included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Pursuant to such regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted. It is the opinion of management that all adjustments (which include normal recurring adjustments) necessary for a fair statement of financial results are reflected in the financial statements for the interim periods presented. The condensed consolidated balance sheet as of December 31, 2017 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The results of operations for the three and nine month periods ended September 30, 2018 are not indicative of the operating results for the full year.

 

 

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and acquired entities since their respective dates of acquisition. All significant inter-company amounts were eliminated in consolidation.

 

Foreign Currency

Assets and liabilities denominated in foreign currencies are translated into U.S. dollars based upon exchange rates prevailing at the end of each reporting period. The resulting translation adjustments, along with any related tax effects, are included in accumulated other comprehensive (loss) income, a component of stockholders’ equity. Translation adjustments are reclassified to earnings upon the sale or substantial liquidation of investments in foreign operations. Revenues and expenses are translated at the average month-end exchange rates during the year. Gains and losses related to transactions in a currency other than the functional currency, including operations outside the U.S. where the functional currency is the U.S. dollar, are reported net in the Company’s condensed consolidated statements of operations, depending on the nature of the activity.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the U.S. 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 financial statements and the reported amounts of revenues and expenses during the reporting period. The more significant areas requiring use of estimates and judgment relate to revenue recognition, accounts receivable valuation reserves, ability to realize intangible assets and goodwill, ability to realize deferred income tax assets, fair value of certain financial instruments and the evaluation of contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates. There were no significant changes in accounting estimates used by management during the quarter.

Significant Accounting Policies

 

There have been no significant changes in the Company’s significant accounting policies during the first nine months of 2018 from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on March 21, 2018, except as further described below under Recently Adopted Accounting Standards.

 

Segment Reporting

 

Our TM2 solution offerings comprise an overall single business from which the Company earns revenues and incurs costs. The Company’s TM2 solution offerings are centrally managed and reported on that basis to its Chief Operating Decision Maker who evaluates its business as a single segment. See Note 14 for detailed information regarding the composition of revenues.

 

Accounting Standards Update

 

Recently Adopted Accounting Standards

 

Accounting Standards Codification 606 “Revenue from Contracts with Customers”. In May 2014, ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” was issued. This ASU requires the use of a five-step methodology to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the ASU requires enhanced disclosure regarding revenue recognition.

The standard permits the use of either the retrospective or cumulative effect transition method (modified retrospective method). The Company adopted the ASU on a modified retrospective transition method on January 1, 2018 and will apply the guidance to the most current period presented in the financial statements issued subsequent to the adoption date. The Company did not record a cumulative adjustment to retained earnings as of January 1, 2018 since the Company was recognizing revenue consistent with the provisions of ASC 606 and any adjustment would have been deemed immaterial. In preparation for adoption of the standard, the Company has implemented internal controls to enable the preparation of financial information and have reached conclusions on key accounting assessments related to the standard, including that accounting for variable consideration is immaterial.

 

The Company adopted the standard through the application of the portfolio approach and selected a sample of customer contracts to assess under the guidance of the new standard that are characteristically representative of each revenue stream. The Company has completed its review of the sample contracts, and the Company does not anticipate a significant change to the pattern or timing of revenue recognition as a result of adopting the new standard. The Company revised its revenue recognition policy as follows to incorporate the requirements of the new standard.

 

Revenue from Contracts with Customers

 

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

 

Nature of Products and Services

 

The Company’s TM2 solution consists of three broad services as described below:   

 

 

 

 

 

Significant Judgments

 

The Company’s contracts with customers often include promises to transfer multiple products and services to a customer under a fixed rate or fixed fee arrangement. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Components of our managed service solution are generally distinct performance obligations that are not interdependent and can be completed within a month. The Company’s products are generally sold with a right of return and the Company may provide other event driven credits or disincentives for not meeting performance obligations which are accounted for as variable consideration when estimating the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period as additional information becomes available and only to the extent that it is probable that a significant reversal of any incremental revenue will not occur.

 

Contract Balances

 

A significant portion of contract balances represent revenues earned on federal government contracts. Timing of revenue recognition may differ materially from the timing of invoicing to customers due a long-standing practice of issuing a consolidated managed service invoice. A consolidated invoice usually requires data such as billable hours, units managed, credentials issued, accessories sold and usage data from telecommunications providers and other suppliers. As a result it could take between thirty (30) to sixty (60) days after all performance obligations have been met to deliver a complete customer invoice. As a result, the Company may have both accounts receivables (invoiced revenue) and unbilled receivables (revenue recognize but not yet invoiced) that could represent one or more months of revenue. Additionally, the Company may be required under contractual terms to bill for services in advance and deferred recognition of revenue until all performance obligations have been met.

 

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within thirty (30) to ninety (90) days. Government contract billings are generally due within thirty (30) days of the invoice date. Government accounts receivable payments could be delayed due to administrative processing delays by the government agency, continuing budget resolutions that may delay availability of contract funding, and/or administrative only invoice correction requests by contracting officers that may delay payment processing by our government customer. Commercial accounts receivables are billed based on the underlying contract terms and conditions which generally have repayment terms that range from thirty (30) to ninety (90) days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers.

 

The allowance for doubtful accounts reflects the Company’s best estimate of probable losses inherent in uncollected accounts receivable. Customer accounts receivable balances that remain uncollected for more than 45 days are reviewed for collectability and are considered past due after 90 days unless different contractual repayment terms were extended under a contract with a customer. The Company determines its allowance for doubtful accounts after considering factors that could affect collectability of past due accounts receivable and such factors regularly include the customers’ financial condition and credit worthiness, recent payment history, type of customer and the length of time accounts receivable are past due. Upon specific review and its determination that a bad debt reserve may be required, the Company will reserve such amount if it views the account as potentially uncollectable. Customer accounts receivable balances that remain uncollected for more than 120 days and/or that have not been settled in accordance with contractual repayment terms and for which no firm payment commitments exist are placed with a third party collection agency and a reserve is established for the entire uncollected balance. The Company writes off accounts receivable after 180 days or earlier when they become uncollectible. Payments subsequently received on such receivables are credited to the allowance for doubtful accounts. If the accounts receivable has been written off and no allowance for doubtful accounts exist subsequent payments received are credited to bad debt expense as a recovery.

 

 

Costs to Obtain a Contract with a Customer

 

The Company does not recognize assets from the costs to obtain a contract with a customer and generally expenses these costs as incurred.  The Company primarily uses internal labor to manage and oversee the customer acquisition process and to finalize contract terms and conditions and commence customer start-up activities, if any.  Internal labor costs would be incurred regardless of the outcome of a contract with a customer and as such those costs are not considered incremental to the cost to obtain a contract with a customer.  The Company does not typically incur significant incremental costs to obtain a contract with a customer after such contract has been awarded.  Incremental costs to obtain a contract with a customer may include payment of commissions to certain internal and/or external sales agents upon collection of invoiced sales from the customer.  The Company does not typically prepay sales commissions in advance of being paid for services delivered. 

 

Accounting Standards under Evaluation

 

In February 2016, the FASB issued new accounting guidance on leases. The guidance, effective January 1, 2019, with early adoption permitted, requires virtually all leases to be recognized on the Company’s condensed consolidated balance sheets. The Company will adopt the standard effective January 1, 2019. The new guidance currently requires a modified retrospective transition approach, which would cause us to record existing operating leases on the condensed consolidated balance sheets upon adoption and in the comparative period. In January 2018, the FASB released an exposure draft that, if issued in its current form, would provide the Company with the option to adopt the provisions of the new guidance prospectively, without adjusting the comparative periods presented. The Company is currently reviewing its property and equipment leases and evaluating and interpreting the requirements under the guidance, including the available accounting policy elections, in order to determine the impacts on the consolidated financial position, results of operations and cash flows upon adoption.

 

In January 2017, ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment” was issued. Under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss should not exceed the total amount of goodwill allocated to that reporting unit. The ASU also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity should apply this ASU on a prospective basis and for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The Company is continuing to evaluate the effect this guidance will have on the consolidated financial statements and related disclosures. 

 

In June 2018, the FASB issued ASU 2018-07, Compensation-Stock Compensation (Topic 718); Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 simplifies the accounting for share-based payments made to nonemployees so the accounting for such payments is substantially the same as those made to employees. Under this ASU, share-based awards to non employees will be measured at fair value on the grant date of the awards, entities will need to assess the probability of satisfying performance conditions if any are present, and awards will continue to be classified according to ASC 718 upon vesting, which eliminates the need to reassess classification upon vesting, consistent with awards granted to employees. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. We do not anticipate this update will have a material effect on our consolidated financial statements.

 

On April 30, 2017, the Company entered into an Asset Purchase Agreement with Probaris Technologies, Inc. (“Seller”) and paid approximately $304,300 to purchase certain commercial identity and authentication software assets (the “Software Assets”). Under the terms of the Asset Purchase Agreement, the Company agreed to pay contingent consideration of $100,000 to the Seller if the Seller’s sole government customer renewed its license agreement in 2018. The Company principally purchased the Software Assets to ensure that a key component in the delivery of the Company’s identify management solution offering was neither acquired by a competitor nor no longer made available to license. During the nine month period ended September 30, 2018 the Company settled its contingent consideration and paid $100,000 to the Seller upon renewal of the customer’s annual contract in April 2018.

 

A significant portion of the Company’s receivables are billed under firm fixed price contracts with agencies of the U.S. federal government and similar pricing structures with several large multinational publicly traded and private corporations. Accounts receivable consist of the following by customer type in the table below as of the periods presented:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	(Unaudited)
Government	$5,738,189	$6,055,397
Commercial	2,381,034	2,183,246
Gross accounts receivable	8,119,223	8,238,643
Less: allowances for doubtful
accounts	96,846	107,618
Accounts receivable, net	$8,022,377	$8,131,025

 

Provision for Doubtful Accounts

 

For the three and nine month periods ended September 30, 2018, the Company did not recognize any material provisions for bad debt or write-offs of existing provisions for bad debt. For the nine month period ended September 30, 2017, the Company recorded a provision for bad debt of approximately $31,200 related to a billing dispute with a commercial customer and wrote-off a previously reserved uncollectible customer account of approximately $274,500.

 

The Company has not historically maintained a bad debt reserve for its government customers as it has not experienced material or recurring bad debt charges and the nature and size of the contracts has not necessitated the Company’s establishment of such a bad debt reserve.

 

Significant Concentrations

 

The following table presents customers that represent ten (10) percent or more of consolidated trade accounts receivable in the current and/or comparative period:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	As a % of	As a % of
Customer Name	Receivables	Receivables
	(Unaudited)
U.S. Customs Border Patrol	8%	12%
U.S. Immigration and Customs Enforcement	14%	13%
U.S. Federal Air Marshall Service	4%	10%

 

The following table presents customers that represent ten (10) percent or more of consolidated revenues in the current and/or comparative period:

 

	THREE MONTHS ENDED		NINE MONTHS ENDED
	SEPTEMBER 30,		SEPTEMBER 30,
	2018	2017	2018	2017
	As a % of	As a % of	As a % of	As a % of
Customer Name	Revenues	Revenues	Revenues	Revenues
	(Unaudited)
U.S. Immigration and Customs Enforcement	16%	18%	18%	17%
U.S. Customs Border Patrol	15%	9%	11%	11%
U.S. Citizenship and Immigration Services	15%	5%	5%	5%

 

 

Unbilled accounts receivable represent revenues earned but not invoiced to the customer at the balance sheet date due to either timing of invoice processing or delays due to fixed contractual billing schedules. A significant portion of our unbilled accounts receivable consist of carrier services and hardware and software products delivered but not invoiced at the end of the reporting period.

 

The following table presents customers that represent ten (10) percent or more of consolidated unbilled accounts receivable in the current and/or comparative period:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	As a % of	As a % of
Customer Name	Receivables	Receivables
	(Unaudited)
U.S. Department of Homeland Security Headquarters	13%	11%
U.S. Immigration and Customs Enforcement	30%	27%
U.S. Transportation Safety Administration	12%	12%

 

Other current assets consisted of the following as of the periods presented below:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	(Unaudited)
Inventories	$218,703	$157,058
Prepaid rent, insurance and other assets	744,946	610,886
Total other current assets	$963,649	$767,944

 

Accrued expenses consisted of the following as of the periods presented below:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	(Unaudited)
Carrier service costs	$6,798,020	$7,339,150
Salaries and payroll taxes	1,229,736	1,259,331
Inventory purchases, consultants and other costs	1,012,029	762,770
Severance costs	1,634	328,109
U.S. income tax payable	11,350	8,850
Foreign income tax payable (receivable)	11,600	(1,860)
Contingent consideration (Note 3)	-	100,000
Total accrued expenses	$9,064,369	$9,796,350

 

 

Major classes of property and equipment consisted of the following as of the periods presented below:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	(Unaudited)
Computer hardware and software	$2,042,522	$1,943,180
Furniture and fixtures	334,984	296,316
Leasehold improvements	253,759	260,748
Automobiles	182,314	188,238
Gross property and equipment	2,813,579	2,688,482
Less: accumulated depreciation and
amortization	1,754,793	1,370,062
Property and equipment, net	$1,058,786	$1,318,420

 

During the three and nine month periods ended September 30, 2018 there were other disposals of fully depreciated owned property and equipment with related cost and accumulated depreciation of approximately $129,000.

 

 

During the nine month period ended September 30, 2017, the Company relocated from the Lewis Center Facility to a larger facility in Columbus and abandoned undepreciated building and leasehold improvements with a gross cost and accumulated depreciation of approximately $282,200 and $105,500, respectively. The Company recorded within general and administrative expenses a loss on disposal of approximately $176,700 as a result of the move.

 

There were no changes in the estimated useful lives used to depreciate property and equipment during the three and nine month periods ended September 30, 2018 and 2017.

 

Assets under capital lease included in the table above consisted of the following as of the periods presented below:

 

	SEPTEMBER 30,	DECEMBER 31,
	2018	2017
	(Unaudited)
Automobiles	$97,706	$100,882
Computer hardware and software	290,223	290,223
Gross leased property and equipment	$387,929	$391,105
Less: accumulated amortization	110,539	20,890
Capital lease assets, net	$277,390	$370,215

 

During the nine month period ended September 30, 2018, the Company did not enter into any capital lease arrangements and there were no material sales or disposals of assets under capital leases. During the nine month period ended September 30, 2017, the Company acquired two automobiles under capital lease arrangements and recognized a gross asset of $93,301. For the nine month period ended September 30, 2017, the Company disposed of two leased automobiles with a net book value of $47,800 and received gross proceeds of approximately $51,800. The Company recognized a net gain on disposal of approximately $4,100.

 

Property and equipment depreciation expense (including amortization of capital leases) was approximately as follows for the periods presented below:

 

	THREE MONTHS ENDED		NINE MONTHS ENDED
	SEPTEMBER 30,		SEPTEMBER 30,
	2018	2017	2018	2017
	(Unaudited)
Owned property and equipment depreciation	$108,600	$94,200	$323,200	$282,000
Leased property and equipment amortization	30,500	6,000	91,300	13,800
Total property and equipment depreciation and
amortization	$139,100	$100,200	$414,500	$295,800

 

The Company has recorded goodwill of $18,555,578 as of September 30, 2018. There were no changes in the carrying amount of goodwill during the three and nine month periods ended September 30, 2018. There were no indicators of impairment during the three and nine month periods ended September 30, 2018.

 

The Company has recorded net intangible assets of $3,284,626, consisting of purchased intangibles and internally developed software used to deliver managed service solutions offered by the Company. For the three and nine month periods ended September 30, 2018, the Company capitalized internally developed software costs of approximately $78,500 and $230,100, respectively, related to costs associated with our next generation TDI Optimiser™ application. There were no disposals of intangible assets during the three month period ended September 30, 2018. For the nine month period ended September 30, 2018 there were disposals of fully amortized intangible assets of approximately $2,374,700. There were no material disposals of intangible assets during the three and nine month periods ended September 30, 2017.

 

The aggregate amortization expense recorded for the three month periods ended September 30, 2018 and 2017 were approximately $213,800 and $276,400, respectively. The aggregate amortization expense recorded for the nine month periods ended September 30, 2018 and 2017 were approximately $700,400 and $812,200, respectively. The total weighted remaining average life of all purchased intangible assets and internally developed software costs was approximately 5.8 years and 1.8 years, respectively, at September 30, 2018.

 

 

Commercial Loan Agreement Facility

 

On June 15, 2017, the Company entered into a Loan and Security Agreement with Access National Bank (the “Loan Agreement”). The Loan Agreement provides for a $5.0 million working capital revolving line of credit. Effective April 30, 2018, the Company entered into a second modification agreement (“Modification Agreement”) with Access National Bank to amend the existing Loan Agreement. The Modification Agreement extended the maturity date of the facility through April 30, 2019 and added an additional financial covenant requiring the Company to maintain consolidated minimum adjusted earnings before interest, taxes, depreciation and amortization, plus share-based compensation, plus non-cash charges (EBITDA) (as defined in the Modification Agreement) of at least two times interest expense to be measured as of the last day of each quarterly period.

 

The Loan Agreement requires that the Company meet the following financial covenants on a quarterly basis: (i) maintain a minimum adjusted tangible net worth of at least $2.0 million, (ii) maintain minimum consolidated adjusted EBITDA of at least two times interest expense and (iii) maintain a current ratio of 1.10:1.

 

The available amount under the working capital line of credit is subject to a borrowing base, which is equal to the lesser of (i) $5.0 million or (ii) 70% of the net unpaid balance of the Company’s eligible accounts receivable. The interest rate for the working capital line of credit is the Wall Street Journal prime rate plus 1.0%. The facility is secured by a first lien security interest on all of the Company’s personal property, including its accounts receivable, general intangibles, inventory and equipment maintained in the United States. As of September 30, 2018, the Company was eligible to borrow up to $4.8 million under the borrowing base formula.

 

Capital Leases and Other Term Obligations

 

Capital leases and other term obligations consisted of the following:

 

	SEPTEMBER 30, 2018			DECEMBER 31, 2017
	Current	Non-Current		Current	Non-Current
	Portion	Portion	Total	Portion	Portion	Total
	(Unaudited)			(Unaudited)
Capital Lease Obligations (1)	$105,712	$151,037	$256,749	$101,591	$232,109	$333,700
Deferred Rent Liability (2)	45,043	64,006	109,049	70,021	78,336	148,357
Short term installment borrowings (3)	62,066	-	62,066	133,250	-	133,250
Total Other Term Obligations	$107,109	$64,006	$171,115	$203,271	$78,336	$281,607
Total Capital Leases and Other
Term Obligations	$212,821	$215,043		$304,862	$310,445

 

(1) As more fully described in Note 7, the Company entered into capital leases to acquire computer hardware and software for its client facing infrastructure and two automobiles that expire between 2020 and 2021.

 

(2) The Company has two long term building lease obligations that contain fixed rent escalations and rent abatements. The Company has recognized a deferred rent liability related to the difference between actual cash rent paid and rent recognized for financial reporting purposes.

 

(3) The Company annually finances the cost of its commercial liability insurance premiums for a period of less than 12 months.

 

 

Capital Lease Obligations

 

Minimum lease payments required under capital leases range from $695 to $8,900, respectively, and these leases expire in March 2020. The following sets forth the Company’s future minimum payment obligations under these capital lease agreements for fiscal years ending September 30 (unaudited):

 

2018	$121,951
2019	121,951
2020	36,432
Total principal and interest payments	280,334
Less: portion representing interest	23,585
Present value of minimum lease payments
under capital leases	256,749
Less: current portion	105,712
Capital leases, net of current portion	$151,037

 

The Company files U.S. federal income tax returns with the Internal Revenue Service (“IRS”) as well as income tax returns in various states and certain foreign countries. The Company may be subject to examination by the IRS or various state taxing jurisdictions for tax years 2003 and forward. The Company may be subject to examination by various foreign countries for tax years 2014 forward. As of September 30, 2018, the Company was not under examination by the IRS, any state or foreign tax jurisdiction. The Company did not have any unrecognized tax benefits at either September 30, 2018 or December 31, 2017. In the future if applicable, any interest and penalties related to uncertain tax positions will be recognized in income tax expense.

 

As of September 30, 2018, the Company had approximately $36.7 million in net operating loss (NOL) carry forwards available to offset future taxable income for federal income tax purposes, net of the potential Section 382 limitations. These federal NOL carry forwards expire between 2020 and 2037. Included in the recorded deferred tax asset, the Company had a benefit of approximately $44.0 million available to offset future taxable income for state income tax purposes. These state NOL carry forwards expire between 2024 and 2036. Because of the change of ownership provisions of the Tax Reform Act of 1986, use of a portion of our domestic NOL may be limited in future periods. Further, a portion of the carryforwards may expire before being applied to reduce future income tax liabilities.

 

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. Under existing income tax accounting standards such objective evidence is more heavily weighted in comparison to other subjective evidence such as our projections for future growth, tax planning and other tax strategies. A significant piece of objective negative evidence considered in management’s evaluation of the realizability of its deferred tax assets was the existence of cumulative losses over the latest three-year period. Management forecast future taxable income, but concluded that there may not be enough of a recovery before the end of the fiscal year to overcome the negative objective evidence of three years of cumulative losses. On the basis of this evaluation, management recorded a valuation allowance against all deferred tax assets. If management’s assumptions change and we determine we will be able to realize these deferred tax assets, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets will be accounted for as a reduction of income tax expense.

 

 

There were no issuances of preferred stock during the nine month periods ended September 30, 2018 and 2017.

Common Stock

 

The Company is authorized to issue 110,000,000 shares of common stock, $.001 par value per share. As of September 30, 2018, there were 84,062,446 shares issued (including 980,851 restricted stock awards issued, of which 300,000 were unvested) and 83,762,446 shares of common stock outstanding. There were no shares of common stock issued as a result of the vesting of restricted stock awards (RSA) or stock option exercises during the three month period ended September 30, 2018. The Company issued 102,525 shares of common stock, as a result of the vesting of a portion of RSAs during the three month period ended September 30, 2017. See Note 12 for additional information regarding RSA activity.

 

 

There were no shares of common stock issued as a result of stock option exercises during the three month periods ended September 30, 2018 and 2017. Shares of common stock issued as a result of stock option exercises and realized gross proceeds during the nine month period ended September 30, 2018 were 50,000 and $22,000, respectively. Shares of common stock issued as a result of stock option exercises and realized gross proceeds during the nine month period ended September 30, 2017 were 30,000 and $17,100, respectively. See Note 12 for additional information regarding the stock incentive plans.

The Company’s stock incentive plan is administered by the Compensation Committee and authorizes the grant or award of incentive stock options, nonqualified stock options, restricted stock awards, stock appreciation rights, dividend equivalent rights, performance unit awards and phantom shares. The Company issues new shares of common stock upon the issuance of restricted stock or exercise of stock options. Any shares associated with unvested restricted stock and non-qualified stock options forfeited are added back to the number of shares that underlie stock options to be granted under the stock incentive plan. The Company has issued restricted stock awards and non-qualified stock option awards as described below.

Valuation of Stock Awards

The Company estimates the fair value of nonqualified stock awards using a Black-Scholes Option Pricing model (“Black-Scholes model”). The fair value of each stock award is estimated on the date of grant using a Black-Scholes model, which requires an assumption of dividend yield, risk free interest rates, volatility, forfeiture rates and expected option life. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant. Expected volatilities are based on the historical volatility of our common stock over the expected option term. The expected term of options granted is based on analyses of historical employee termination rates and option exercises. There were 125,000 non-qualified stock option awards granted during the three and nine month periods ended September 30, 2018.

The Company records the fair value of all restricted stock awards based on the grant date fair value and amortizes stock compensation on a straight-line basis over the vesting period. Restricted stock award shares are issued when granted and included in the total number of common shares issued but not included in total common shares outstanding until the vesting requirements have been met. As of September 30, 2018, there were 980,851 shares of restricted stock included in shares issued, of which 300,000 were unvested as of September 30, 2018.

Restricted Stock Award Activity

 

A summary of RSA activity as of September 30, 2018 and 2017, and changes during the nine month periods ended September 30, 2018 and 2017 are set forth below:

 

	2018		2017
NON-VESTED AWARDS	(Unaudited)
Non-vested awards outstanding, January 1,	-		250,000
Granted (+)	980,851	(1)	300,000
Cancelled (-)	-		150,000
Vested (-)	680,851	(1)	275,000
Non-vested awards outstanding, September 30,	300,000		125,000
Weighted-average remaining contractual life (in years)	0.8		0.2
Unamortized RSA compensation expense	$153,418		$1,090
Aggregate intrinsic value of RSAs non-vested, September 30	$138,000		$81,250
Aggregate intrinsic value of RSAs vested, September 30	$320,000		$177,750

 

(1) During the nine month period ended September 30, 2018, the Company granted 980,851 RSAs, of which i) 300,000 of RSAs were awarded as part of additional compensation plan to align key employees with the Company’s long term financial goals, and ii) 680,851 were awarded to members of the Company’s board of directors as part of their annual board retainer fee and vested during the period.

 

 

(2) During the nine month period ended September 30, 2017, the Company granted 300,000 RSAs to its former Chief Executive Officer that had a grant date fair value of approximately $246,000. The vesting of these RSAs were tied to attainment of certain financial goals as outlined by the Company’s Compensation Committee of the Board of Directors. On June 30, 2017, in connection with resignation of our former Chief Executive Officer, the Board of Directors accelerated vesting of 150,000 RSAs and cancelled the remaining unvested RSAs.

 

(3) During the nine month period ended September 30, 2017, 125,000 RSAs vested upon expiration of the employment agreement between Steve L. Komar and the Company. On January 3, 2017, the Company issued 84,188 shares of the Company’s common stock. Mr. Komar received less than 125,000 shares vested because he elected to have 40,812 of such shares withheld in satisfaction of the corresponding tax liability of approximately $46,000. The Company's payment of this tax liability was recorded as a cash flow from financing activity on the Condensed Consolidated Statements of Cash Flows.

 

Non-Qualified Stock Option Award Activity

 

A summary of stock option activity as of September 30, 2018 and 2017, and changes during the nine month periods ended September 30, 2018 and 2017 are set forth below:

 

	2018			2017
			Weighted			Weighted
			Average			Average
			Grant Date			Grant Date
NON-VESTED AWARDS	Shares		Fair Value	Shares		Fair Value
	(Unaudited)
Non-vested balances, January 1,	2,685,004		$0.35	920,000		$0.59
Granted (+)	125,000	(1)	$0.25	3,440,000	(2)	$0.30
Cancelled (-)	50,000	(3)	$0.32	860,000	(3)	$0.68
Vested/Excercised (-)	312,500		$0.26	110,000		$0.69
Non-vested balances, September 30,	2,447,504		$0.35	3,390,000		$0.27

 

 

	2018			2017
			Weighted			Weighted
			Average			Average
OUTSTANDING AND EXERCISABLE AWARDS	Shares		Exercise Price	Shares		Exercise Price
	(Unaudited)
Awards outstanding, January 1,	4,173,334		$0.60	2,090,668		$0.86
Granted (+)	125,000	(1)	$0.50	3,440,000	(2)	$0.59
Cancelled (-)	110,000	(3)	$1.11	1,402,334	(3)	$0.97
Exercised (-)	50,000	(4)	$0.44	30,000	(4)	$0.57
Awards outstanding, September 30,	4,138,334		$0.58	4,098,334		$0.60
Awards vested and expected to vest,
September 30,	3,547,472		$0.58	3,614,538		$0.59
Awards outstanding and exercisable,
September 30,	1,690,830		$0.56	708,334		$0.73