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| Share Name | Share Symbol | Market | Type |
|---|---|---|---|
| ImageWare Systems Incorporated (CE) | USOTC:IWSY | OTCMarkets | Common Stock |
| Price Change | % Change | Share Price | Bid Price | Offer Price | High Price | Low Price | Open Price | Shares Traded | Last Trade | |
|---|---|---|---|---|---|---|---|---|---|---|
| 0.00 | 0.00% | 0.000001 | 0.00 | 01:00:00 |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2021
| ☐ | 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 001-15757
IMAGEWARE SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
| Delaware | 33-0224167 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. 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) | ||
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| Common Stock, par value $0.01 per share | IWSY | OTCQB Marketplace |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 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 a shorter period that the registrant was required to submit such files). Yes ☒ 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 | ☒ | Small 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. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes ☐ No ☒
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of June 30, 2021, the last business day of the registrant’s most recently completed second fiscal quarter, as reported on the OTCQB marketplace was $12,307,779. This number excludes shares of common stock held by affiliates, executive officers and directors.
As of April 12, 2022, there were 347,962,742 shares of the registrant’s common stock outstanding.
Form 10-K
For the Year Ended December 31, 2021
Table of Contents
| Page |
|||
| PART I |
|||
| Item 1. |
1 | ||
| Item 1A. |
6 | ||
| Item 1B. |
18 | ||
| Item 2. |
18 | ||
| Item 3. |
18 | ||
| Item 4. |
18 | ||
| PART II |
|||
| Item 5. |
19 | ||
| Item 6. |
19 | ||
| Item 7. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
19 | |
| Item 7A. |
37 | ||
| Item 8. |
37 | ||
| Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
37 | |
| Item 9A. |
37 | ||
| Item 9B. |
37 | ||
| Part III |
|||
| Item 10. |
38 | ||
| Item 11. |
42 | ||
| Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters |
44 | |
| Item 13. |
Certain Relationships and Related Transactions, and Director Independence |
48 | |
| Item 14. |
49 | ||
| PART IV |
|||
| Item 15. |
50 | ||
| 50 | |||
| 54 | |||
CAUTIONARY STATEMENT
This Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Annual Report. Additionally, statements concerning future matters such as the development of new products, sales levels, expense levels and other statements regarding matters that are not historical are forward-looking statements.
Although forward-looking statements in this Annual Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed under the heading “Risk Factors” in Item 1A, as well as those discussed elsewhere in this Annual Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report. Readers are urged to carefully review and consider the various disclosures made in this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.
| ITEM 1. |
BUSINESS |
Imageware Systems, Inc., a Delaware corporation, has its principal place of business at 11440 West Bernardo Court, Suite 300, San Diego, California 92127. We maintain a corporate website at www.imageware.io. Our common stock, par value $0.01 per share (“Common Stock”), is currently listed for quotation on the OTCQB marketplace under the symbol “IWSY”. As used in this Annual Report, “we”, “us”, “our”, “Imageware”, “Imageware Systems” or the “Company” refers to Imageware Systems, Inc. and all of its subsidiaries.
Overview
Imageware Systems, Inc. (“Imageware,” the “Company,” “we,” “our”) provides biometric solutions to identify, verify, and authenticate people based on their true identity, rather than on what keys and codes they have. A pioneer in the field, Imageware was the first multimodal biometric solution provider in history and holds dozens of patents, including some of the most cited patents in the industry. Our Cloud-based and on-premises solutions provide faster, more accurate identification to better secure communities, data, and assets. In fact, governments, law enforcement agencies, and public and private enterprises worldwide trust Imageware with critical identity solutions which manage millions of identities every day.
Recent Developments
December 2021 Credit Facility
On December 29, 2021 (the “Closing Date”), the Company entered into a Term Loan and Security Agreement (the “Agreement”) with certain funds and separate accounts managed by Nantahala Capital Management, LLC (collectively, “Nantahala”), as lenders, and other lenders set forth on the signature pages thereto (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2,500,000 (the “Credit Facility”). All loans (each a “Loan", and collectively, the “Loans”) under the Credit Facility will bear interest at a rate of 12% for the initial six months after the Closing Date, and at 17% thereafter until the maturity date of 12 months from the Closing Date (the “Maturity Date”). All amounts borrowed by the Company under the Credit Facility are secured by a first-priority lien on all the assets of the Company. On the Closing Date, the Company received an initial draw-down on the Credit Facility of $600,000. As of April 12, 2022, the Company received two subsequent draw-downs aggregating $1,050,000. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes.
The Company may prepay amounts borrowed under the Credit Facility in whole or in part, at a price equal to 105% of the principal amount borrowed under the Credit Facility (including any interest capitalized thereon), subject to additional prepayment terms pursuant to the Agreement, a copy of which is filed as an Exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission (the “SEC”) on January 4, 2022. In addition, pursuant to the Agreement, at any time after the Closing Date, each Lender shall have the right, but not the obligation, on mutually agreed upon terms, to exchange each such Lender’s pro rata portion of shares of the Company’s Series D Convertible Preferred Stock, par value $0.01 (“Series D Preferred”) held by such Lender for a mutually agreed upon portion of any subsequent Delayed Draw Loan (as defined in the Agreement) (an “Exchange”). Upon the Company's receipt by a Lender of a notice stating a Lender's intent to participate in an Exchange, the Company is required to offer to all holders of Series D Preferred the opportunity, but not the obligation, to exchange each such holder’s pro rata portion of shares of the Company's Series D Preferred held by such holder for participation in any subsequent Delayed Draw Loan, upon substantially similar terms as those provided in the applicable notice of Exchange by a Lender.
Strategic Review and Going Concern
On August 12, 2021, the Company retained an investment bank to initiate a review of available alternatives to maximize shareholder value, which may include, among other alternatives, (i) a merger, consolidation, or other business combination or a purchase involving all or a substantial amount of the business, securities or assets of the Company, and/or (ii) the private placement of securities to meet its working capital requirements or otherwise as necessary in connection with the consummation of any of the above transactions. To date, the Company has not received any offers or other indications of interest on terms and conditions acceptable to the Board of Directors (“Board”), nor has the Board received any committed financing arrangements to support our projected cash shortfall to address our projected working capital requirements during the next twelve months, 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 capital through the issuance of debt and/or equity securities, or entering into any other transaction that addresses our ability to continue as a going concern. The consummation of a transaction will likely involve substantial dilution to the Company’s stockholders and may result in the loss of your entire investment. In the event the Company is unable to consummate one or more transactions in the near term, the Company will not be able to continue as a going concern.
New Products
In February 2021, we released a new and improved Imageware Authenticate (formerly, GoVerifyID) solution, enabling users to leverage multimodal biometrics on a central server or in the Cloud to log into applications and services.
In October 2021, we completed Imageware Capture, the first module of the new Law Enforcement 2.0 solution. Imageware Capture facilitates the fastest capture of biographic and biometric detail such as face, fingerprint, palm print, iris, and Scars, Marks and Tattoos (“SMTs”) in the industry.
In December 2021, we completed Imageware Investigate, the second module of the new Law Enforcement 2.0 solution. Imageware Investigate enables law enforcement professionals to rapidly create digital lineups.
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 April 12, 2022, the global outbreak of COVID-19 continues to 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 continued 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.
Products and Solutions
Our patented Imageware Biometric Engine® is one of the most accurate and fastest biometrics matching engines in the industry, capable of our patented biometrics fusion. We are a “biometrics first” company, leveraging unique human characteristics to provide unparalleled accuracy for identification while protecting your identity.
Our product portfolio, called the Imageware Identity Platform, is built around three key areas: Enroll & Identify, Badge & Credential, and Authenticate. All of these areas are built on top of the Imageware Biometric Engine. The Platform is a fully-modular, customizable, and pre-integrated portfolio of capabilities to support state and local law enforcement, Federal agencies, and enterprises alike.
Enroll & Identify
The Enroll & Identify area includes four key modules: Imageware Proof, Imageware Capture, Imageware Identify, and Imageware Investigate.
Imageware Proof enables an entity to prove someone’s identity from their biometrics, government issued ID, and 3rd party databases (such as credit bureau data). Imageware Capture enables the fastest capture of biographic and biometric detail (such as face, fingerprint, palm print, iris, and SMT’s) in the industry. Imageware Identify enables a user to identify someone from their biometrics in seconds. Imageware Investigate enables an officer to create digital lineups very quickly.
Badge & Credential
The Badge & Credential area includes two key modules: Imageware Credential (formerly EPI Suite) and Imageware Digital ID. Imageware Credential enables a user to design, build, and print badges for access control systems. This includes tickets, smart badges, wristbands, Personal Identity Verification (“PIV”) cards, and more. Imageware Digital ID is a decentralized identity service that enables self-sovereign identity underpinned by blockchain technology tied to biometrics.
Authenticate
The Authenticate area includes Imageware Authenticate, which enables users to leverage multimodal biometrics hosted in a central server or cloud to log in to services and applications from any device. Imageware Authenticate is easily integrated into existing solutions leveraging OpenID Connect (“OIDC”), Security Assertion Mark-up Language (“SAML”), or OAuth2 protocols, and includes a software development kit (“SDK”) for partners and customers to easily embed into their existing applications.
Imageware Biometric Engine
The Imageware Biometric Engine® is a patented biometric identity and authentication database built for multi-biometric enrollment, management and authentication. It is hardware agnostic and can utilize different types of biometric algorithms from any vendor. It allows different types of biometrics to be operated at the same time on a seamlessly integrated platform. It is also offered as an SDK, enabling developers and system integrators to implement biometric solutions or integrate biometric capabilities, into existing applications.
Imageware Law Enforcement
Our modules are leveraged across many industries and use cases with minimal customization needed. One of the key areas includes our Law Enforcement 2.0 solution which enables state, local and federal agencies to quickly capture, archive, search, retrieve, and share digital images, fingerprints and other biometrics, as well as criminal history records on a stand-alone, networked, wireless or browser-based platform. Our Imageware Law Enforcement 2.0 solution includes Imageware Capture, Imageware Identify, Imageware Investigate, Imageware Credential, and Imageware Authenticate. Other modules can also be easily leveraged as needed.
Maintenance and Customer Support
Maintenance and support enrollment entitles software license customers to technical support services, including telephone and email support, problem resolution services, and the right to receive unspecified product upgrades, maintenance releases and patches released during the term of the support period. Maintenance and support service fees are an important source of recurring revenue, and we invest continuing resources into providing maintenance and support services.
Customers
We have a wide variety of domestic and international customers. Most of our Law Enforcement 2.0 customers are government agencies at the federal, state and local levels in the United States and Canada, but we also have clients outside of North America. For the year ended December 31, 2021, three customers accounted for approximately 51% or $1,787,000 of total revenue and had trade receivables of approximately $172,000 as of the end of the year. For the year ended December 31, 2020, two customers accounted for approximately 61% or $2,921,000 of total revenue and had trade receivables of approximately $250,000 as of the end of the year.
Our Strategy
Our strategy is to be a “biometric first” cybersecurity company bringing the highest level of security to systems, data and places by identifying and authenticating people through biometrics. We sell to governments, law enforcement and public safety, as well as enterprises, through key partners and large systems integrators and with our own direct sales team.
With recent COVID-19 events, remote work and social distancing have quickly been brought to the forefront of society. And while the impact of these events will be seen in the coming years, many problems have been immediately realized by corporations and government agencies, who are diligently looking for solutions to operate in a new business environment.
Within a matter of weeks, corporations and government agencies have had to heavily rely upon remote access technologies to enable work continuity through the pandemic. This increase in employees remotely accessing sensitive corporate systems has increased the risk of both cybercrime and unintentional information leaks. This risk is also increased by the fact that many employees now use a mixture of personal and corporate owned devices on the job, a trend known as, Bring Your Own Device (“BYOD”).
Verification of an individual through biometrics is an effective way to authenticate users accessing sensitive information and systems. Imageware Authenticate provides this functionality and is already integrated in many of the authentication systems leveraged by large companies and agencies to manage the identities of their employees and users. We will market and sell Imageware Authenticate as a solution for protecting corporate data to the most relevant business verticals during this time of increased susceptibility to broad cyberattacks, such as malware, viruses, trojans, ransomware infections and phishing attacks.
Additionally, social distancing and the need to limit personal contact throughout everyday life is driving governments and corporations to deploy new ways to continue work and commerce while minimizing contact points between individuals. We believe this trend will increase the acceptance and use of biometrics as a means of contactless and touchless authentication for health, retail, finance/banking, government services, higher education and transportation.
Scaling out biometrics across these verticals is going to require new methods and solutions to support the increased number of users and transactions. With our decades of experience innovating and scaling government grade biometric solutions and our years executed strategy of creating multimodal, vendor agnostic solutions, Imageware has had a rich portfolio of products and solutions to address these new challenges brought on by the pandemic.
Additionally, the law enforcement community continues to be an important market and customer base. Over the past few years, innovation within our law enforcement product line has been static, which has resulted in revenue being primarily driven from support and maintenance. Recently, Imageware released the Law Enforcement 2.0 solution, with the first two modules, Imageware Capture and Imageware Investigate, launched in October 2021 and December 2021, respectively. The law enforcement market will immediately benefit from this solution. Beyond the law enforcement vertical, the modules in the Law Enforcement 2.0 solution can be leveraged to service other verticals such as financial services, telecommunications, education,, hospitality and entertainment.
We believe the increasing demand for biometric technology will drive demand for our solutions. In the coming year, we will work to develop additional modules within the Imageware Identity Platform. This platform combines all of our products into a modular, end-to-end, Cloud-based platform. Our platform allows a customer to create and manage a verified digital identity, issue both physical and digital credentials, and leverage biometrics for both identification and authentication. We have built out a multi-year strategic roadmap for additional modules to include into the Imageware Identity Platform and open additional use cases, industries, and high value sales for the Company.
Sales and Marketing
We market and sell our products in most major world markets directly through our sales force and indirectly through channel partners, including resellers, distributors and systems integrators. Our sales force includes both field, and inside sales, which provides us a lower-cost channel for additional sales into existing customers and for expanding our customer base.
International Operations
We are a global company. We are headquartered in San Diego, California with a remote office in Ottawa, Canada. Our main business operations are based in San Diego, California. We regularly seek out opportunities to efficiently expand our operations in international locations that offer highly talented resources as a way to maximize our global competitiveness.
Software Licenses
The bulk of our revenue presently is generated from new subscription and historical maintenance payments for our software solutions for Law Enforcement, Badging, Identity Management, and Multi-Factor Authentication (“MFA”). We currently have four primary revenue sources:
- Annual Maintenance of our Law Enforcement Solution;
- Perpetual license revenue of our Badging Solution;
- Term Subscriptions of our Imageware Authenticate solution; and
- Professional Services fees associated with implementation and training for our customers.
We are actively engaged in simplifying our revenue sources, migrating our existing customers’ annual maintenance, and perpetual license agreements to more consistent and sustainable subscription models.
Software as a Service Business Model
We also provide an on-demand SaaS offering for Imageware Authenticate and all solutions in the Law Enforcement 2.0 solution. SaaS offerings will be offered on a subscription term-limited basis. We are exploring offering additional products as SaaS offerings on a subscription term-limited basis.
Competition
Biometric Market
The market to provide biometric systems to the identity management market is evolving and we face competition from a number of sources. We believe that the strength of our competitive position is based on:
| ● |
Our ability to provide a system which enables the enrollment, management and authentication of multiple biometrics managing population databases of unlimited sizes; |
| ● |
Searches can be 1:1 (verification), 1:N (identification), and N:N (database integrity); and |
| ● |
The system is technology and biometric agnostic, enabling the use of biometric devices and algorithms from any vendor, and the support of the following biometric types: finger, face, iris, palm and voice. |
Our multifactor-biometric product faces competition from Duo, HYPR, Daon and Aware Inc., none of which have offerings with the scope and flexibility of our Biometric Engine and its companion suite of products or relevant patent protection.
Credential Market
Due to the breadth of our software offering in the secure credential market space, we face differing degrees of competition in certain market segments. The strength of our competitive position is based upon:
| ● |
Our strong brand reputation with a customer base, which includes small and medium-sized businesses, Fortune 1000 corporations and large government agencies; |
| ● |
The ease of integrating our technology into other complex applications; |
| ● |
The leveraged strength that comes from offering customers software tools, packaged solutions and web-based service applications that support a wide range of hardware peripherals; and |
| ● |
The ease of hacking traditional NFC access control systems. |
Our software faces competition from a number of companies, like HID Global, ASSA ABLOY, Gemalto, as well as small, regionally based companies.
The Law Enforcement and Public Safety Markets
Due to the fragmented nature of the law enforcement and public safety market and the modular nature of our product suite, we face different degrees of competition with respect to each Law Enforcement module. We believe the principal bases on which we compete with respect to all of our products are:
| ● |
The unique ability to integrate our modular products into a complete biometric, LiveScan, imaging and investigative system; |
| ● |
Our reputation as a reliable systems supplier; |
| ● |
The usability and functionality of our products; |
| ● |
The responsiveness, availability and reliability of our customer support; and |
| ● |
Hardware agnostic across many biometric vendors. |
Our law enforcement product line faces competition from other companies such as DataWorks Plus, Idemia, Gemalto and NEC. Internationally, there are often a number of local companies offering solutions in most countries.
Intellectual Property
We rely on trademark, patent, trade secret and copyright laws and confidentiality and license agreements to protect our intellectual property. We have several federally registered trademarks, including the trademark Imageware and Biometric Engine, as well as trademarks for which there are pending trademark registrations with the United States, Canadian and other International Patent & Trademark Offices.
We hold several issued patents and have several other patent applications pending for elements of our products. We believe we have the foundational patents regarding the use of multiple biometrics and continue to be an IP leader in the biometric arena. It is our belief that this intellectual property leadership will create a sustainable competitive advantage.
We are an early pioneer of patents related to multi-modal biometrics and currently are a worldwide leader in multi-modal biometric patents, with 27 issued patents worldwide and 14 pending or allowed patent applications worldwide as well. The Company’s patents are as follows:
US Issued Patents – 17
US Allowed Patents – 1
US Patent Applications – 3
International Issued Patents – 10
International Patent Applications – 10
Total Worldwide Issued Patents – 27
Total Worldwide Allowed Patents – 1
Total Worldwide Patent Applications – 14
Employees
We had a total of 26 full-time employees as of December 31, 2021, of which 22 employees are based in the United States and four employees are based in Canada. Our employees are not covered by any collective bargaining agreement, and we have never experienced a work stoppage. We believe that our relations with our employees are good.
Environmental Regulation
Our business does not require us to comply with any particular environmental regulations.
Additional Available Information
We make available, free of charge, at our corporate website www.imageware.io copies of our annual reports filed with the SEC on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and all amendments to these reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act. We also provide copies of our Forms 8-K, 10-K, 10-Q, and proxy statements at no charge to investors upon request. Additionally, all reports filed by us with the SEC are available free of charge via EDGAR through the SEC website at www.sec.gov.
| RISK FACTORS |
Our business is subject to significant risks. You should carefully consider the risks described below and the other information in this Annual Report, including our financial statements and related notes, before you decide to invest in our Common Stock. If any of the following risks or uncertainties actually occur, our business, results of operations or financial condition could be materially harmed, the trading price of our Common Stock could decline, and you could lose all or part of your investment. The risks and uncertainties described below are those that we currently believe may materially affect us; however, they may not be the only ones that we face. Additional risks and uncertainties of which we are unaware or currently deem immaterial may also become important factors that may harm our business. Except as required by law, we undertake no obligations to update any risk factors.
RISKS RELATED TO OUR LIQUIDITY, BUSINESS AND INDUSTRY
Available cash resources are currently insufficient to provide for our working capital needs. As a result, we need to raise additional capital in the near term to continue as a going concern.
At December 31, 2021 and 2020, we had negative working capital of $8,046,000 and $19,349,000, respectively. Our principal source of liquidity at December 31, 2021 and 2020 consisted of cash and cash equivalents of $1,202,000 and $8,345,000, respectively. Considering the financings consummated in 2020 and 2021, as well as our projected cash requirements, and assuming we are unable to generate incremental revenue, our available cash is insufficient to satisfy our cash requirements. These factors raise substantial doubt about our ability to continue as a going concern. To address our working capital requirements, management is actively seeking additional equity and/or debt financing through the issuance of additional debt and/or equity securities and is contemporaneously seeking strategic or other transactions intended to increase shareholder value. There are currently no formal committed financing arrangements to support our projected cash shortfall during the next twelve months, 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 capital through the issuance of debt and/or equity securities, or entering into any other transaction that addresses our ability to continue as a going concern.
To continue as a going concern, the Company is currently exploring strategic options and is reviewing its assets, the outcome of which is uncertain and may involve substantial dilution to shareholders and/or a loss of your entire investment.
As reported in the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 23, 2021, on August 12, 2021, the Company retained an investment bank to initiate a review of available alternatives to maximize shareholder value, which may include, among other alternatives, (i) a merger, consolidation, or other business combination or a purchase involving all or a substantial amount of the business, securities or assets of the Company, and/or (ii) the private placement of securities to meet its working capital requirements or otherwise as necessary in connection with the consummation of any of the above transactions. To date, the Company has not received any offers or other indications of interest acceptable to the Company’s Board, and no assurances can be given that the Company will be successful in consummating any or a combination of such alternatives. The consummation of a transaction will likely involve substantial dilution to the Company’s stockholders and may involve the loss of your entire investment. In the event the Company is unable to consummate one or more transactions, the Company may not be able to continue as a going concern.
We have a history of significant recurring losses totaling approximately $204.3 million at December 31, 2021 and $213.2 million and December 31, 2020, and these losses may continue in the future.
As of December 31, 2021 and 2020, we had an accumulated deficit of approximately $204.3 million and $213.2 million, respectively, and these losses may continue in the future. We expect to continue to incur significant sales and marketing, research and development, and general and administrative expense. As a result, we will need to generate significant revenue to achieve profitability, and we may never achieve profitability.
Our operating results have fluctuated in the past and are likely to fluctuate in the future.
Our operating results have fluctuated in the past. These fluctuations in operating results are the consequence of the following, amongst other things:
| ● | Varying demand for and market acceptance of our technology and products; |
| ● | Changes in our product or customer mix; |
| ● | The gain or loss of one or more key customers or their key customers, or significant changes in the financial condition of one or more of our key customers or their key customers; |
| ● | Our ability to introduce, certify and deliver new products and technologies on a timely basis; |
| ● | The announcement or introduction of products and technologies by our competitors; |
| ● | Competitive pressures on selling prices; |
| ● | Costs associated with acquisitions and the integration of acquired companies, products and technologies; |
| ● | Our ability to successfully integrate acquired companies, products and technologies; |
| ● | Our accounting and legal expense; and |
| ● | General economic conditions. |
These factors, some of which are not within our control, will likely continue in the future. To respond to these and other factors, we may need to make business decisions that could result in failure to meet financial expectations. If our quarterly operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and significantly. Most of our expense, such as employee compensation and inventory, is relatively fixed in the short term. Moreover, our expense levels are based, in part, on our expectations regarding future revenue levels. As a result, if our revenue for a particular period was below our expectations, we may not be able to proportionately reduce our operating expense for that period. Any revenue shortfall would have a disproportionately negative effect on our operating results for the period.
We depend upon a small number of large system sales ranging from $100,000 to in excess of several million dollars and we may fail to achieve one or more large system sales in the future.
Historically, we have derived a substantial portion of our revenue from a small number of sales of large, relatively expensive systems, typically ranging in price from $100,000 to $2,000,000. If we fail to receive orders for these large systems in a given sales cycle on a consistent basis, our business could be significantly harmed. Further, our quarterly results are difficult to predict because we cannot predict in which quarter, if any, large system sales will occur in a given year. As a result, we believe that quarter-to-quarter comparisons of our results of operations are not a good indication of our future performance. In some future quarters, our operating results may be below the expectations of securities analysts and investors, in which case the market price of our Common Stock may decrease significantly.
Our lengthy sales cycle may cause us to expend significant resources for one year or more in anticipation of a sale to certain customers, yet we still may fail to complete the sale.
When considering the purchase of a large identity management product, potential customers may take as long as eighteen months to evaluate different solutions and obtain approval for the purchase. Under these circumstances, if we fail to complete a sale, we will have expended significant resources and received no revenue in return. Generally, customers consider a wide range of issues before committing to purchase our products, including product benefits, ability to operate with their current systems, product reliability and their own budgetary constraints. While potential customers are evaluating our products, we may incur substantial selling costs and expend significant management resources in an effort to accomplish potential sales that may never occur. In times of economic recession, our potential customers may be unwilling or unable to commit resources to the purchase of new and costly systems.
A number of our customers and potential customers are local, state, and federal government agencies that are subject to unique political and budgetary constraints and have special contracting requirements, which may affect our ability to obtain new and retain current government customers.
A significant number of our customers are government agencies. These agencies often do not set their own budgets and therefore have little control over the amount of money they can spend from quarter-to-quarter or year-to-year. In addition, these agencies experience political pressure that may dictate the manner in which they spend money. Due to political and budgetary processes and other scheduling delays that may frequently occur relating to the contract or bidding process, some government agency orders may be canceled or substantially delayed, and the receipt of revenue or payments from these agencies may be substantially delayed. In addition, future sales to government agencies will depend on our ability to meet government contracting requirements, certain of which may be onerous or impossible to meet, resulting in our inability to obtain a particular contract. Common requirements in government contracts include bonding requirements, provisions permitting the purchasing agency to modify or terminate at will the contract without penalty, and provisions permitting the agency to perform investigations or audits of our business practices, any of which may limit our ability to enter into new contracts or maintain our current contracts.
Three customers accounted for approximately 51% of our total revenue during the year ended December 31, 2021, and two customers accounted for approximately 61% of our total revenue during the year ended December 31, 2020. In the event of any material decrease in revenue from these customers, or if we are unable to replace the revenue through the sale of our products to additional customers, our financial condition and results from operations could be materially and adversely affected.
During the year ended December 31, 2021, three customers accounted for approximately 51% or $1,787,000 of total revenue. During the year ended December 31, 2020, two customers accounted for approximately 61% or $2,921,000 of total revenue and had trade receivables of approximately $250,000 as of the end of the year. If these customers were to significantly reduce their relationship with the Company, or in the event that we are unable to replace the revenue through the sale of our products to additional customers, our financial condition and results from operations could be negatively impacted, and such impact would be material.
We face competition from companies with greater financial, technical, sales, marketing and other resources, and, if we are unable to compete effectively with these competitors, our market share may decline and our business could be harmed.
We face competition from other established companies. A number of our competitors have longer operating histories, larger customer bases, significantly greater financial, technological, sales, marketing and other resources than we do. As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or client requirements, more quickly develop new products or devote greater resources to the promotion and sale of their products and services than we can. Likewise, their greater capabilities in these areas may enable them to better withstand periodic downturns in the identity management solutions industry and compete more effectively on the basis of price and production. In addition, new companies may enter the markets in which we compete, further increasing competition in the identity management solutions industry.
We believe that our ability to compete successfully depends on a number of factors, including the type and quality of our products and the strength of our brand names, as well as many factors beyond our control. We may not be able to compete successfully against current or future competitors, and increased competition may result in price reductions, reduced profit margins, loss of market share and an inability to generate cash flows that are sufficient to maintain or expand the development and marketing of new products, any of which would adversely impact our results of operations and financial condition.
RISKS RELATED TO OUR TECHNOLOGY
We occasionally rely on systems integrators to manage our large projects, and if these companies do not perform adequately, we may lose business.
We occasionally act as a subcontractor to systems integrators who manage large projects that incorporate our systems. We cannot control these companies, and they may decide not to promote our products or may price their services in such a way as to make it unprofitable for us to continue our relationship with them. Further, they may fail to perform under agreements with their customers, in which case we might lose sales to these customers. If we lose our relationships with these companies, our business, financial condition and results of operations may suffer.
Some third parties integrate our software into their platforms or solutions. Any delay in the integration of our software or the launch of third-party products may materially affect our results from operations and financial condition.
We sell some of our software through larger product partners and/or resellers that will either resell our product alongside theirs, Original Equipment Manufacture a white label version of our products, or sell our products fully integrated into their offerings. In these cases, we are dependent upon the successful rollout of our products by our distribution partners. Any delays negatively affect our results from operations and financial condition.
If our security measures or those of our third-party data center hosting facilities, Cloud computing platform providers, or third-party service partners, are breached, and unauthorized access is obtained to a customer’s data, our data or our IT systems, or authorized access is blocked or disabled, our services may be perceived as not being secure, customers may curtail or stop using our services, and we may incur significant legal and financial exposure and liabilities.
Our services involve the storage and transmission of our customers’ and our customers’ customers’ proprietary and other sensitive data, including financial information and other personally identifiable information. While we have security measures in place, they may be breached as a result of efforts by individuals or groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states. Our security measures could also be compromised by employee error or malfeasance, which could result in someone obtaining unauthorized access to, or denying authorized access to our Information Technology systems, our customers’ data or our data, including our intellectual property and other confidential business information. Additionally, third parties may attempt to fraudulently induce employees or customers into disclosing sensitive information such as usernames, passwords or other information to gain access to our customers’ data, our data or our IT systems.
We take extraordinary measures to ensure identity authentication of users who access critical IT infrastructure, including but not limited to, two-factor, multi-factor and biometric identity verification. This substantially reduces the threat of unauthorized access by bad actors using compromised user credentials.
Because the techniques used to breach, obtain unauthorized access to, or sabotage IT systems change frequently, grow more complex over time, and generally are not recognized until launched against a target, we may be unable to anticipate or implement adequate measures to prevent against such techniques.
Our services operate in conjunction with and are dependent on products and components across a broad ecosystem and, if there are security vulnerabilities in one of these components, a security breach could occur. In addition, our internal IT systems continue to evolve, and we are often early adapters of new technologies and new ways of sharing data and communicating internally and with partners and customers, which increases the complexity of our IT systems. These risks are mitigated by our ability to maintain and improve business and data governance policies and processes and internal security controls, including our ability to escalate and respond to known and potential risks.
In addition, our customers may authorize third-party technology providers to access their customer data, and some of our customers may not have adequate security measures in place to protect their data that is stored on our servers. Because we do not control our customers or third-party technology providers, or the processing of such data by third-party technology providers, we cannot ensure the integrity or security of such transmissions or processing. Malicious third parties may also conduct attacks designed to temporarily deny customers access to our services.
A security breach could expose us to a risk of loss or inappropriate use of proprietary and sensitive data, or the denial of access to this data. A security breach could also result in a loss of confidence in the security of our services, damage our reputation, negatively impact our future sales, disrupt our business and lead to legal liability. Finally, the detection, prevention and remediation of known or potential security vulnerabilities, including those arising from third-party hardware or software may result in additional direct and indirect costs, for example additional infrastructure capacity to mitigate any system degradation that could result from remediation efforts.
RISKS RELATED TO INTELLECTUAL PROPERTY
If the patents we own or license, or our other intellectual property rights, do not adequately protect our products and technologies, we may lose market share to our competitors and our business, financial condition and results of operations would be adversely affected.
Our success depends significantly on our ability to protect our rights to the technologies used in our products. We rely on patent protection, trade secrets, as well as a combination of copyright and trademark laws and nondisclosure, confidentiality and other contractual arrangements to protect our technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. In addition, we cannot be assured that any of our current and future pending patent applications will result in the issuance of a patent to us. The U.S. Patent and Trademark Office (“PTO”) may deny or require significant narrowing of claims in our pending patent applications, and patents issued as a result of the pending patent applications, if any, may not provide us with significant commercial protection or may not be issued in a form that is advantageous to us. We could also incur substantial costs in proceedings before the PTO. These proceedings could result in adverse decisions as to the claims included in our patents.
Our issued and licensed patents and those that may be issued or licensed in the future may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products. Additionally, upon expiration of our issued or licensed patents, we may lose some of our rights to exclude others from making, using, selling or importing products using the technology based on the expired patents. We also must rely on contractual rights with the third parties that license technology to us to protect our rights in the technology licensed to us. Although we have taken steps to protect our intellectual property and technology, there is no assurance that competitors will not be able to design around our patents. We also rely on unpatented proprietary technology. We cannot assure you that we can meaningfully protect all our rights in our unpatented proprietary technology or that others will not independently develop substantially equivalent proprietary products or processes or otherwise gain access to our unpatented proprietary technology. We seek to protect our know-how and other unpatented proprietary technology with confidentiality agreements and intellectual property assignment agreements with our employees. However, such agreements may not provide meaningful protection for our proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements or in the event that our competitors discover or independently develop similar or identical designs or other proprietary information. In addition, we rely on the use of registered and common law trademarks with respect to the brand names of some of our products. Our common law trademarks provide less protection than our registered trademarks. Loss of rights in our trademarks could adversely affect our business, financial condition and results of operations.
Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. If we fail to apply for intellectual property protection or if we cannot adequately protect our intellectual property rights in these foreign countries, our competitors may be able to compete more effectively against us, which could adversely affect our competitive position, as well as our business, financial condition and results of operations.
If third parties claim that we infringe their intellectual property rights, we may incur liabilities and costs and may have to redesign or discontinue selling certain products.
Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. We face the risk of claims that we have infringed on third parties’ intellectual property rights. Searching for existing intellectual property rights may not reveal important intellectual property and our competitors may also have filed for patent protection, which is not yet a matter of public knowledge, or claimed trademark rights that have not been revealed through our availability searches. Our efforts to identify and avoid infringing on third parties’ intellectual property rights may not always be successful. Any claims of patent or other intellectual property infringement, even those without merit, could:
| ● | Increase the cost of our products; |
| ● | Be expensive and time consuming to defend; |
| ● | Result in us being required to pay significant damages to third parties; |
| ● | Force us to cease making or selling products that incorporate the challenged intellectual property; |
| ● | Require us to redesign, reengineer or rebrand our products; |
| ● | Require us to enter into royalty or licensing agreements in order to obtain the right to use a third party’s intellectual property, the terms of which may not be acceptable to us; |
| ● | Require us to indemnify third parties pursuant to contracts in which we have agreed to provide indemnification to such parties for intellectual property infringement claims; |
| ● | Divert the attention of our management; and |
| ● | Result in our customers or potential customers deferring or limiting their purchase or use of the affected products until the litigation is resolved. |
In addition, new patents obtained by our competitors could threaten a product’s continued life in the market even after it has already been introduced.
REGULATORY AND LEGAL RISK FACTORS
Failure to comply with federal, state and international laws and regulations and our contractual obligations relating to privacy, data protection and consumer protection, or the expansion of current or the enactment of new laws or regulations relating to privacy, data protection and consumer protection, could adversely affect our business and our financial condition.
We collect and maintain significant amounts of personal data and other data relating to our customers and employees. A variety of federal, state and international laws and regulations, and certain industry standards, govern or apply to our collection, use, retention, sharing and security of consumer data. We are subject to certain laws, regulations, contractual obligations and industry standards (including, for example, the Payment Card Industry Data Security Standard, or PCI-DSS) relating to privacy, data protection, information security and consumer protection, which are evolving and subject to potentially differing interpretations. These requirements may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another or may conflict with other rules or our practices. As a result, our practices may not comply or may not comply in the future with all such laws, regulations, requirements and obligations. Any failure, or perceived failure, by us to comply with our privacy policies or with any federal, state or international laws, regulations, industry self-regulatory principles, industry standards or codes of conduct, regulatory guidance, orders to which we may be subject or other legal or contractual obligations relating to privacy, data protection, information security or consumer protection could adversely affect our reputation, brand and business, and may result in claims, proceedings or actions against us by governmental entities or others or other liabilities or require us to change our operations and/or cease or modify our use of certain data sets. Any such claim, proceeding or action could hurt our reputation, brand and business, force us to incur significant expenses in defense of such proceedings, distract our management, increase our costs of doing business, result in a loss of customers and suppliers or an inability to process credit card payments and may result in the imposition of monetary penalties. We may also be contractually required to indemnify and hold harmless third parties from the costs or consequences of non-compliance with any laws, regulations or other legal obligations relating to privacy or consumer protection or any inadvertent or unauthorized use or disclosure of data that we store or handle as part of operating our business.
Foreign laws and regulations relating to privacy, data protection, information security and consumer protection often are more restrictive than those in the United States. The European Union (“EU”), for example, traditionally has imposed stricter obligations under its laws and regulations relating to privacy, data protection and consumer protection than the United States. In May 2018 the European Union's new regulation governing data practices and privacy called the General Data Protection Regulation, or GDPR, became effective and substantially replaced the data protection laws of the individual European Union member states. The law requires companies to meet more stringent requirements regarding the handling of personal data of individuals in the EU than were required under predecessor EU requirements. In the United Kingdom, a Data Protection Bill that substantially implements the GDPR also became law in May 2018. The law also increases the penalties for non-compliance, which may result in monetary penalties of up to €20.0 million or 4% of a company's worldwide turnover, whichever is higher. The GDPR and other similar regulations require companies to give specific types of notice and in some cases seek consent from consumers and other data subjects before collecting or using their data for certain purposes, including some marketing activities. Outside of the European Union, many countries have laws, regulations, or other requirements relating to privacy, data protection, information security, and consumer protection, and new countries are adopting such legislation or other obligations with increasing frequency. Many of these laws may require consent from consumers for the use of data for various purposes, including marketing, which may reduce our ability to market our products. There is no harmonized approach to these laws and regulations globally. Consequently, we increase our risk of non-compliance with applicable foreign data protection laws by operating internationally. We may need to change and limit the way we use personal information in operating our business and may have difficulty maintaining a single operating model that is compliant. In addition, various federal, state and foreign legislative and regulatory bodies, or self-regulatory organizations, may expand current laws or regulations, enact new laws or regulations or issue revised rules or guidance regarding privacy, data protection, information security and consumer protection. For example, California recently adopted the California Consumer Privacy Act of 2018 (“CCPA”), which provides new data privacy rights for consumers and new operational requirements for businesses. The CCPA includes a statutory damages framework and private rights of action against businesses that fail to comply with certain CCPA terms or implement reasonable security procedures and practices to prevent data breaches. The CCPA went into effect in January 2020. The effects of the CCPA potentially are significant, however, and may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. As a general matter, compliance with laws, regulations, and any applicable rules or guidance from self-regulatory organizations relating to privacy, data protection, information security and consumer protection, may result in substantial costs and may necessitate changes to our business practices, which may compromise our growth strategy, adversely affect our ability to acquire customers, and otherwise adversely affect our business, financial condition and operating results.
We may have additional tax assessments.
We are subject to income taxes in the United States. Significant judgments are required in determining our provisions for income taxes. In the course of preparing our tax provisions and returns, we must make calculations where the ultimate tax determination may be uncertain. Our tax returns are subject to examination by the Internal Revenue Service (“IRS”) and state tax authorities. There can be no assurance as to the outcome of these examinations. If the ultimate determination of taxes owed is for an amount in excess of amounts previously accrued, our operating results, cash flows, and financial condition could be adversely affected.
We operate in foreign countries and are exposed to risks associated with foreign political, economic and legal environments and with foreign currency exchange rates.
We operate in foreign countries. As a result, we are exposed to risks, including among others, risks associated with foreign political, economic and legal environments and with foreign currency exchange rates. Our results may be adversely affected by, among other things, changes in government policies with respect to laws and regulations, anti-inflation measures, currency conversions, collection of receivables abroad and rates and methods of taxation.
We have identified material weaknesses in our internal control over financial reporting. If we are unable to remediate these material weaknesses, or if we identify additional material weaknesses in the future or otherwise fail to maintain effective internal control over financial reporting, we may not be able to accurately or timely report our financial condition or results of operations, which may adversely affect our business.
During the second quarter of our fiscal year 2021, we identified material weaknesses in our internal control over financial reporting related to our financial statement close process and policies. We did not have adequate review policies and procedures in place to ensure the timely, effective review of the measurement of the fair value of certain derivative liabilities. Additionally, during the fourth quarter of fiscal year 2021, we identified an additional material weakness in our internal control over financial reporting. We did not design and maintain formal accounting policies, procedures and controls to achieve complete, accurate and timely financial accounting, reporting and disclosures relating to segregation of duties and controls over the preparation and review of journal entries, account reconciliations and consolidation. These material weaknesses did not result in a misstatement to the financial statements. However, if we are unable to remediate these material weaknesses, or if we identify additional material weaknesses in the future or otherwise fail to maintain effective internal control over financial reporting, these material weaknesses could result in a misstatement of our account balances or disclosures that would result in a material misstatement of our annual or interim financial statements that would not be prevented or detected.
GOVERNANCE RISKS AND RISKS RELATED TO OUR SECURITIES
Our Common Stock is subject to “penny stock” rules.
Our Common Stock is currently defined as a “penny stock” under Rule 3a51-1 promulgated under the Exchange Act which are subject to Rules 15g-2 through 15g-7 and Rule 15g-9, which impose additional sales practice requirements on broker-dealers that sell penny stocks to persons other than established customers and institutional accredited investors. Among other things, for transactions covered by these rules, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, these rules may affect the ability of broker-dealers to sell our Common Stock and affect the ability of holders to sell their shares of our Common Stock in the secondary market. To the extent our Common Stock is subject to the penny stock regulations, the market liquidity for our shares will be adversely affected.
Our stock price has been volatile, and your investment in our Common Stock could suffer a decline in value.
There has been significant volatility in the market price and trading volume of equity securities, which is unrelated to the financial performance of the companies issuing the securities. These broad market fluctuations may negatively affect the market price of our Common Stock. You may not be able to resell your shares at or above the price you pay for those shares due to fluctuations in the market price of our Common Stock caused by changes in our operating performance or prospects and other factors.
Some specific factors that may have a significant effect on our Common Stock market price include:
| ● | Actual or anticipated fluctuations in our operating results or future prospects; |
| ● | Our announcements or our competitors’ announcements of new products; |
| ● | The public’s reaction to our press releases, our other public announcements and our filings with the SEC; |
| ● | Strategic actions by us or our competitors, such as acquisitions or restructurings; |
| ● | New laws or regulations or new interpretations of existing laws or regulations applicable to our business; |
| ● | Changes in accounting standards, policies, guidance, interpretations or principles; |
| ● | Changes in our growth rates or our competitors’ growth rates; |
| ● | Developments regarding our patents or proprietary rights or those of our competitors; |
| ● | Our inability to raise additional capital as needed; |
| ● | Substantial sales of Common Stock underlying warrants and preferred stock; |
| ● | Concern as to the efficacy of our products; |
| ● | Changes in financial markets or general economic conditions; |
| ● | Sales of Common Stock by us or members of our management team; and |
| ● | Changes in stock market analyst recommendations or earnings estimates regarding our Common Stock, other comparable companies or our industry generally. |
Our future sales of our Common Stock could adversely affect its price and our future capital-raising activities could involve the issuance of equity securities, which would dilute shareholders’ investments and could result in a decline in the trading price of our Common Stock.
We may sell securities in the public or private equity markets if and when conditions are favorable, even if we do not have an immediate need for additional capital at that time. Sales of substantial amounts of our Common Stock, or the perception that such sales could occur, could adversely affect the prevailing market price of our Common Stock and our ability to raise capital. We may issue additional Common Stock in future financing transactions or as incentive compensation for our executive management and other key personnel, consultants and advisors. Issuing any equity securities would be dilutive to the equity interests represented by our then-outstanding shares of Common Stock. The market price for our Common Stock could decrease as the market takes into account the dilutive effect of any of these issuances. Furthermore, we may enter into financing transactions at prices that represent a substantial discount to the market price of our Common Stock. A negative reaction by investors and securities analysts to any discounted sale of our equity securities could result in a decline in the trading price of our Common Stock.
The holders of our Preferred Stock (as defined below) have certain rights and privileges that are senior to our Common Stock, and we may issue additional shares of Preferred Stock without stockholder approval that could have a material adverse effect on the market value of the Common Stock.
Our Board of Directors has the authority to issue a total of up to 5.0 million shares of preferred stock, par value $0.01 per share (“Preferred Stock”) and to fix the rights, preferences, privileges, and restrictions, including voting rights, of the Preferred Stock, which typically are senior to the rights of the Common Stock, without any further vote or action by the holders of our Common Stock. The rights of the holders of our Common Stock will be subject to, and may be adversely affected by, the rights of the holders of the Preferred Stock that have been issued or might be issued in the future. Preferred Stock also could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. This could delay, defer, or prevent a change in control. Furthermore, holders of our Preferred Stock may have other rights, including economic rights, senior to the Common Stock. As a result, their existence and issuance could have a material adverse effect on the market value of the Common Stock. We have in the past issued and may from time to time in the future issue, Preferred Stock for financing or other purposes with rights, preferences, or privileges senior to the Common Stock. As of December 31, 2021, we had two series of Preferred Stock outstanding, the Series B Preferred, and Series D Preferred.
The provisions of our Series B Preferred prohibit the payment of dividends on our Common Stock unless the dividends on our preferred shares are first paid. In addition, upon a liquidation, dissolution or sale of our business, the holders of our Series B Preferred will be entitled to receive, in preference to any distribution to the holders of Common Stock, initial distributions of $2.50 per share, plus all accrued but unpaid dividends. As of December 31, 2021 and December 31, 2020, there were 239,400 shares of Series B Preferred outstanding. As of December 31, 2021, we had cumulative undeclared dividends on our Series B Preferred of approximately $8,000.
The provisions of our Series D Preferred prohibit the payment of dividends on our Common Stock unless the dividends on our preferred shares are first paid. In addition, upon a liquidation, dissolution or sale of our business, the holders of our Series D Preferred will be entitled to receive, in preference to any distribution to the holders of Common Stock, initial distributions of $1,000 per share, plus all accrued but unpaid dividends. As of December 31, 2021 and December 31, 2020, there were 23,862.4 and 22,863.28 shares of Series D Preferred outstanding, respectively. As of December 31, 2021, we had no cumulative undeclared dividends on our Series D Preferred.
The conversion of our Series B Preferred Stock and Series D Preferred Stock and the exercise of currently outstanding warrants, stock options and vesting of Restricted Stock Units could result in significant dilution to the holders of our common stock.
The holders of our Series B Preferred Stock and Series D Preferred Stock may elect to convert their shares of Preferred Stock into shares of Common Stock. As of December 31, 2021, 239,400 shares of Series B Preferred Stock, which are convertible into 47,001 shares of Common Stock; and 23,216.4 shares of Series D Preferred Stock, which are convertible into 398,222,985 shares of Common Stock, were outstanding. In addition to our outstanding shares of Preferred Stock, as of December 31, 2021, there were outstanding warrants to purchase 3,150,000 shares of our Common Stock, outstanding stock options to purchase 4,848,876 shares of our Common Stock and outstanding Restricted Stock Units that upon vesting will result in the issuance of 81,019,401 shares of our Common Stock.
The conversion of our Series B Preferred Stock and Series D Preferred Stock, as well as the exercise of our outstanding warrants, outstanding stock options and the vesting of our Restricted Stock Units could result in significant dilution to existing common shareholders, adversely affect the market price of our Common Stock and impair our ability to raise capital through the sale of additional equity securities.
Upon the occurrence of certain events, we may be required to redeem all or a portion of our Preferred Stock.
Holders of certain of our Preferred Stock may require us to redeem all or any portion of such Holder’s shares Preferred Stock within specific date from issuance or in the event of the consummation of a Change of Control (as such term is defined in the Certificate of Designations, Preferences and Rights of each class of Preferred Stock). We cannot assure you that we will maintain sufficient cash reserves or that our business will generate cash flow from operations at levels sufficient to permit us to redeem our shares of Preferred Stock if and when required to do so. In the event we have insufficient cash available or do not have access to additional third-party financings on commercially reasonable terms or at all to complete such redemption, our business, results of operations, and financial condition may be materially adversely affected.
Certain large shareholders may have certain personal interests that may affect the Company.
As a result of the securities issued to Nantahala Capital Management, LLC, and the related entities controlled by Nantahala Capital Management, (i) Blackwell Partners LLC - Series A, (ii) Nantahala Capital Partners Limited Partnership, (iii) Nantahala Capital Partners II Limited Partnership, (iv) Nantahala Capital Partners SI, LP, (v) NCP QR Limited Partnership, and (vi) Silver Creek CS SAV, L.L.C. (collectively, “Nantahala”), Nantahala beneficially owns, in the aggregate, approximately 37.3% of the Company’s outstanding voting securities as of March 25, 2022. As a result, Nantahala has the potential ability to exert influence over the outcome of issues requiring approval by the Company’s shareholders. This concentration of ownership may have effects such as delaying or preventing a change in control of the Company that may be favored by other shareholders or preventing transactions in which shareholders might otherwise recover a premium for their shares over current market prices.
Our corporate documents and Delaware law contain provisions that could discourage, delay or prevent a change in control of the Company.
Provisions in our Amended and Restated Certificate of Incorporation (the “Amended Charter”) and bylaws may discourage, delay or prevent a merger or acquisition involving us that our stockholders may consider favorable. For example, our certificate of incorporation authorizes Preferred Stock, which carries special rights, including voting and dividend rights. With these rights, holders of Preferred Stock could make it more difficult for a third party to acquire us.
Our Amended Charter designates courts within the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, and the federal district courts for the United States of America for claims brought under the Securities Act of 1933, as amended, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents.
The Amended Charter requires that, to the fullest extent permitted by law, and unless the Company consents in writing to the selection of an alternative forum, a state court located within the State of Delaware (or, if no state court located within the State of Delaware has jurisdiction, the federal district court for the District of Delaware), will, to the fullest extent permitted by law, be the sole and exclusive forum for each of the following:
| ● | Any derivative action or proceeding brought on behalf of the Company; |
| ● | Any action asserting a claim of breach of a fiduciary duty owed by any director or officer or other employee of the Company to the Company or the Company’s stockholders; |
| ● | Any action asserting a claim against the Company or any director or officer or other employee of the Company arising pursuant to any provision of the Delaware General Corporation Law or the Company’s Amended Charter, or the Amended and Restated Bylaws; or |
| ● | Any action asserting a claim against the Company or any director or officer or other employee of the Company governed by the internal affairs doctrine. |
Furthermore, the Amended Charter sets forth that the federal district courts of the United States of America are the exclusive forum for the resolution of any causes of action arising under the Securities Act of 1933, as amended (the “Securities Act”).
Because the applicability of the exclusive forum provision is limited to the extent permitted by law, we believe that the exclusive forum provision would not apply to suits brought to enforce any duty or liability created by the Securities Exchange Act of 1934, as amended (“Exchange Act”), or any other claim for which the federal courts have exclusive jurisdiction. We note that there is uncertainty as to whether a court would enforce the provision and that investors cannot waive compliance with the federal securities laws and the rules and regulations thereunder. Although we believe this provision benefits us by providing increased consistency in the application of Delaware law and federal law under the Securities Act in the types of lawsuits to which they apply, the provisions may have the effect of discouraging lawsuits against our directors and officers.
We do not expect to pay cash dividends on our Common Stock for the foreseeable future.
We have never paid cash dividends on our Common Stock and do not anticipate that any cash dividends will be paid on the Common Stock for the foreseeable future. The payment of any cash dividend by us will be at the discretion of our Board of Directors and will depend on, among other things, our earnings, capital, regulatory requirements and financial condition. Furthermore, the terms of our Series B Preferred and Series D Preferred directly limit our ability to pay cash dividends on our Common Stock.
GENERAL RISK FACTORS
Cyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position.
Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users’ or customers’ data, or acting in a coordinated manner to launch coordinated attacks. Nation state and state sponsored actors can deploy significant resources to plan and carry out exploits. Inadequate account security practices may also result in unauthorized access to confidential data. Employees or third parties may intentionally compromise our or our users’ security or systems or reveal confidential information. Malicious actors may employ the IT supply chain to introduce malware through software updates or compromised supplier accounts or hardware.
Cyberthreats are constantly evolving and becoming increasingly sophisticated and complex, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our network or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improve technologies or remediate the impacts of attacks, or otherwise adversely affect our business.
While we expect the impacts of COVID-19 to have an adverse effect on our business, financial condition and results of operations, we are unable to predict the extent or nature of these impacts at this time.
Due to the COVID-19 pandemic we have been limited in our ability to: (i) conduct face-to-face meetings with customers and prospective customers, (ii) present in-person demonstrations of our software solutions, (iii) attend trade shows and conferences which typically generate future sales opportunities, or (iv) meet with prospective strategic partners. These effects caused by the COVID-19 pandemic will likely have an adverse impact on our operating and financial results over at least the next several quarters.
The extent to which our operating and financial results will continue to be affected by the COVID-19 pandemic will depend on various factors and consequences beyond our control, such as the duration and scope of the pandemic; the impact of the emergence of new variants of the virus that causes COVID-19; additional actions by businesses and governments in response to the pandemic; and the speed and effectiveness of responses to combat the virus, including vaccine development and distribution. COVID-19, and the volatile regional and global economic conditions stemming from the pandemic, could also aggravate our other risk factors described in this Form 10-K.
Certain key personnel have terminated their employment with the Company. Given that we are dependent on key personnel, the loss of any additional personnel, including our Chief Executive Officer, could materially and adversely affect our plan of operations and ability to obtain financing.
We are dependent to a significant extent upon the efforts and abilities of our executive officers and other key personnel. During the current fiscal year, we have lost certain key personnel due to the absence of meaningful equity incentives, among other causes. The loss of the services of any additional key employees, including our Chief Executive Officer, and any negative market or industry perception arising from the loss of such services, could have a material adverse effect on us, our plan of operations and ability to obtain financing. Our business will also be dependent upon our ability to attract and retain qualified personnel. Acquiring and keeping these personnel has proven difficult as the market value of our Common Stock has declined and could cost substantially more than estimated. We cannot be certain that we will be able to retain such personnel or attract a high caliber of personnel in the future.
| UNRESOLVED STAFF COMMENTS |
None.
| PROPERTIES |
Our corporate headquarters is located in San Diego, California and is currently leased on a month-to-month basis. We sublet our former headquarters effective March 1, 2021. As of December 31, 2021, in addition to our corporate headquarters, we lease properties in the following locations: Ottawa, Province of Ontario, Canada; Portland, Oregon; Mexico City, México. Management believes that leaving the former headquarters and subleasing the space saves the company money. The new corporate headquarters space is small and adequate for our needs today. When the company reaches cash flow positive, we will be looking for a new space that takes into account the distributed workforce.
| LEGAL PROCEEDINGS |
There is currently no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of the Company or any of our subsidiaries, threatened against or affecting the Company, our Common Stock, any of our subsidiaries or of the Company’s or our subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.
| MINE SAFETY DISCLOSURES |
N/A.
| ITEM 5. |
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Market Information
Our Common Stock does not trade on an established securities exchange. Our Common Stock is quoted under the symbol “IWSY” on the OTCQB marketplace. Any OTCQB marketplace quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.
Holders
As of March 18, 2022, we had approximately 275 registered holders of record of our Common Stock. A significant number of our shares of Common Stock were held in street name and, as such, we believe that the actual number of beneficial owners of our Common Stock is significantly higher.
Dividends
We have never declared or paid cash dividends on our Common Stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our Board of Directors and will depend on our financial condition, results of operations, capital requirements, general business conditions and other factors that our Board of Directors may deem relevant.
As of December 31, 2021 and 2020, we had cumulative undeclared dividends of approximately $0 relating to our Series A Preferred, $0 related to our Series A-1 Preferred, $8,000 relating to our Series B Preferred, and $0 related to our Series D Preferred.
Securities Authorized for Issuance under Equity Compensation Plans
For a discussion of our equity compensation plans, please see Item 11 of this Annual Report.
Recent Sales of Unregistered Securities
We issued certain equity securities in unregistered transactions during 2021 and fiscal year 2020. All of the securities issued in non-registered transactions were issued in reliance on Section 3(a)(9) and/or Section 4(a)(2) of the Securities Act and were reported in our Quarterly Reports on Form 10-Q and in our Current Reports on Form 8-K filed with the Securities and Exchange Commission during the fiscal year ended December 31, 2021 and through the date of this report.
| SELECTED FINANCIAL DATA |
The disclosures in this section are not required because we qualify as a smaller reporting company under federal securities laws.
| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion should be read in conjunction with our consolidated financial statements and the related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K. Readers are also urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the factors which affect our business, including (without limitation) the disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors”, and in the audited consolidated financial statements and related notes included in this Annual Report on Form 10-K.
Overview
Imageware Systems, Inc. (“Imageware,” the “Company,” “we,” “our”) provides biometric solutions to identify, verify, and authenticate people based on their true identity, rather than on what keys and codes they have. A pioneer in the field, Imageware was the first multimodal biometric solution provider in history and holds dozens of patents, including some of the most cited patents in the industry. Our Cloud-based and on-premises solutions provide faster, more accurate identification to better secure communities, data, and assets. In fact, governments, law enforcement agencies, and public and private enterprises worldwide trust Imageware with critical identity solutions which manage millions of identities every day.
Our patented Imageware Biometric Engine® is one of the most accurate and fastest biometrics matching engines in the industry, capable of our patented biometrics fusion. We are a “biometrics first” company, leveraging unique human characteristics to provide unparalleled accuracy for identification while protecting your identity.
Our product portfolio, called the Imageware Identity Platform, is built around three key areas: Enroll & Identify, Badge & Credential, and Authenticate. All of these areas are built on top of the Imageware Biometric Engine. The Platform is a fully-modular, customizable, and pre-integrated portfolio of capabilities to support state and local law enforcement, Federal agencies, and enterprises alike.
Enroll & Identify
The Enroll & Identify area includes four key modules: Imageware Proof, Imageware Capture, Imageware Identify, and Imageware Investigate.
Imageware Proof enables an entity to prove someone’s identity from their biometrics, government issued ID, and 3rd party databases (such as credit bureau data). Imageware Capture enables the fastest capture of biographic and biometric detail (such as face, fingerprint, palm print, iris, and SMT’s) in the industry. Imageware Identify enables a user to identify someone from their biometrics in seconds. Imageware Investigate enables an officer to create digital lineups very quickly.
Badge & Credential
The Badge & Credential area includes two key modules: Imageware Credential (formerly EPI Suite) and Imageware Digital ID. Imageware Credential enables a user to design, build, and print badges for access control systems. This includes tickets, smart badges, wristbands, Personal Identity Verification (“PIV”) cards, and more. Imageware Digital ID is a decentralized identity service that enables self-sovereign identity underpinned by blockchain technology tied to biometrics.
Authenticate
The Authenticate area includes Imageware Authenticate, which enables users to leverage multimodal biometrics hosted in a central server or cloud to log in to services and applications from any device. Imageware Authenticate is easily integrated into existing solutions leveraging OpenID Connect (“OIDC”), Security Assertion Mark-up Language (“SAML”), or OAuth2 protocols, and includes a software development kit (“SDK”) for partners and customers to easily embed into their existing applications.
Imageware Biometric Engine
The Imageware Biometric Engine® is a patented biometric identity and authentication database built for multi-biometric enrollment, management and authentication. It is hardware agnostic and can utilize different types of biometric algorithms from any vendor. It allows different types of biometrics to be operated at the same time on a seamlessly integrated platform. It is also offered as an SDK, enabling developers and system integrators to implement biometric solutions or integrate biometric capabilities, into existing applications.
Imageware Law Enforcement
Our modules are leveraged across many industries and use cases with minimal customization needed. One of the key areas includes our Law Enforcement 2.0 solution which enables state, local and Federal agencies to quickly capture, archive, search, retrieve, and share digital images, fingerprints and other biometrics, as well as criminal history records on a stand-alone, networked, wireless or browser-based platform. Our Imageware Law Enforcement 2.0 solution includes Imageware Capture, Imageware Identify, Imageware Investigate, Imageware Credential, and Imageware Authenticate. Other modules can also be easily leveraged as needed.
Recent Market Conditions
During March 2020, a global pandemic was declared by the World Health Organization related to the rapidly growing outbreak of a novel strain of coronavirus (“COVID-19”).
The pandemic has significantly impacted the economic conditions both in the United States and worldwide, with accelerated effects in February 2020 through the date of this Annual Report, as federal, state and local governments react to the public health crisis, creating significant uncertainties in both the worldwide and the United States economies. The situation is rapidly changing and additional impacts to our business may arise that we are not aware of currently. We cannot predict whether, when or the manner in which the conditions surrounding COVID-19 will change including the timing of lifting any restrictions or office closure requirements.
The full extent of COVID-19’s impact on our operations and financial performance depends on future developments that are uncertain and unpredictable, including the duration and spread of the pandemic, its impact on capital and financial markets and any new information that may emerge concerning the severity of the virus, its spread to other regions as well as the actions taken to contain it, among others.
In addition to the impact resulting from COVID-19, recent geopolitical conflicts, specifically the war in Ukraine, may have an additional impact on purchasing decisions both in the United States and worldwide, which creates additional uncertainties in both the worldwide and the United States economies. These factors could affect our ability to obtain additional financing or consummate a strategic transaction, although no assurances can be given.
Critical Accounting Estimates
The discussion and analysis of our consolidated financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements in accordance with GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the consolidated financial statements and the reported amounts of revenue and expense during a fiscal period. The SEC considers an accounting policy to be critical if it is important to a company’s financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application.
Significant estimates include the evaluation of our ability to continue as a going concern, the allowance for doubtful accounts receivable, assumptions used in the Black-Scholes model to calculate the fair value of share-based payments, fair value of Series D Preferred and financial instruments issued with and affected by the Series D Preferred Financing (defined below), fair value of financial instruments with and affected by the Series C Preferred (defined below), fair value of Series A Preferred (defined below), fair value of Series A-1 Preferred (defined below), assumptions used in the application of revenue recognition policies, assumptions used in the derivation of the Company’s incremental borrowing rate used in the computation of the Company’s operating lease liabilities and assumptions used in the application of fair value methodologies to calculate the fair value of pension assets and obligations. Actual results could differ from estimates.
The following are our critical accounting policies because we believe they are both important to the portrayal of our financial condition and results of operations and require critical management judgments and estimates about matters that are uncertain. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected.
Revenue Recognition. Effective January 1, 2018, we adopted Accounting Standards Codification (“ASC”), Topic 606, Revenue from Contracts with Customers (“ASC 606”), using the modified retrospective transition method.
In accordance with ASC 606, revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.
The core principle of the standard is that we should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve that core principle, we apply the following five step model:
| 1. |
Identify the contract with the customer; |
| 2. |
Identify the performance obligation in the contract; |
| 3. |
Determine the transaction price; |
| 4. |
Allocate the transaction price to the performance obligations in the contract; and |
| 5. |
Recognize revenue when (or as) each performance obligation is satisfied. |
At contract inception, we assess the goods and services promised in a contract with a customer and identify as a performance obligation each promise to transfer to the customer either: (i) a good or service (or a bundle of goods or services) that is distinct or (ii) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. We recognize revenue only when we satisfy a performance obligation by transferring a promised good or service to a customer.
Determining the timing of the satisfaction of performance obligations as well as the transaction price and the amounts allocated to performance obligations requires judgement.
We disclose disaggregation of our customer revenue by classes of similar products and services as follows:
| ● |
Software licensing and royalties; |
| ● |
Sales of computer hardware and identification media; |
| ● |
Services; and |
| ● |
Post-contract customer support. |
Software licensing and royalties
Software licenses consist of revenue from the sale of software for identity management applications. Our software licenses are functional intellectual property and typically provide customers with the right to use our software in perpetuity as it exists when made available to the customer. We recognize revenue from software licensing at a point in time upon delivery, provided all other revenue recognition criteria are met.
Royalties consist of revenue from usage-based arrangements and guaranteed minimum-based arrangements. We recognize revenue for royalty arrangements at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied.
Computer hardware and identification media
We generate revenue from the sale of computer hardware and identification media. Revenue for these items is recognized upon delivery of these products to the customer, provided all other revenue recognition criteria are met.
Services
Services revenue is comprised primarily of software customization services, software integration services, system installation services and customer training. Revenue is generally recognized upon completion of services and customer acceptance provided all other revenue recognition criteria are met.
Post-contract customer support (“PCS”)
PCS consists of maintenance on software and hardware for our identity management solutions. We recognize PCS revenue from periodic maintenance agreements. Revenue is generally recognized ratably over the respective maintenance periods provided no significant obligations remain. Costs related to such contracts are expensed as incurred.
Arrangements with multiple performance obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. In addition to selling software licenses, hardware and identification media, services and post-contract customer support on a standalone basis, certain contracts include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on our best estimate of the relative standalone selling price. The standalone selling price for a performance obligation is the price at which we would sell a promised good or service separately to a customer. The primary methods used to estimate standalone selling price are as follows: (i) the expected cost-plus margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service and (ii) the percent discount off of list price approach.
Contract costs
We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We apply a practical expedient to expense costs as incurred for costs to obtain a contract when the amortization period is one year or less.
Other items
We do not offer rights of return for our products and services in the normal course of business.
Sales tax collected from customers is excluded from revenue.
Impairment of Goodwill, Other Intangible and Long-Lived Assets. The Company accounts for its intangible assets under the provisions of ASC Topic 350, Intangibles - Goodwill and Other (“ASC 350”). In accordance with ASC 350, intangible assets with a definite life are analyzed for impairment under ASC 360-10-05 “Property, Plant and Equipment” and intangible assets with an indefinite life are analyzed for impairment under ASC 360 annually, or more often if circumstances dictate. The Company performs its annual simplified 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 did not record any goodwill impairment charges for the years ended December 31, 2021 or 2020.
The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. The Company’s management currently believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company’s products under development will continue. Either of these could result in future impairment of long-lived assets.
There are many management assumptions and estimates underlying the determination of an impairment loss, and estimates using different, but reasonable, assumptions could produce significantly different results. Significant assumptions include estimates of future levels of revenue and operating expense. Therefore, the timing and recognition of impairment losses by us in the future, if any, may be highly dependent upon our estimates and assumptions. There can be no assurance that goodwill impairment will not occur in the future.
Stock-Based Compensation. At December 31, 2021 and 2020, the Company had one stock-based compensation plan for employees and nonemployee directors, which authorizes the granting of various equity-based incentives including stock options and restricted stock.
The Company estimates the fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC Topic 718, Compensation – Stock Compensation (“ASC 718”). The fair value of stock options granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense is reported in general and administrative, sales and marketing, engineering and customer service expense based upon the departments to which substantially all of the associated employees report and credited to additional paid-in capital.
ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. For the years ended December 31, 2021 and 2020, the Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best measure of expected volatility is based on the historical weekly volatility of the Company’s Common Stock. Historical volatility factors utilized in the Company’s Black-Scholes computations for options granted during the years ended December 31, 2021 and 2020 ranged from 57% and 99%. The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin Topic 14. The expected term used by the Company to value the grants issued in 2021 and 2020 as computed by this method ranged from 3.33 to 5.17 years. The effect of the difference between the actual historical expected life and the simplified method was immaterial. The interest rate used is the risk-free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations ranged from 1.37% to 2.58%% for the years ended December 31, 2021 and 2020. Dividend yield is zero, as the Company does not expect to declare any dividends on the Company’s common shares in the foreseeable future.
In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has utilized an estimated annualized forfeiture rate ranging from approximately 5.0% to 10% for corporate officers, 4.1% to 10% for members of the Board of Directors and 15.0% to 25% for all other employees for options granted during the years ended December 31, 2021 and 2020. The Company reviews the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.
Income Taxes. The Company accounts for income taxes in accordance with ASC Topic 740, Accounting for Income Taxes (“ASC 740”). Deferred income taxes are recognized for the tax consequences related to temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for tax purposes at each year-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established when necessary, based on the weight of available evidence, if it is considered more likely than not that all or some portion of the deferred tax assets will not be realized. Income tax expense is the sum of current income tax plus the change in deferred tax assets and liabilities.
ASC 740-10 requires a company to first determine whether it is more-likely-than-not (defined as a likelihood of more than fifty percent) that a tax position will be sustained based on its technical merits as of the reporting date, assuming that taxing authorities will examine the position and have full knowledge of all relevant information. A tax position that meets this more-likely-than-not threshold is then measured and recognized at the largest amount of benefit that is greater than fifty percent likely to be realized upon effective settlement with a taxing authority.
We recognize and measure uncertain tax positions in accordance with GAAP, pursuant to which we only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Any tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. GAAP further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the quarter of such change. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
We file annual income tax returns in multiple taxing jurisdictions around the world. A number of years may elapse before an uncertain tax position is audited and finally resolved. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, we believe that our analysis of income tax reserves reflects the most likely outcome. We adjust these reserves, if any, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular position could require the use of cash.
Significant judgment is required in evaluating the Company’s uncertain tax positions and determining the Company’s provision for income taxes. No assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in the Company’s historical income tax provisions and accruals. The Company adjusts these items in light of changing facts and circumstances. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.
The Internal Revenue Code (the “Revenue Code”) limits the availability of certain tax credits and net operating losses that arose prior to certain cumulative changes in a corporation’s ownership resulting in a change of control of the Company. The Company’s use of its net operating loss carryforwards and tax credit carryforwards will be significantly limited because the Company believes it underwent “ownership changes”, as defined under Section 382 of the Revenue Code, in 1991, 1995, 2000, 2003, 2004, 2011, 2012, 2018 and 2020, though the Company has not performed a study to determine the limitation. The Company has reduced its deferred tax assets to zero relating to its federal and state research credits because of such limitations. The Company continues to disclose the tax effect of the net operating loss carryforwards at their original amount as the actual limitation has not yet been quantified. The Company has also established a full valuation allowance for substantially all deferred tax assets due to uncertainties surrounding its ability to generate future taxable income to realize these assets. Since substantially all deferred tax assets are fully reserved, future changes in tax benefits will not impact the effective tax rate. Management periodically evaluates the recoverability of the deferred tax assets. If it is determined at some time in the future that it is more likely than not that deferred tax assets will be realized, the valuation allowance would be reduced accordingly at that time.
Fair-Value Measurements. The Company accounts for fair value measurements in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below:
Level 1- Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2- Applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3- Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).
Assessing the significance of a particular input to the fair value measurement requires judgment, considering factors specific to the asset or liability. Determining whether a fair value measurement is based on Level 1, Level 2, or Level 3 inputs is important because certain disclosures are applicable only to those fair value measurements that use Level 3 inputs. The use of Level 3 inputs may include information derived through extrapolation or interpolation which involves management assumptions as well as valuation techniques employing Monte Carlo simulation methodologies.
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 ASC Topic 842 – Leases (“ASC 842”). In accordance with ASC 842, the Company has determined that such arrangements are operating leases and accordingly the Company has, as of January 1, 2019, recorded operating lease right-of-use assets and related lease liability for the present value of the lease payments over the lease terms using the Company’s estimated weighted-average incremental borrowing rate of approximately 14.5%. The Company has utilized the practical expedient regarding lease and nonlease components and has combined such items into a single combined component. The Company has also utilized the practical expedient regarding leases of twelve months or less and has excluded such leases from its computation of lease liability and related right-of-use assets. The Company has also elected the optional transition package of practical expedients which include:
A package of practical expedient to not reassess:
| ● |
Whether a contract is or contains a lease |
| ● |
Lease classification |
| ● |
Initial direct costs |
The company evaluates its operating lease right-of-use assets for impairment. As of December 31, 2021, and through the date of this report, management’s review indicated that there was an impairment of an operating lease right-of-use asset and the Company recorded an impairment loss of approximately $333,000. Impairment is based on the excess of the carrying amount over the fair value, based on market value when available, or expected future economic benefits to the company from the operating lease right-of-use asset and is recorded in the period in which the determination is made. Such amount is included in the Company’s Consolidated Statement of Operations for the year ended December31, 2021 under the caption “General and administrative” expense.
For a detailed discussion on the application of these and other accounting policies, see Note 2 to the Notes to the Consolidated Financial Statements for the Year Ended December 31, 2021.
Comparison of Results for Fiscal Years Ended December 31, 2021 and 2020
Product Revenue
| Twelve Months Ended December 31, |
||||||||||||||||
| Net Product Revenue |
2021 |
2020 |
$ Change |
% Change |
||||||||||||
| (dollars in thousands) |
||||||||||||||||
| Software and royalties |
$ | 383 | $ | 872 | $ | (489 | ) |
(56 | )% |
|||||||
| Percentage of total net product revenue |
45 | % |
39 | % |
||||||||||||
| Hardware and consumables |
$ | 290 | $ | 84 | $ | 206 | 245 | % |
||||||||
| Percentage of total net product revenue |
34 | % |
4 | % |
||||||||||||
| Services |
$ | 181 | $ | 1,275 | $ | (1,094 | ) |
(86 | )% |
|||||||
| Percentage of total net product revenue |
21 | % |
57 | % |
||||||||||||
| Total net product revenue |
$ | 854 | $ | 2,231 | $ | (1,377 | ) |
(62 | )% |
|||||||
Software and royalty revenue decreased 56% or approximately $489,000 during the year ended December 31, 2021 as compared to the corresponding period in 2020. This decrease is attributable to lower identification project related revenue of approximately $442,000 and lower royalty revenue of approximately $110,000 offset by higher law enforcement project related revenue of approximately $33,000 and higher sales of boxed identity management software sold through our distribution channel of approximately $30,000. The decrease in identification project related revenue is reflective of lower software licenses sold into identification projects during the year ended December 31, 2021 and the decrease in royalty revenue results primarily from lower reported usage from certain customers. The increase in boxed identity management software sold through our distribution channel reflects higher procurement from certain international customers and the increase in law enforcement software reflects the expansion of our installed base among existing customers.
Revenue from the sale of hardware and consumables increased approximately $206,000 during the year ended December 31, 2021 as compared to the corresponding period in 2020 due to an increase in project related solutions containing hardware and consumable sales primarily to law enforcement customers.
Services revenue consists primarily of software integration services, system installation services and customer training. Such revenue decreased $1,094,000 during the year ended December 31, 2021 as compared to the corresponding period in 2020, due to a decrease in the service element of project related work completed during the year ended December 31, 2021.
We believe that the period-to-period fluctuations of identity management software revenue in project-oriented solutions are largely due to the timing of government procurement with respect to the various programs we are pursuing. Although no assurances can be given, based on management’s current visibility into the timing of potential government procurements and potential partnerships and current pilot programs, we believe that we will see an increase in government procurement and implementations with respect to identity management initiatives; however, government procurement initiatives, implementations and pilots are frequently delayed and extended and we cannot predict the timing of such initiatives.
As discussed more fully elsewhere in this Annual Report, the full extent of COVID-19’s impact on our operations and financial performance depends on future developments that are uncertain and unpredictable, including the duration and spread of the pandemic, its impact on our ability to close sales transactions and on capital and financial markets and any new information that may emerge concerning the severity of the virus, its spread to other regions as well as the actions taken to contain it, among others.
During the year ended December 31, 2021, we have focused on strategically modernizing our modules within the Imageware Identity Platform, prioritized by market opportunities. We relaunched Imageware Authenticate (formerly GoVerify ID®) in February 2021. This relaunch includes a new container and microservices-based architecture along with refreshed mobile and desktop clients. We believe these updates will result in additional customers implementing our Imageware Authenticate solution. Additionally, we launched Imageware Capture, our first module of the Law Enforcement 2.0 solution in October 2021 and Imageware Investigate in December 2021. These are the first of many modules that we plan to build and modernize throughout 2022 and beyond. Prior to releasing Imageware Investigate, we closed our largest software-as-a-service (SaaS) deal in company history with Imageware Investigate. Management believes that these initiatives will result in the expansion of our solutions into state & local law enforcement, federal government, and enterprises alike.
Maintenance Revenue
| Twelve Months Ended December 31, |
||||||||||||||||
| Maintenance Revenue |
2021 |
2020 |
$ Change |
% Change | ||||||||||||
| (dollars in thousands) |
||||||||||||||||
| Total maintenance revenue |
$ | 2,618 | $ | 2,554 | $ | 64 | 3 | % | ||||||||
Maintenance revenue was approximately $2,618,000 for the year ended December 31, 2021, as compared to approximately $2,554,000 for the corresponding periods in 2020. For the year ended December 31, 2021, identity management maintenance revenue was approximately $1,385,000 as compared to $1,264,000 for the comparable period in 2020. The increase of $121,000 in identification software maintenance revenue for the year ended December 31, 2021 as compared to the corresponding period of 2020 is reflective of certain additional maintenance services provided by the Company during the year ended December 31, 2021. For the year ended December 31, 2021, law enforcement maintenance revenue was approximately $1,233,000 as compared to $1,290,000 for the comparable period in 2020. The decrease of $57,000 in law enforcement maintenance revenue for the year ended December 31, 2021 as compared to the corresponding period of 2020 reflects the expiration of certain maintenance contracts.
We anticipate growth of our maintenance revenue through the retention of existing customers combined with the expansion of our installed base resulting from the completion of project-oriented work; however, we cannot predict the timing of this anticipated growth.
Cost of Product Revenue
| Twelve Months Ended December 31, |
||||||||||||||||
| Cost of Product Revenue: |
2021 |
2020 |
$ Change |
% Change |
||||||||||||
| (dollars in thousands) |
||||||||||||||||
| Software and royalties |
$ | 28 | $ | 54 | $ | (26 | ) |
(48 | )% |
|||||||
| Percentage of software and royalty product revenue |
7 | % |
6 | % |
||||||||||||
| Hardware and consumables |
$ | 200 | $ | 52 | $ | 148 | 285 | % |
||||||||
| Percentage of hardware and consumables product revenue |
69 | % |
62 | % |
||||||||||||
| Services |
$ | 94 | $ | 694 | $ | (600 | ) |
(86 | )% |
|||||||
| Percentage of services product revenue |
52 | % |
54 | % |
||||||||||||
| Total product cost of revenue |
$ | 322 | $ | 800 | $ | (478 | ) |
60 | % |
|||||||
| Percentage of total product revenue |
38 | % |
36 | % |
||||||||||||
The cost of software and royalty product revenue decreased approximately $26,000 due to lower software and royalty revenue for the year ended December 31, 2021 of approximately $489,000. In addition to changes in costs of software and royalty product revenue caused by revenue level fluctuations, costs of products can vary as a percentage of product revenue from period to period depending upon level of software customization and third-party software license content included in product sales during a given period.
The cost of product revenue for our hardware and consumable sales during the year ended December 31, 2021 increased approximately $148,000 as compared to the corresponding period in 2020 due primarily to higher hardware and consumable product revenue of approximately $206,000 during the 2021 period.
The cost of services revenue decreased approximately $600,000 during the year ended December 31, 2021 as compared to the corresponding period in 2020 due to lower service revenue of approximately $1,094,000. Although changes in costs of services product revenue are sometimes caused by revenue level fluctuations, costs of services can also vary as a percentage of service revenue from period to period depending upon both the level and complexity of professional service resources utilized in the completion of the service element.
Cost of Maintenance Revenue
| Maintenance cost of revenue |
Twelve Months Ended December 31, |
|||||||||||||||
| (dollars in thousands) |
2021 |
2020 |
$ Change |
% Change |
||||||||||||
| Total maintenance cost of revenue |
$ | 346 | $ | 448 | $ | (102 | ) |
(23 | )% |
|||||||
| Percentage of total maintenance revenue |
13 | % |
18 | % |
||||||||||||
Cost of maintenance revenue decreased approximately $102,000 during the year ended December 31, 2021 as compared to the corresponding period in 2020 despite higher maintenance revenue of approximately $64,000. This decrease is reflective of lower maintenance labor costs incurred during the year ended December 31, 2021 as compared to the corresponding period in 2020 due primarily to the headcount reductions in our customer support department and a reduction in fixed maintenance costs.
Product Gross Profit
| Twelve Months Ended December 31, |
||||||||||||||||
| Product gross profit |
2021 |
2020 |
$ Change |
% Change |
||||||||||||
| (dollars in thousands) |
||||||||||||||||
| Software and royalties |
$ | 355 | $ | 818 | $ | (463 | ) |
(57 | )% |
|||||||
| Percentage of software and royalty product revenue |
93 | % |
94 | % |
||||||||||||
| Hardware and consumables |
$ | 90 | $ | 32 | $ | 58 | 181 | % |
||||||||
| Percentage of hardware and consumables product revenue |
31 | % |
38 | % |
||||||||||||
| Services |
$ | 87 | $ | 581 | $ | (494 | ) |
(85 | )% |
|||||||
| Percentage of services product revenue |
48 | % |
46 | % |
||||||||||||
| Total product gross profit |
$ | 532 | $ | 1,431 | $ | (899 | ) |
(63 | )% |
|||||||
| Percentage of total product revenue |
62 | % |
64 | % |
||||||||||||
Software and royalty gross profit decreased 57% or approximately $463,000 for the year ended December 31, 2021 as compared to the corresponding period in 2020, due primarily to lower software and royalty revenue of approximately $489,000 combined with lower software and royalty cost of revenue of $26,000 for the same period. This revenue decrease with only a minimal decrease in software and royalty cost of revenue reflects low third-party software costs. In addition to changes in costs of software and royalty product revenue caused by revenue level fluctuations, costs of products can vary as a percentage of product revenue from period to period depending upon level of software customization and third-party software license content included in product sales during a given period.
Hardware and consumables gross profit increased approximately $58,000 for the year ended December 31, 2021, as compared to the 2020 period, due primarily to higher hardware and consumable revenue of approximately $206,000 combined with higher cost of hardware and consumable revenue of approximately $148,000. These increases result from an increase in project related solutions containing hardware and consumable components.
Services gross profit decreased approximately $494,000 for the year ended December 31, 2021 as compared to the corresponding period in 2020 due to lower service revenue of approximately $1,094,000 combined with lower service cost of revenue of $600,000 for the year ended December 31, 2021 as compared to the corresponding period in 2020. Although changes in costs of services product revenue are sometimes caused by revenue level fluctuations, costs of services can also vary as a percentage of service revenue from period to period depending upon both the level and complexity of professional service resources utilized in the completion of the service element.
Maintenance Gross Profit
| Maintenance gross profit |
Twelve Months Ended December 31, |
|||||||||||||||
| (dollars in thousands) |
2021 |
2020 |
$ Change |
% Change |
||||||||||||
| Total maintenance gross profit |
$ | 2,272 | $ | 2,106 | $ | 166 | 8 | % |
||||||||
| Percentage of total maintenance revenue |
87 | % |
82 | % |
||||||||||||
Gross profit related to maintenance revenue increased 8% or approximately $166,000 for the year ended December 31, 2021 as compared to the corresponding period in 2020. This increase reflects higher maintenance revenue of approximately $64,000 combined with lower cost of maintenance revenue of approximately $102,000. The increase in maintenance revenue results from the provision of certain additional maintenance services to a certain customer during the year ended December 31, 2021. The decrease cost of maintenance revenues for the year ended December 31, 2021 as compared to the corresponding period in 2020 is due primarily to reductions in headcount in our customer support department and reductions in certain fixed maintenance costs. Maintenance gross profit can change from period to period depending upon both the level and complexity of labor resources utilized in the provision of the maintenance services.
Operating Expense
| Twelve Months Ended December 31, |
||||||||||||||||
| Operating expense |
2021 |
2020 |
$ Change |
% Change |
||||||||||||
| (dollars in thousands) |
||||||||||||||||
| General and administrative |
$ | 6,151 | $ | 4,102 | $ | 2,049 | 50 | % |
||||||||
| Percentage of total net revenue |
177 | % |
86 | % |
||||||||||||
| Sales and marketing |
$ | 2,892 | $ | 2,936 | $ | (44 | ) |
(1 | )% |
|||||||
| Percentage of total net revenue |
83 | % |
61 | % |
||||||||||||
| Research and development |
$ | 4,461 | $ | 5,706 | $ | (1,245 | ) |
(22 | )% |
|||||||
| Percentage of total net revenue |
128 | % |
119 | % |
||||||||||||
| Depreciation and amortization |
$ | 56 | $ | 72 | $ | (16 | ) |
(22 | )% |
|||||||
| Percentage of total net revenue |
2 | % |
2 | % |
||||||||||||
General and Administrative Expense
General and administrative expense is comprised primarily of salaries and other employee-related costs for executive, financial, and other infrastructure personnel. General legal, accounting and consulting services, insurance, occupancy and communication costs are also included with general and administrative expense.
The dollar increase of approximately $2,049,000 in general and administrative expense for the year ended December 31, 2021 as compared to the corresponding period in 2020 is comprised of the following major components:
| ● |
Overall decrease in personnel related expense of approximately $417,000 is due to reductions in headcount of various senior management positions changes; |
| ● |
Increases in professional services of approximately $679,000 which includes higher legal fees of approximately $93,000, higher Board of Director fees of approximately $70,000, higher auditing fees of approximately $25,000, higher contractor and contract service expenses of approximately $635,000 offset by reductions in patent-related legal and other fees of approximately $115,000, reductions in general corporate expense of $11,000 and lower investor and public relations fees of approximately $18,000; |
| ● |
Increase in insurance related expense of approximately $191,000 driven by higher director & officer insurance premiums, increases in licenses, dues and subscription expense of approximately $213,000, increases in travel of approximately $17,000 and increases of approximately $10,000 in other miscellaneous expense offset by reductions in office related costs of approximately $99,000 driven by the sublet of our former San Diego office facility; |
| ● |
Recognition of impairment loss on an operating lease right-of-use asset of $333,000; As of December 31, 2021, and through the date of this report, management’s review indicated that there was an impairment of an operating lease right-of-use asset and the Company recorded an impairment loss based on the excess of the carrying amount over the fair value, based on market value when available, or expected future economic benefits to the company from the operating lease right-of-use asset. |
| ● |
Increase in financing expense of approximately $829,000; and |
| ● |
Increase in stock-based compensation expense related to options and restricted stock units (“RSU’s”) of approximately $293,000. |
We continue to focus our efforts on achieving additional future operating efficiencies by reviewing and improving upon existing business processes and evaluating our cost structure. We believe these efforts will allow us to continue to gradually decrease our level of general and administrative expense expressed as a percentage of total revenue.
Sales and Marketing Expense
Sales and marketing expense consists primarily of the salaries, commissions, other incentive compensation, employee benefits and travel expense of our sales, marketing, and business development personnel.
The dollar decrease of approximately $44,000 during the year ended December 31, 2021 as compared to the corresponding period in 2020 is primarily comprised of the following major components:
| ● |
Decrease in personnel related expense of approximately $269,000 driven primarily by headcount reductions; |
| ● |
Increase in contractor and contract services of approximately $148,000 resulting from reduced utilization of certain sales consultants of approximately $150,000 offset by higher contract service expense of approximately $298,000; |
| ● |
Increase in travel, trade show expense and office related expense of approximately $121,000; |
| ● |
Increase in stock-based compensation expense of approximately $234,000; and |
| ● |
Decrease in our Mexico sales office expense of approximately $278,000 due to the shutdown of this sales office. |
Research and Development Expense
Research and development expense consists primarily of salaries, employee benefits and outside contractors for new product development, product enhancements, custom integration work and related facility costs.
Research and development expense decreased approximately $1,245,000 for the year ended December 31, 2021, as compared to the corresponding period in 2020, due primarily to the following major components:
| ● |
Decrease in personnel related expense of approximately $1,498,000 due to headcount reductions; |
| ● |
Increase in contractor fees and contract services of approximately $109,000; |
| ● |
Decrease in rent, office related expense and engineering tools and supplies of approximately $61,000; and |
| ● |
Increase in stock based-compensation expense of approximately $205,000. |
Depreciation and Amortization
During the year ended December 31, 2021, depreciation and amortization expense decreased approximately $16,000 as compared to the corresponding period in 2020. The relatively small amount of depreciation and amortization reflects the relatively small property and equipment carrying value.
Interest (Income) Expense, Net
For the year ended December 31, 2021, we recognized interest income of $0 and interest expense of $2,000. Interest expense for the year ended December 31, 2021 was comprised of approximately $1,000 on our related party notes payable and approximately $1,000 in deferred financing fee amortization on our related party notes payable classified as interest expense. For the year ended December 31, 2020, we recognized interest income of $2,000 and interest expense of $104,000.
Other (Income) Expense, Net
For the year ended December 31, 2021, we recognized other income of approximately $156,000 and other expense of approximately $82,000. The primary components of other income were approximately $131,000 from the write-off of liabilities at amounts less than their carrying value and $25,000 from sublease income. Other expense for the year ended December 31, 2021 is comprised of approximately $82,000 from the write-off of abandoned furniture. For the year ended December 31, 2020, we recognized approximately $2,000 in other expense related to late payment penalty fees.
(Gain) on Change in Fair Value of Derivative Liabilities
For the year ended December 31, 2021, we recognized approximately $18,809,000 from the change in fair value of derivative liabilities arising from the Series D Financing. Such decrease was determined by management using fair value methodologies and is included as non-cash income under the caption “(Gain on change in fair value of derivative liabilities” in our consolidated statement of operations for the year ended December 31, 2021.
For the year ended December 31, 2020, we recognized approximately $369,000 from the decrease of derivative liabilities arising from the consummation of the Series C Financing in September 2019. Such decrease was determined by management using fair value methodologies and is included as non-cash income under the caption “Change in fair value of derivative liabilities” in our consolidated statement of operations for twelve months ended December 31, 2020. Also for the year ended December 31, 2020, we recognized approximately $1,883,000 from the decrease in fair value of derivative liabilities arising from the Series D Financing. Such decrease was determined by management using fair value methodologies and is included as non-cash income under the caption “Change in fair value of derivative liabilities” in our consolidated statement of operations for the year ended December 31, 2020.
(Gain) on Extinguishment of Debt
For the year ended December 31, 2021, we recognized a gain on debt extinguishment from the forgiveness of our PPP Loan. In September 2021, we received notification from the Small Business Administration (“SBA”) that our Paycheck Protection Program (“PPP”) Loan of $1,571,000 was forgiven in its entirety along with accrued unpaid interest of approximately $10,000. Such gain is included in the caption “(Gain) on extinguishment of debt” in our consolidated statement of operations for the year ended December 31, 2021.
Loss on Extinguishment of Derivative Liabilities
For the year ended December 31, 2021, we recognized a net loss on the extinguishment of derivative liabilities of approximately $311,000 pursuant to the conversion of 646 shares of Series D Preferred into Common Stock. Such loss is included in the caption “Loss on extinguishment of derivative liabilities” in our consolidated statement of operations for the year ended December 31, 2021.
Income Tax Expense
During the years ended December 31, 2021 and 2020, we recorded an expense for income taxes of $10,000 and $7,000, respectively. These tax expenses relate to taxes on income generated in certain foreign jurisdictions offset by research and development tax credits generated in certain foreign jurisdictions.
We have incurred consolidated pre-tax losses during the years ended December 31, 2021, and 2020, and have incurred operating losses in all prior periods. Management has determined that it is more likely than not that a tax benefit from such losses will not be realized and has established a full valuation allowance for any tax benefits. Accordingly, we did not record a benefit for income taxes for these periods.
Liquidity, Capital Resources and Going Concern
Historically, our principal sources of cash have included proceeds from the issuance of common and preferred stock and proceeds from the issuance of debt, and, to a lesser extent, customer payments from the sale of our products. 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 this condition is currently expected to continue for the foreseeable future. As a result, the Company has been dependent on equity and debt financings to satisfy its working capital requirements and continue as a going concern. Due to the Company’s deteriorating liquidity, management has determined that there is substantial doubt about the Company’s ability to continue as a going concern.
At December 31, 2021 and 2020, we had negative working capital of $8,046,000 and $19,349,000, respectively. Included in our negative working capital as of December 31, 2021 and 2020 are $5,292,000 and $24,128,000, respectively, 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 December 31, 2021 the Liquidation Preference Amount totaled $23,216,000. Considering the financings consummated in 2020 and 2021, 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 in the near term, and for the next twelve months from the date of this filing. At April 12, 2022, cash on hand approximated $588,000. Based on the Company’s rate of cash consumption during the year ended December 31, 2021 and the first quarter ended March 31, 2022, the Company estimates it will need additional capital in the second quarter of 2022 and its prospects for obtaining that capital are uncertain. As a result of the Company’s historical losses, financial condition, and challenges raising additional capital given the volatile capital markets, there is substantial doubt about the Company’s ability to continue as a going concern.
To address our working capital requirements, management has instituted several cost cutting measures and has utilized cash proceeds available under the Credit Facility with Nantahala and other lenders, as described below, and under the purchase agreement with Lincoln Park Capital Fund, LLC (“Lincoln Park”), as described below, to satisfy its working capital requirements (“LPC Purchase Agreement”). In addition, as reported in the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 23, 2021, on August 12, 2021, the Company retained an investment bank to initiate a review of available alternatives to maximize shareholder value, which may include, among other alternatives, (i) a merger, consolidation, or other business combination or a purchase involving all or a substantial amount of the business, securities or assets of the Company, and/or (ii) the private placement of securities to meet its working capital requirements or otherwise as necessary in connection with the consummation of any of the above transactions. Other than the LPC Purchase Agreement with Lincoln Park and our Credit Facility with Nantahala, which are currently restricted in our ability to access additional capital, there are currently no financing arrangements to support our projected cash shortfall. We currently have no other 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. The consummation of a transaction will involve substantial dilution to the Company’s stockholders.
In view of the matters described in the preceding paragraphs, 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, generate positive cash flows from operations, or otherwise consummate a transaction that addresses the Company’s working capital requirements. There is no assurance that the Company will be able to obtain additional capital, consummate a transaction that addresses its liquidity concerns, or 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 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.
December 2021 Credit Facility
On December 29, 2021 (the “Closing Date”), the Company entered into a Term Loan and Security Agreement (the “Agreement”) with certain funds and separate accounts managed by Nantahala Capital Management, LLC (collectively, “Nantahala”), as lenders, and the other lenders set forth on the signature pages thereto (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2,500,000 (the “Credit Facility”). All loans (each a “Loan", and collectively, the “Loans”) under the Credit Facility will bear interest at a rate of 12% for the initial six months after the Closing Date, and at 17% thereafter until the maturity date of 12 months from the Closing Date (the “Maturity Date”). All amounts borrowed by the Company under the Credit Facility are secured by a first-priority lien on all the assets of the Company. On the Closing Date, the Company received in initial draw-downs on the Credit Facility of $600,000. As of April 12, 2022, the Company received two subsequent draw-down aggregating $1,050,000. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes.
The Company may prepay amounts borrowed under the Credit Facility in whole or in part, at a price equal to 105% of the principal amount borrowed under the Credit Facility (including any interest capitalized thereon). Upon the occurrence of: (I) any Debt Issuances, Dispositions, or Equity Interests (each as defined in the Agreement), the Company must prepay the Loans in an aggregate amount equal to the lesser of (a) the outstanding principal balance outstanding under the Credit Facility (including any interest capitalized thereon), and (b) 100% of the Net Cash Proceeds (as defined in the Agreement) received thereunder; and (II) a Change of Control (as defined in the Agreement), the Company must prepay the Loans in an aggregate amount equal to the lesser of (y) the outstanding principal balance outstanding under the Credit Facility (including any interest capitalized thereon), and (z) 105% of the Net Cash Proceeds received in connection therewith.
Pursuant to the Agreement, at any time after the Closing Date, each Lender shall have the right, but not the obligation, on mutually agreed upon terms, to exchange each such Lender’s pro rata portion of shares of the Company’s Series D Convertible Preferred Stock, par value $0.01 (“Series D Preferred”) held by such Lender for a mutually agreed upon portion of any subsequent Delayed Draw Loan (as defined in the Agreement) (an “Exchange”). Upon the Company's receipt by a Lender of a notice stating a Lender's intent to participate in an Exchange, the Company is required to offer to all holders of Series D Preferred the opportunity, but not the obligation, to exchange each such holder’s pro rata portion of shares of the Company's Series D Preferred held by such holder for participation in any subsequent Delayed Draw Loan, upon substantially similar terms as those provided in the applicable notice of Exchange by a Lender.
The Agreement contains customary events of default (each an “Event of Default”). If an Event of Default occurs, all amounts due and payable under the Credit Facility shall incur interest at the current rate of interest plus 4%. The Agreement further contains: (i) customary representations, warranties and covenants of the Company, including among others, covenants by the Company regarding title to the Company's Assets, the Company's rights to its intellectual property, the Company's use of the proceeds received thereunder, tax liabilities, and status of the Company's material contracts; and (ii) customary indemnification provisions whereby the Company will indemnify the Lenders for certain losses arising out of inaccuracies in, or breaches of, the representations, warranties and covenants of the Company, and certain other matters.
2021 Lincoln Park Financing
On May 17, 2021 (the “Execution Date”), the Company entered into a purchase agreement, dated as of the Execution Date (the “2021 LPC Purchase Agreement”), and a registration rights agreement, dated as of the Execution Date (the “Registration Rights Agreement”), with Lincoln Park Capital Fund, LLC (“Lincoln Park”), pursuant to which Lincoln Park has committed to purchase up to $15,100,000 of the Company's Common Stock.
Under the terms and subject to the conditions of the 2021 LPC Purchase Agreement, the Company has the right, but not the obligation, to sell to Lincoln Park, and Lincoln Park is obligated to purchase up to $15,100,000 worth of shares of Common Stock. Such sales of Common Stock by the Company, if any, will be subject to certain limitations, and may occur from time to time, at the Company's sole discretion, over the 24-month period commencing on July 23, 2021, the date that the registration statement covering the resale of shares of Common Stock that have been and may be issued under the 2021 LPC Purchase Agreement, which was filed with the SEC pursuant to the Registration Rights Agreement, and was declared effective by the SEC and a final prospectus in connection therewith is filed and the other conditions set forth in the 2021 LPC Purchase Agreement are satisfied, all of which are outside the control of Lincoln Park (such date on which all of such conditions are satisfied, the “Commencement Date”).
Under the 2021 LPC Purchase Agreement, on any business day over the term of the 2021 LPC Purchase Agreement, the Company has the right, in its sole discretion, to present Lincoln Park with a purchase notice (each, a “Purchase Notice”) directing Lincoln Park to purchase up to 250,000 shares of Common Stock per business day (“Regular Purchase”), which (i) increases to up to 300,000 shares in the event the price of the Company’s Common Stock is not below $0.10 per share, (ii) increases to 350,000 shares of Common Stock per Business Day in the event the price of the Company’s Common Stock is not below $0.25 per share, and (iii) increases to 500,000 shares in the event the price of the Company’s Common Stock is not below $0.50 per share (in each case, subject to adjustment for any reorganization, recapitalization, non-cash dividend, stock split, reverse stock split or other similar transaction as provided in the 2021 LPC Purchase Agreement). In each case, Lincoln Park's maximum commitment in any single Regular Purchase may not exceed $500,000. The parties may mutually agree to increase the number of shares to be purchased by Lincoln Park pursuant to any Regular Purchase up to 2,000,000 shares. The 2021 LPC Purchase Agreement provides for a purchase price per Purchase Share (the “Purchase Price”) equal to the lesser of:
| ● | The lowest sale price of the Company's Common Stock on the purchase date; and |
| ●
|
The average of the three lowest closing sale prices for the Company's Common Stock during the fifteen consecutive business days ending on the business day immediately preceding the purchase date of such shares. |
In addition, on any date on which the Company submits a Purchase Notice to Lincoln Park, the Company also has the right, in its sole discretion, to present Lincoln Park with an accelerated purchase notice (each, an “Accelerated Purchase Notice”) directing Lincoln Park to purchase an amount of stock (the “Accelerated Purchase”) equal to up to the lesser of (i) three times the number of shares of Common Stock purchased pursuant to such Regular Purchase; and (ii) 30% of the aggregate shares of the Company's Common Stock traded during all or, if certain trading volume or market price thresholds specified in the 2021 LPC Purchase Agreement are crossed on the applicable Accelerated Purchase Date, the portion of the normal trading hours on the applicable Accelerated Purchase Date prior to such time that any one of such thresholds is crossed (such period of time on the applicable Accelerated Purchase Date, the “Accelerated Purchase Measurement Period”), provided that Lincoln Park will not be required to buy shares of Common Stock pursuant to an Accelerated Purchase Notice that was received by Lincoln Park on any business day on which the last closing trade price of the Company's Common Stock on the OTC Markets (or alternative national exchange in accordance with the 2021 LPC Purchase Agreement) is below $0.25 per share. The parties may mutually agree to increase the number of shares to be purchased by Lincoln Park pursuant to any Accelerated Purchase. The purchase price per share of Common Stock for each such Accelerated Purchase will be equal to 95% of the lesser of:
| ● | The volume weighted average price of the Company's Common Stock during the applicable Accelerated Purchase Measurement Period on the applicable Accelerated Purchase Date; and
|
| ● | The closing sale price of the Company's Common Stock on the applicable Accelerated Purchase Date. |
The Company may also direct Lincoln Park on any business day on which an Accelerated Purchase has been completed and all of the shares to be purchased thereunder have been properly delivered to Lincoln Park in accordance with the 2021 LPC Purchase Agreement, to purchase an amount of stock (the “Additional Accelerated Purchase”) equal to up to the lesser of (i) three times the number of shares purchased pursuant to such Regular Purchase; and (ii) 30% of the aggregate number of shares of the Company's Common Stock traded during a certain portion of the normal trading hours on the applicable Additional Accelerated Purchase date as determined in accordance with the 2021 LPC Purchase Agreement (such period of time on the applicable Additional Accelerated Purchase date, the “Additional Accelerated Purchase Measurement Period”). The parties may mutually agree to increase the number of shares to be purchased by Lincoln Park pursuant to any Additional Accelerated Purchase. Additional Accelerated Purchases will be equal to 95% of the lower of:
| ● | The volume weighted average price of the Company's Common Stock during the applicable Additional Accelerated Purchase Measurement Period on the applicable Additional Accelerated Purchase date; and |
| ● | The closing sale price of the Company's Common Stock on the applicable Additional Accelerated Purchase date. |
The aggregate number of shares that the Company can sell to Lincoln Park under the 2021 LPC Purchase Agreement may in no case exceed that number which, together with Lincoln Park’s then current holdings of Common Stock, exceed 4.99% of the Common Stock outstanding immediately prior to the delivery of the Purchase Notice.
Lincoln Park has no right to require the Company to sell any shares of Common Stock to Lincoln Park, but Lincoln Park is obligated to make purchases as the Company directs, subject to certain conditions. There are no upper limits on the price per share that Lincoln Park must pay for shares of Common Stock.
The Company has agreed with Lincoln Park that it will not enter into any “variable rate" transactions with any third party for a period defined in the 2021 LPC Purchase Agreement.
The Company issued to Lincoln Park 1,000,000 shares of Common Stock as commitment shares in consideration for entering into the 2021 LPC Purchase Agreement on the Execution Date.
The 2021 LPC Purchase Agreement and the Registration Rights Agreement contain customary representations, warranties, agreements and conditions to completing future sale transactions, indemnification rights and obligations of the parties. The Company has the right to terminate the 2021 LPC Purchase Agreement at any time, at no cost or penalty, subject to the survival of certain provisions set forth in the 2021 LPC Purchase Agreement. During any “event of default" under the 2021 LPC Purchase Agreement, all of which are outside of Lincoln Park's control, Lincoln Park does not have the right to terminate the 2021 LPC Purchase Agreement; however, the Company may not initiate any regular or other purchase of shares by Lincoln Park, until such event of default is cured. In addition, in the event of bankruptcy proceedings by or against the Company, the 2021 LPC Purchase Agreement will automatically terminate.
Actual sales of shares of Common Stock to Lincoln Park under the 2021 LPC Purchase Agreement will depend on a variety of factors to be determined by the Company from time to time, including, among others, market conditions, the trading price of the Common Stock and determinations by the Company as to the appropriate sources of funding for the Company and its operations. Lincoln Park has no right to require any sales by the Company but is obligated to make purchases from the Company as it directs in accordance with the 2021 LPC Purchase Agreement. Lincoln Park has covenanted not to cause or engage in any manner whatsoever, any direct or indirect short selling or hedging of the Company's shares.
In connection with the execution of the 2021 LPC Purchase Agreement, the Company has agreed to sell, and Lincoln Park has agreed to purchase, 1,000,000 shares of Common Stock for a purchase price of $100,000 (“Original Purchase”).
Due to the terms of the 2021 LPC Purchase Agreement as described above, management is not currently expecting the related proceeds from this agreement to be sufficient to sustain operations for an extended period of time.
Prior to entering into the 2021 LPC Purchase Agreement, the Company and Lincoln Park terminated the previous agreement between the Company and Lincoln Park entered into on June 11, 2020 (the “2020 LPC Purchase Agreement”).
The Series D Preferred Stock 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 resulting in gross proceeds to the Company of $12.06 million, less fees and expenses. 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 SEC on February 12, 2021.
Operating Activities
Net cash used in operating activities was approximately $7,737,000 during the year ended December 31, 2021 as compared to $8,009,000 during the year ended December 31, 2020. During the year ended December 31, 2021, net cash used in operating activities consisted of net income of $9,282,000 and an increase in working capital and other assets and liabilities of $589,000. Those amounts in addition to approximately $17,608,000 of non-cash income, including $18,809,000 in income from the change in fair value of derivative liabilities and $1,581,000 in income from the extinguishment of debt offset by $1,528,000 in stock-based compensation, $56,000 in depreciation and amortization, $82,000 in non-cash expense from the disposal of fixed assets, $364,000 in non-cash expense from the write-off of deferred stock issuance costs, $311,000 in non-cash expense from the extinguishment of derivative liabilities, $333,000 from the recognition of an impairment loss of an operating lease right-of -use asset, $50,000 from the write-off of an abandoned patent and $58,000 from the issuance of common stock as compensation in lieu of cash. During the year ended December 31, 2021, we generated cash of $139,000 from decreases in current assets offset by $44,000 from increases in our operating leases right-of-use assets and generated cash of $531,000 through increases in current liabilities and deferred revenue offset by increases of $37,000 in pension liability.
Net cash used in operating activities was $8,009,000 during the year ended December 31, 2020 as compared to $11,267,000 during the year ended December 31, 2019. During the year ended December 31, 2020, net cash used in operating activities consisted of net loss of $7,253,000 and an increase in working capital and other assets and liabilities of $438,000. Those amounts in addition to approximately $1,194,000 of non-cash income, including $2,252,000 in income from the change in fair value of derivative liabilities offset by $862,000 in stock-based compensation, $72,000 in depreciation and amortization and $124,000 from the application of rent deposits.
Investing Activities
Net cash used in investing activities during the year ended December 31, 2021 was $53,000 as compared to $0 for the corresponding period in 2020. For the year ended December 31, 2021, we used cash of $53,000 to fund capital expenditures of computer hardware.
Financing Activities
Cash generated from financing activities for the year ended December 31, 2021 was approximately $572,000, which consisted of approximately $600,000 received by the Company in the form of a draw-down from its Credit Facility, net of direct financing costs of $77,000 and $100,000 from the sale of 1,000,000 shares of Common Stock for $0.10 per share and used cash of approximately $51,000 for the payment of dividends on our Series B Preferred Stock.
Cash generated from financing activities for the year ended December 31, 2020 was approximately $15,475,000, which consisted of approximately $12,060,000 generated from the sale of 12,060 shares of Series D Preferred. Such amount includes $2,187,000 received by the Company in the form of a Bridge Loan which was converted into shares of Series D Preferred before recognition of approximately $726,000 in cash direct stock issuance costs. We also generated cash of approximately $900,000 from the issuance of related party notes payable and generated cash of $1,571,000 from the issuance of the PPP Loan under the CARES Act. Also in the year ended December 31, 2020, we generated cash of approximately $2,360,000 from the sales of 15,700,000 shares of Common Stock before recognition of approximately $64,000 in direct stock issuance costs. We used cash of approximately $575,000 to repay certain related party notes payable and used cash of approximately $51,000 for the payment of dividends on our Series B Preferred.
Real Property 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.
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.
Stock-Based Compensation
Stock-based compensation related to equity options and restricted stock has been classified as follows in the accompanying consolidated statements of operations (in thousands):
| Year Ended December 31, |
||||||||
| 2021 |
2020 |
|||||||
| Cost of revenue |
$ | 29 | $ | 15 | ||||
| General and administrative |
842 | 550 | ||||||
| Sales and marketing |
336 | 163 | ||||||
| Research and development |
321 | 134 | ||||||
| Total |
$ | 1,528 | $ | 862 | ||||
Off-Balance Sheet Arrangements
At December 31, 2021, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, special purpose or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we did not engage in trading activities involving non-exchange traded contracts. As a result, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have relationships and transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed elsewhere in this Annual Report.
Recently Issued Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (the “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. See Note 2 to these consolidated financial statements for a detailed discussion of recently issued accounting pronouncements.
Impact of Inflation
The primary inflationary factor affecting our operations is labor costs, and we do not believe that inflation has materially affected earnings during the past four years. Substantial increases in costs and expense, particularly labor and operating expense, could have a significant impact on our operating results to the extent that such increases cannot be passed along to customers and end users.
| QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Our business extends to countries outside the United States, and we intend to continue to expand our foreign operations. As a result, our revenue and results of operations are affected by fluctuations in currency exchange rates, interest rates, and other uncertainties inherent in doing business in more than one currency. In addition, our operations are exposed to risks that are associated with changes in social, political, and economic conditions in the foreign countries in which we operate, including changes in the laws and policies that govern foreign investment, as well as, to a lesser extent, changes in United States laws and regulations relating to foreign trade and investment.
We had approximately $111,000 and $23,000 in revenue from sources outside the United States for the years ended December 31, 2021 and 2020, respectively. We made payments in foreign currencies to fund our foreign operations of approximately $894,000 and $1,015,000 for the years ended December 31, 2021 and 2020, respectively. Changes in currency exchange rates affect the relative prices at which we sell our products and purchase goods and services. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, results of operations, or financial condition. We do not use foreign currency exchange contracts or derivative financial instruments for hedging or speculative purposes. To the extent foreign sales become a more significant part of our business in the future, we may seek to implement strategies which make use of these or other instruments in order to minimize the effects of foreign currency exchange on our business.
| FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Our consolidated financial statements as of and for the years ended December 31, 2021 and 2020 and the report of our independent registered public accounting firm are included in Item 15 of this Annual Report.
| CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| CONTROLS AND PROCEDURES |
(a) Evaluation of Disclosure Controls and Procedures
Our management, Chief Executive Officer and Principal Financial and Accounting Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2021. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Principal Financial and Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Principal Financial and Accounting Officer concluded that our disclosure controls and procedures was not effective at the reasonable assurance level as of December 31, 2021. This conclusion was based on the material weaknesses in our internal control over financial reporting as further described below.
Material Weaknesses
During the second quarter of our fiscal year 2021, we identified material weaknesses in our internal control over financial reporting related to our financial statement close process and policies. We did not have adequate review policies and procedures in place to ensure the timely, effective review of the measurement of the fair value of certain derivative liabilities. Additionally, during the fourth quarter of fiscal year 2021, we identified an additional material weakness in our internal control over financial reporting. We did not design and maintain formal accounting policies, procedures and controls to achieve complete, accurate and timely financial accounting, reporting and disclosures relating to segregation of duties and controls over the preparation and review of journal entries, account reconciliations and consolidation.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected and corrected on a timely basis.
Remediation Efforts to Address Material Weaknesses
To remediate the material weaknesses described above, management is adding controls to further enhance and revise the design of the existing controls including:
| ● |
Establishing policies and procedures to ensure timely review, by qualified personnel, of inputs and assumptions used in measuring fair value of certain financial instruments as well as the journal entries to record the change in fair value. |
| ● |
Reassessing the design and operation of internal controls over financial reporting and review procedures over the preparation of our financial statements. |
| ● |
Maintaining adequate internal qualified personnel to properly supervise and review the information provided by the outside consulting technical experts to ensure certain significant complex transactions and technical matters were properly accounted for. |
| ● |
Establishing additional review procedures through the adding of additional personnel to achieve segregation of duties and performance of review procedures over the preparation and review of journal entries, account reconciliations and consolidation. |
These material weaknesses did not result in any restatements of our audited and unaudited consolidated financial statements or disclosures for any prior period previously reported by us.
(b) Management’s Annual Report on Internal Control over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes of accounting principles generally accepted in the United States.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives.
Our Chief Executive Officer and Principal Financial and Accounting Officer evaluated the effectiveness of our internal control over financial reporting as of December 31, 2021. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) in Internal Control—Integrated Framework. Based on this evaluation, our Chief Executive Officer and Principal Financial and Accounting Officer concluded that, as of December 31, 2021 our internal control over financial reporting was not effective.
(c) Changes in Internal Controls over Financial Reporting.
The Company’s Chief Executive Officer and Principal Financial and Accounting Officer have determined that there have been no changes in the Company’s internal control over financial reporting during the period covered by this report identified in connection with the evaluation described in the above paragraph that have materially affected, or are reasonably likely to materially affect, Company’s internal control over financial reporting.
| OTHER INFORMATION |
Not applicable.
| ITEM 10. |
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
The following sets forth certain information regarding each of our directors and executive officers.
| Name |
Age |
Title/Position Held with the Company |
||
| Kristin Taylor |
54 |
President, Chief Executive Officer, Director |
||
| James M. Demitrieus |
73 |
Director |
||
| Douglas Morgan |
69 |
Director |
||
| Lauren C. Anderson |
64 |
Director |
There are no familial relationships between any of the Company’s executive officers and directors listed above.
The following biographical information regarding the foregoing directors and officers of the Company following the Board Restructuring is presented below:
Kristin Taylor, President, Chief Executive Officer and Director. Ms. Taylor serves as our President and Chief Executive Officer since her appointment in March 2020 and as a member of our Board since May 2020, and is a seasoned innovative technology executive with over 20 years of experience in leading organizational modernization and developing go-to-market strategies. She formerly served as Principal of Veritas Lux since November 2019 and principal of Kristin Taylor Consulting since 2012, in which she developed a proprietary algorithmic methodology to weigh and rank the most influential global technical analysts. From 2017 to 2019, Ms. Taylor served as Global Vice President of Worldwide Analyst Relations at IBM and led the efforts to modernize and transform IBM's analyst relations organization to drive revenue, not just influence. From 2013 to 2017, she served as Vice President, Global Analyst and Public Relations at MediaTek, the third largest fabless semiconductor company in the world with a $30 billion market cap, where she led the buildout of a new global Public and Analyst Relations organization to penetrate the North American, European, Latin American, Russian and Indian markets. Prior to that, she served in various positions of increasing responsibility with Qualcomm from 1998 to 2010 including: Head of Industry Analyst Relations, Senior Director of Business Development, and Director of Information Technology. Ms. Taylor developed and commercialized a highly successful embedded computing module, designed for notebook computers which thrust Qualcomm into the computing sector in 2006 to create hundreds of millions of valuation as they expanded from mobile. Ms. Taylor earned her Bachelor's degree in Sociology and Business Management from the University of New Hampshire in Durham, New Hampshire.
James M. Demitrieus. Mr. Demitrieus was appointed as a member of the Board of Directors on November 13, 2020. From March 2018 to present, Mr. Demitrieus has served as Managing Director of Jameson Associates, a specialty investment management and financial advisory firm. Prior to Jameson, he served in multiple positions at Eyelock Corporation beginning in 2009, including Chief Executive Officer from 2010 to 2018. Eyelock Corporation provides iris based biometric solutions to various business verticals. Prior to Eyelock Corporation, he served in various senior executive roles, including as President of Sherwood Valve, a division of Harsco Corporation, and as Chief Executive Officer at Aluma Systems. Earlier in Mr. Demitrieus’ career, he served in numerous senior accounting and finance roles, including with the public accounting firm of Arthur Andersen & Co. Mr. Demitrieus holds a Bachelor's in Business Administration from Adelphi University in New York.
Mr. Demitrieus was selected as a member of the Board due to his experience in the field of biometrics, as well as his extensive management, finance and accounting experience, that management believes will provide the Board with valuable insights regarding monetizing the Company’s product offerings and intellectual property.
Douglas Morgan. Mr. Morgan was appointed as a member of the Board of Directors on November 24, 2020. From March 2019 to present, Mr. Morgan has served as an Advisory Board member and Consultant to Clyra Medical Technologies, a biotechnology company specializing in wound healing and antimicrobial solutions, and prior to that as a Consultant to the public parent company, BioLargo (symbol: BLGO) on business strategy and a capital raise. He is CEO of Performance Strategies, Inc., a business and technology consulting firm where he has worked with companies across numerous sectors including security, payments and biotech, assisting them with financing strategies, market positioning, technology development and IP strategy. Earlier in his career, he helped found Hirsch Electronics, a security systems company known for its patented ScamblePad product. He served as Hirsch’s VP Engineering managing the development of their entire line of security systems and controllers, and later as a Director helped negotiate Hirsch’s merger with publicly traded Identiv (symbol: INVE) where he again served on the Board of Directors. He graduated Summa Cum Laude from both MIT with a BS in Computer Science, and Stanford University with an MS in Electrical Engineering, and was also a National Science Foundation Fellow.
Mr. Morgan was selected as a member of the Board due to his past experience in the Security industry, his background in intellectual property development and strategies, and his work and broad experience in business strategy, product definition and market positioning for technology-based companies.
Lauren C. Anderson. Ms. Anderson joined the Company’s Board in February 2021. She is the founder and Chief Executive Officer of LC Anderson International Consulting, founded in 2013. Ms. Anderson, a former Federal Bureau of Investigation (“FBI”) Senior Executive, has a background in high risk, complex, domestic, and international environments and currently serves as an advisor to the U.S. Comptroller General at the Government Accountability Office on international security, intelligence, criminal justice, law enforcement, and women’s leadership. Ms. Anderson also serves as an advisor and special skilled role player for the U.S. Army, and she is an advisor with Stellar Solutions. Ms. Anderson worked in various leadership roles for the FBI from February 1984 until December 2012, and was the FBI Legal Attaché at United States Embassies in France and Morocco from March 2002 through November 2006. Ms. Anderson holds numerous professional awards and certifications, including achievement awards from the Director of National Intelligence, Legal Momentum, LIM College and Muhlenberg College. She is a member of the Council on Foreign Relations, a director emeritus for the Women's Forum of NY, served as a judge for the Women's Safety XPrize and the Stevie Awards, and is a mentor with the Women's Foreign Policy Group and Girl Security. She holds a security clearance and numerous certifications with the United States government. Ms. Anderson has an Honorary Doctorate of Humane Letters, awarded in 2019, by LIM College, New York City, a Bachelor of Arts in Psychology from Muhlenberg College, in Allentown, Pennsylvania, and completed executive programs at each of Harvard Business School, Northwestern University's Kellogg School of Management, Cambridge Judge Business School, and the George C. Marshall European Center for Security Studies in Garmisch, Germany.
Ms. Anderson was selected as a member of the Board due to her extensive experience as a security expert at the highest level within the Federal government, and her relationships with law enforcement and government agencies, each key markets for the Company.
There have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any director or nominee set forth above during the past ten years.
Board of Directors; Attendance at Meetings
The Board held 19 meetings and acted by unanimous written consent 6 times during the year ended December 31, 2021. Each director attended at least 75% of Board meetings during the year ended December 31, 2021. We have no formal policy with respect to the attendance of Board members at annual meetings of shareholders, but encourage all incumbent directors and director nominees to attend each annual meeting of shareholders.
Director Independence
Our Board has determined that all of its current members, other than Ms. Taylor, are “independent” within the meaning of the Nasdaq Stock Market Rules and SEC rules regarding independence.
Board Committees and Charters
Our Board has an Audit Committee, a Compensation Committee and a Nominating and Corporate Governance Committee, each of which has the composition and responsibilities described below.
Audit Committee
The Audit Committee provides assistance to the Board in fulfilling its legal and fiduciary obligations in matters involving our accounting, auditing, financial reporting, internal control and legal compliance functions by approving the services performed by our independent accountants and reviewing their reports regarding our accounting practices and systems of internal accounting controls. The Audit Committee also oversees the audit efforts of our independent accountants and takes those actions as it deems necessary to satisfy it that the accountants are independent of management. The Audit Committee currently consists of Messrs. Demitrieus (Committee Chair), and Morgan, each of whom is a non-management member of our Board. Mr. Demitrieus is also our Audit Committee financial expert, as currently defined under current SEC rules. The Audit Committee met four times during the year ended December 31, 2021. We believe that the composition of our Audit Committee meets the criteria for independence under, and the functioning of our Audit Committee complies with the applicable Nasdaq Stock Market Rules and SEC rules and regulations.
Compensation Committee
The Compensation Committee determines our general compensation policies and the compensation provided to our directors and officers. The Compensation Committee also reviews and determines bonuses for our officers and other employees. In addition, the Compensation Committee reviews and determines equity-based compensation for our directors, officers, employees and consultants and administers our stock option plans. The Compensation Committee currently consists of Messrs. Morgan (Committee Chair) and Demitrieus, each of whom is a non-management member of our Board. The Compensation Committee did not meet during the year ended December 31, 2021. All members of the Compensation Committee currently meet the criteria for independence under the applicable Nasdaq Stock Market Rules and SEC rules and regulations.
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee is responsible for making recommendations to the Board regarding candidates for directorships and the size and composition of the Board. In addition, the Nominating and Corporate Governance Committee is responsible for overseeing our corporate governance guidelines and reporting and making recommendations to the Board concerning corporate governance matters. The Nominating and Corporate Governance Committee currently consists of all the members of the Board. The Nominating and Corporate Governance Committee did not meet during the year ended December 31, 2021.
Board Leadership Structure
Our Board has discretion to determine whether to separate or combine the roles of Chief Executive Officer and Chair of the Board. Prior to the appointment of Kristin Taylor as President and Chief Executive Officer on March 2, 2020, and during the year ended December 31, 2020, S. James Miller held the roles of both Chief Executive Officer and Chair of the Board since 1996, and our Board believed that at the time, his combined role was advantageous to the Company and its shareholders. Currently, Ms. Taylor serves as both Chief Executive Officer and Chair of the Board as the Board believes, at this time, her combined role is advantageous to the Company and its shareholders.
The Board maintains effective independent oversight through a number of governance practices, including open and direct communication with management, input on meeting agendas, and regular executive sessions.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors and executive officers, and persons who beneficially own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of our Common Stock and other equity securities. Such persons are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the fiscal year ended December 31, 2021, all Section 16(a) filing requirements were complied with in a timely manner other than the below:
| ● |
Kristin Taylor, Chief Executive Officer and Chair of the Board of the Company, filed a Form 4 reporting one late transaction; |
| ● |
Douglas Morgan, a director of the Company, filed a Form 4 reporting one late transaction; |
| ● |
James Demitrieus, a director of the Company, filed a Form 4 reporting one late transaction; and |
| ● |
Lauren C. Anderson, a director of the Company, filed a Form 4 reporting one late transaction. |
Board Role in Risk Assessment
Management, in consultation with outside professionals, as applicable, identifies risks associated with the Company’s operations, strategies and financial statements. Risk assessment is also performed through periodic reports received by the Audit Committee from management, counsel and the Company’s independent registered public accountants relating to risk assessment and management. Audit Committee members meet privately in executive sessions with representatives of the Company’s independent registered public accountants. The Board also provides risk oversight through its periodic reviews of the financial and operational performance of the Company.
Code of Ethics
The Company has adopted a Code of Business Conduct and Ethics policy that applies to our directors and employees (including the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions). The Company intends to promptly disclose (i) the nature of any amendment to this code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and (ii) the nature of any waiver, including an implicit waiver, from a provision of this code of ethics that is granted to one of these specified individuals, the name of such person who is granted the waiver and the date of the waiver on our website in the future. A copy of our Code of Business Conduct and Ethics can be obtained from our website at http://www.imageware.io.
Indemnification of Officers and Directors
To the extent permitted by Delaware law, the Company will indemnify its directors and officers against expenses and liabilities they incur to defend, settle, or satisfy any civil or criminal action brought against them on account of their being or having been Company directors or officers unless, in any such action, they are adjudged to have acted with gross negligence or willful misconduct.
| EXECUTIVE COMPENSATION |
Summary Compensation Table
The following table sets forth certain information about the compensation paid or accrued during the years ended December 31, 2021 and 2020 to our Chief Executive Officer and each of our two most highly compensated executive officers other than our Chief Executive Officer who were serving as executive officers at December 31, 2021, and whose annual compensation exceeded $100,000 during such year or would have exceeded $100,000 during such year if the executive officer were employed by the Company for the entire fiscal year (collectively the “Named Executive Officers”).
| Name and Principal Position | Year | Salary |
Bonus | Stock Awards (1) | Option Awards(2)(3) |
All Other Compensation | Total | ||||||||||||||||||||
| Kristin Taylor (4) |
2021 |
$ | 348,333 | $ | - | $ | 1,080,000 | (1) | $ | - | $ | 21,773 | (5) | $ | 1,450,106 | ||||||||||||
| Chief Executive Officer and Chair of the Board |
2020 |
$ | 275,000 | $ | - | $ | - | $ | - | $ | 11,561 | (5) | $ | 286,561 | |||||||||||||
| Daniel Dlab |
2021 |
$ | 216,608 | $ | - | $ | 280,000 | (1) | $ | - | $ | 991 | (6) | $ | 497,599 | ||||||||||||
| Vice President of Engineering |
2020 |
$ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||||
| AJ Naddell |
2021 |
$ | 235,417 | (8) | $ | - | $ | 400,000 | (1) | $ | - | $ | 8,838 | (7) | $ | 644,255 | |||||||||||
| Senior Vice President, Product Management and Sales |
2020 |
$ | - | $ | - | $ | - | $ | - | $ | - | $ | - | ||||||||||||||
| (1) |
This amount does not reflect the cash value or realizable value of Restricted Stock Units (“RSUs”) grants to the named executive officer during the year ended December 31, 2021 or 2020. During the year ended December 31, 2021 and 2020, no RSUs vested for the benefit of this named executive officer and therefore no value was realized during the reporting period. The amounts reflect the grant date fair value of the RSUs awarded in the fiscal years ended December 31, 2021 and 2020. There were not RSUs granted to the named executive in 2020. |
| (2) |
All option awards were granted under the Company’s 2020 Plan or the 1999 Plan. |
| (3) |
The amounts presented in this column do not reflect the cash value or realizable value of option grants to the named executive officers during the year ended December 31, 2021 or 2020. During the year ended December 31, 2021 and 2020, no named executive officer exercised an option and therefore no value was realized during the reporting period. The amounts reflect the grant date fair value of the options awarded in the fiscal years ended December 31, 2021 and 2020, respectively, in accordance with the provisions of FASB ASC Topic 718. We have elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. We are required to make various assumptions in the application of the Black-Scholes option-pricing model and have determined that the best measure of expected volatility is based on the historical weekly volatility of our Common Stock. Historical volatility factors utilized in our Black-Scholes computations for options granted during the years ended December 31, 2021 and 2020 ranged from 57% to 99%. We have elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin Topic 14. The expected term used by the Company during the years ended December 31, 2021 and 2020 ranged from 3.33 years to 5.17 years. The interest rate used is the risk-free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for the years ended December 31, 2021 and 2020 ranged from 1.37% to 2.58%. Dividend yield is zero, as we do not expect to declare any dividends on shares of our Common Stock in the foreseeable future. In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. We have estimated an annualized forfeiture rate ranging from 5% to 10% for corporate officers, 4.1% to 10% for members of the Board and 15.0% to 25% for all other employees. We review the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience. |
| (4) |
Ms. Taylor was appointed as the Company’s President and Chief Executive Officer on March 2, 2020, and received no compensation prior to her employment. |
| (5) |
Includes $19,961 and $11,561 paid to Ms. Taylor during fiscal years 2021 and 2020, respectively, in group benefits paid to all employees of the Company and $1,812 in 401(k) contributions.
|
| (6) |
Includes $991 paid to Mr. Dlab in group benefits paid to all employees of the Company.
|
| (7) |
Includes $7,400 paid to Mr. Naddell during fiscal 2021 in group benefits paid to all employees of the Company and $1,438 in 401(k) contributions.
|
| (8) | Includes $14,659 in deferred salary owed to Mr. Naddell as of December 31, 2021. |
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth information regarding unexercised options, stock that has not vested and equity incentive awards held by each of the then Named Executive Officers outstanding as of December 31, 2021:
| Option Awards |
Stock Awards |
|||||||||||||||||||||||
| Number of Securities Underlying Unexercised Options: Exercisable (#) |
Number of Securities Underlying Unexercised Options: Unexercisable (#) |
Option Exercise Price ($) |
Option Expiration Date |
Number of Shares That Have Not Vested (#) |
Market Value of Shares That Have Not Vested ($) |
|||||||||||||||||||
| Named Executive Officers (1) |
||||||||||||||||||||||||
| Kristin Taylor |
- | - | N/A | N/A | 27,000,000 | $ | 1,080,000 | |||||||||||||||||
| Dan Dlab |
- | - | N/A | N/A | 7,000,000 | $ | 280,000 | |||||||||||||||||
| AJ Naddell |
- | - | N/A | N/A | 10,000,000 | $ | 400,000 | |||||||||||||||||
Employment Agreements
Kristin Taylor. On March 2, 2020, we entered into an employment agreement with Ms. Kristin Taylor, the Company’s President and Chief Executive Officer, which agreement was amended March 2, 2021. The agreement initially provided for an annual base salary of $330,000 for a period of 24 months effective April 10, 2020, which was increased to $350,000 effective February 1, 2021 for a period of 48 months from the initial employment agreement date of March 2, 2020. Ms. Taylor’s employment agreement also provides for (i) the grant of a stock option to purchase 27.0 million shares of the Company's Common Stock, which stock option shall vest (a) 10% immediately on the date of the grant; and (b) the remainder over the following three years beginning March 1, 2021; and (ii) an annual bonus equal to 100% of Ms. Taylor's annual salary which bonus and its amount shall be solely at the discretion of the Board. In the event of termination of her employment other than by reason of death or disability, or for cause, the employment agreement is also anticipated to provide Ms. Taylor with certain severance payments, including continuation of her salary for the greater of one year or the remaining term under her employment agreement.
For purposes of the above-referenced agreement, termination for “cause” means the executive’s commission of a criminal act or an act of fraud, embezzlement, breach of trust or other act of gross misconduct; violations of policies or rules of the Company; refusal to follow the direction given by the Company from time to time or breach of any covenant or obligation under the above-referenced agreements or other agreements with the Company; neglect of duty; misappropriation, concealment, or conversion of any money or property of the Company; intentional damage or destruction of property of the Company; reckless conduct which endangers the safety of other persons or property during the course of employment or while on premises leased or owned by the Company; or a breach of any obligation or requirement set forth in the above-referenced agreements. A “change in control” as used in these agreements generally means the occurrence of any of the following events: (i) the acquisition by any person or group of 50% or more of the Company’s outstanding voting stock; (ii) the consummation of a merger, consolidation, reorganization, or similar transaction other than a transaction: (1) in which substantially all of the holders of the Company’s voting stock hold or receive directly or indirectly 50% or more of the voting stock of the resulting entity or a parent company thereof, in substantially the same proportions as their ownership of the Company immediately prior to the transaction, or (2) in which the holders of the Company’s capital stock immediately before such transaction will, immediately after such transaction, hold as a group on a fully diluted basis the ability to elect at least a majority of the directors of the surviving corporation (or a parent company); (iii) there is consummated a sale, lease, exclusive license, or other disposition of all or substantially all of the consolidated assets of the Company and the Company’s subsidiaries, other than a sale, lease, license, or other disposition of all or substantially all of the consolidated assets of the Company and the Company’s subsidiaries to an entity, 50% or more of the combined voting power of the voting securities of which are owned by the Company’s shareholders in substantially the same proportions as their ownership of the Company immediately prior to such sale, lease, license, or other disposition; or (iv) individuals who, on the date the applicable agreement was adopted by the Board, are directors (the “Incumbent Board”) cease for any reason to constitute at least a majority of the directors; provided, however, that if the appointment or election (or nomination for election) of any new director was approved or recommended by a majority vote of the members of the Incumbent Board then still in office, such new member shall, for purposes of the applicable agreement, be considered as a member of the Incumbent Board.
Other than as set forth above, there were no arrangements or understandings between the Company’s Named Executive Officers and any other person pursuant to which they were appointed as officers as of December 31, 2021. None of the Company’s Named Executive Officers as of December 31, 2021 had a family relationship that is required to be disclosed under Item 401(d) of Regulation S-K.
| SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS |
As of April 7, 2022, we had three classes of voting stock issued and outstanding: (i) Common Stock; (ii) our Series B Preferred; and (iii) our Series D Preferred. The following tables sets forth information regarding shares of Series B Preferred, Series D Preferred and Common Stock beneficially owned as of April 7, 2022.
The following tables set forth information regarding shares of Series B Preferred, Series D Preferred, and Common Stock beneficially owned as of April 7, 2022 by
| (i) | Each of our officers and directors; |
| (ii) |
All officer and directors as a group; and
|
| (iii) | Each person known by us to beneficially own five percent or more of the outstanding shares of our Common Stock, Series B Preferred and Series D Preferred. |
Percent ownership is calculated based on 239,400 shares of Series B Preferred, 23,216.4 shares of Series D Preferred and 347,275,242 shares Common Stock outstanding as of April 7, 2022.
| Beneficial Ownership of Series B Preferred Name, Address and Title (if applicable) (1) |
Series B Preferred Stock (2) |
% Ownership of Class (2) |
||||||
| Darrelyn Carpenter |
28,000 | 12 | % |
|||||
| Howard Harrison |
20,000 | 8 | % |
|||||
| Wesley Hampton |
16,000 | 7 | % |
|||||
| Frederick C. Orton |
20,000 | 8 | % |
|||||
| (1) |
Each of the Company’s Named Executive Officers and directors who do not hold shares of Series B Preferred are excluded from this table. The business address of each of the executive officers and directors is 11440 W. Bernardo Court, Suite 300, San Diego, California 92127. |
| (2) |
Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. |
| Beneficial Ownership of Series D Preferred |
Series D Preferred |
% Ownership of |
||||||
| Name, Address and Title (if applicable) (1) |
Stock (2) |
Class (2) |
||||||
| Blackwell Partners LLC (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
2,547.7 | 10.9 | % |
|||||
| Nantahala Capital Partners Limited Partnership (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
995.4 | 4.2 | % |
|||||
| Nantahala Capital Partners II Limited Partnership (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
2,898.9 | 12.4 | % |
|||||
| Nantahala Capital Partners SI LP (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
5,661.9 | 24.1 | % |
|||||
| NCP QR LP (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
1,154.5 | 4.9 | % |
|||||
| NCP QR LP (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
1,853.9 | 7.9 | % |
|||||
| Plum Investments L.P. (4) |
||||||||
| 1807 S. San Gabriel Blvd. |
||||||||
| San Gabriel, CA 91776 |
1,589.0 | 6.8 | % |
|||||
| Silver Creek CS SAV, L.L.C. (3) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
761.6 | 3.2 | % |
|||||
| (1) |
Each of the Company’s Named Executive Officers and directors who do not hold shares of Series D Preferred are excluded from this table. |
| (2) |
Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. |
| (3) |
Nantahala Capital Management, LLC is a Registered Investment Adviser and has been delegated the legal power to vote and/or direct the disposition of securities on behalf of these entities as a General Partner or Investment Manager and would be considered the beneficial owner of such securities. The above shall not be deemed to be an admission by the record owners that they are themselves beneficial owners of these shares of Series D Preferred for purposes of Section 13(d) of the Exchange Act or any other purpose. |
| (4) |
Tom Y. Lee, G.P. of Plum Investments L.P., may be deemed to hold voting and dispositive power over the shares identified herein. |
| Beneficial Ownership of Common Stock |
||||||||
| Number of |
Percent of |
|||||||
| Name and Address |
Shares (1) |
Class(2) |
||||||
| Directors and Named Executive Officers: |
||||||||
| Kristin Taylor, President and Chief Executive Officer |
- | - | ||||||
| James M. Demitrieus |
- | - | ||||||
| Douglas Morgan |
- | - | ||||||
| Lauren C. Anderson |
- | - | ||||||
| Total beneficial ownership of Directors and Named Executive Officers as a group (four persons): |
- | - | ||||||
| 5% Shareholders: |
||||||||
| Blackwell Partners LLC (3)(4) c/o Nantahala Capital Management, LLC 19 Old Kings Highway South, Suite 200 Darien, CT 06820 |
43,699,828 | 12.6 | % |
|||||
| Nantahala Capital Partners Limited Partnership (4)(5) c/o Nantahala Capital Management, LLC 19 Old Kings Highway South, Suite 200 Darien, CT 06820 |
17,073,756 | 4.9 | % |
|||||
| Nantahala Capital Partners II Limited Partnership (4)(6) c/o Nantahala Capital Management, LLC 19 Old Kings Highway South, Suite 200 Darien, CT 06820 |
49,723,842 | 14.3 | % |
|||||
| Nantahala Capital Partners SI LP (4)(7) c/o Nantahala Capital Management, LLC 19 Old Kings Highway South, Suite 200 Darien, CT 06820 |
97,116,638 | 28.0 | % |
|||||
| NCP QR LP (4)(8) c/o Nantahala Capital Management, LLC 19 Old Kings Highway South, Suite 200 Darien, CT 06820 |
19,802,744 | 5.7 | % |
|||||
| NCP QR LP (4)(9) |
||||||||
| c/o Nantahala Capital Management, LLC |
||||||||
| 19 Old Kings Highway South, Suite 200 |
||||||||
| Darien, CT 06820 |
31,799,811 | 9.2 | % |
|||||
| Neal Goldman (10) 767 Third Avenue, 16th Floor New York, NY10017 |
68,327,334 | 19.7 | % |
|||||
| Plum Investments (11) 1807 S. San Gabriel Blvd. San Gabriel, CA 91776 |
27,255,575 | 7.8 | % |
|||||
| Silver Creek CS, SAV, L.L.C (8)(12) c/o Nantahala Capital Management, LLC 19 Old Kings Highway South, Suite 200 Darien, CT 06820 |
13,063,465 | 3.8 | % |
|||||
| W Ryan Goldman (13) 570 Lawrence Ave Westfield, NJ. 07060 |
18,078,902 | 5.2 | % |
|||||
| Shellback Financial (17) 16045 54th Ave N Minneapolis, MN. 55446 |
18,198,971 | 5.2 | % |
| (1) |
All entries exclude beneficial ownership of shares issuable pursuant to options, warrants, or other convertible securities that have not vested, are not convertible, or that are not otherwise exercisable as of the date hereof, or which will not become vested, convertible or exercisable within 60 days of April 7, 2022. |
| (2) |
Percentages are rounded to the nearest one-tenth of one percent. Percentages are based on 347,275,242 shares of Common Stock outstanding as of April 7, 2022. Options, warrants, and other convertible securities that are presently convertible or exercisable, or convertible or exercisable within 60 days of April 7, 2022 are deemed to be beneficially owned by the shareholder holding the options, warrants, or other convertible securities for the purpose of computing the percentage ownership of that shareholder, but are not treated as outstanding for the purpose of computing the percentage of any other shareholder. |
| (3) |
Includes 43,698,828 shares issuable upon the conversion of approximately 2,547.7 shares of Series D Preferred. |
| (4) |
Nantahala Capital Management, LLC is a Registered Investment Adviser and has been delegated the legal power to vote and/or direct the disposition of securities on behalf of this entity as a General Partner or Investment Manager and would be considered the beneficial owner of such securities. Wilmot B. Harkley and Daniel Mack, as principals of Nantahala Capital Management, LLC, may be deemed to hold voting and dispositive power over the shares identified herein. The above shall not be deemed to be an admission by the record owners or these selling shareholders that they are themselves beneficial owners of these shares of securities for purposes of Section 13(d) of the Exchange Act or any other purpose.
|
| (5) |
Includes 17,073,756 shares issuable upon the conversion of approximately 995.4 shares of Series D Preferred. |
| (6) |
Includes 49,723,842 shares issuable upon the conversion of approximately 2,898.9 shares of Series D Preferred. |
| (7) |
Includes 97,116,638 shares issuable upon the conversion of approximately 5,661.9 shares of Series D Preferred. |
| (8) |
Includes 19,802,744 shares issuable upon the conversion of approximately 1,154.5 shares of Series D Preferred.
|
| (9) |
Includes 31,799,313 shares issuable upon the conversion of approximately 1,853.9 shares of Series D Preferred. |
| (10) |
Includes 4,264,151 shares issuable upon the conversion of Series D Preferred. Mr. Goldman exercises sole voting and dispositive power over 49,554,406 shares, including the aforementioned Series D conversion shares and shared voting and dispositive power over 14,508,777 reported shares, of which 3,000,000 shares are owned by the Goldman Family 2012 GST Trust, 11,361,077 are held in an individual retirement account, and 147,700 shares are owned by The Neal and Marlene Goldman Foundation. |
| (11) |
Includes 27,255,575 shares issuable upon the conversion of 1,589 shares of Series D Preferred. Tom Y. Lee, G.P. of Plum Investments L.P., may be deemed to hold voting and dispositive power over the shares identified herein. |
| (12) |
Includes 13,063,465 shares issuable upon the conversion of approximately 761.6 shares of Series D Preferred. |
| (13) |
Includes 18,078,902 shares issuable upon the conversion of approximately 1,054 shares of Series D Preferred. |
| (14) |
Includes 18,198,971 shares issuable upon the conversion of approximately 1,061 shares of Series D Preferred. |
| CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
December 2021 Credit Facility with Nantahala Capital Management
On December 29, 2021 (the “Closing Date”), the Company entered into a Term Loan and Security Agreement (the “Agreement”) with certain funds and separate accounts managed by Nantahala Capital Management, LLC (collectively, “Nantahala”), as lenders, and other lenders set forth on the signature pages thereto (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2.5 million (the “Credit Facility”). Nantahala collectively owns, or otherwise controls, 37.3% of our issued and outstanding voting securities.
All loans (each a “Loan", and collectively, the “Loans”) under the Credit Facility will bear interest at a rate of 12% for the initial six months after the Closing Date, and at 17% thereafter until the maturity date of 12 months from the Closing Date (the “Maturity Date”). All amounts borrowed by the Company under the Credit Facility are secured by a first-priority lien on all the assets of the Company. On the Closing Date, the Company received an initial draw-down on the Credit Facility of $600,000. As of April 12, 2022, the Company received two subsequent draw-downs aggregating $1,050,000 under the Credit Facility. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes.
The Company may prepay amounts borrowed under the Credit Facility in whole or in part, at a price equal to 105% of the principal amount borrowed under the Credit Facility (including any interest capitalized thereon), subject to additional prepayment terms pursuant to the Agreement, a copy of which is filed as an Exhibit to the Company’s Current Report on Form 8-K, filed with the SEC on January 4, 2022. In addition, pursuant to the Agreement, at any time after the Closing Date, each Lender shall have the right, but not the obligation, on mutually agreed upon terms, to exchange each such Lender’s pro rata portion of shares of the Company’s Series D Convertible Preferred Stock, par value $0.01 (“Series D Preferred”) held by such Lender for a mutually agreed upon portion of any subsequent Delayed Draw Loan (as defined in the Agreement) (an “Exchange”). Upon the Company's receipt by a Lender of a notice stating a Lender's intent to participate in an Exchange, the Company is required to offer to all holders of Series D Preferred the opportunity, but not the obligation, to exchange each such holder’s pro rata portion of shares of the Company's Series D Preferred held by such holder for participation in any subsequent Delayed Draw Loan, upon substantially similar terms as those provided in the applicable notice of Exchange by a Lender.
Notes Payable
Factoring Agreement
On February 12, 2020, the Company entered into a factoring agreement (the “Factoring Agreement”) with a former member of the Company’s Board of Directors (the “Factoring Lender”). Under the Factoring Agreement, the Company received $350,000 in proceeds (the “Factoring Principal”) in the form of a loan, bearing interest at a rate of 1% for every seven days until the Factoring Principal and accrued interest are paid in full, with a maturity date of March 4, 2020. Pursuant to the Factoring Agreement, repayment of the Factoring Principal and accrued interest was secured by certain of the Company’s trade accounts receivable approximating $500,000 (the “Factoring Collateral”). During the twelve months ended December 31, 2020, the Company recorded approximately $45,000 in interest expense related to the Factoring Agreement. In May 2020, the Company repaid $35,000 in accrued interest to the Factoring Lender. As a condition to the consummation of the Company's offer and sale (the “Closing”) of shares of its Series D Convertible Preferred Stock, par value $0.01 (the “Series D Financing”), the Factoring Lender agreed to settle the entire Factoring Principal plus accrued interest and release the Company from liabilities due under the Factoring Agreement in exchange for a one-time payment of $360,000 (the “Factoring Settlement”) to be made upon the Closing, and out of the proceeds, of the Series D Financing. On November 16, 2020, the Company fulfilled its obligation under the Factoring Settlement, thereby releasing it from its obligation under the Factoring Agreement.
Convertible Promissory Notes
During the year ended December 31, 2020, the Company received advances from a second former member of the Board of Directors (the “Board Lender”) in the aggregate amount of $450,000. On June 29, 2020, the Company executed a promissory note (the “Board Note”) in the favor of the Board Lender in the principal amount of $450,000 (the “Board Note Principal”), pursuant to which the Board Note Principal accrued simple interest at the rate of 5% per annum, and was convertible into shares of the Company's Common Stock at $0.16 per share of Common Stock at the election of the Board Lender. The Board Note was to mature on the earlier to occur of (i) October 13, 2020, or (ii) on such date that the Company consummates a debt and/or equity financing resulting in net proceeds to the Company of at least $3,000,000.
Also during the year ended December 31, 2020, the Company received advances from a third former member of the Board of Directors (the “Second Board Lender”) in the aggregate amount of $100,000. On June 29, 2020, the Company executed a promissory note (the “Second Board Note", and collectively with the Board Note, the “Board Notes”) in the principal amounts of $100,000 (the “Second Board Note Principal”), pursuant to which the Second Board Note Principal accrued simple interest at the rate of 5% per annum, and was convertible into shares of the Company’s Common Stock at $0.16 per share of Common Stock at the election of the Second Board Lender. The Second Board Note was to mature on the earlier to occur of (i) October 13, 2020, or (ii) on such date that the Company consummates a debt and/or equity financing resulting in net proceeds to the Company of at least $3,000,000.
On November 12, 2020, in connection with the Closing of the Series D Financing, the Board Lenders entered into (i) Debt Exchange Agreements (collectively, the “Debt Exchange Agreements”), and (ii) Satisfaction and Release Agreements (collectively, the “Release Agreements”), for the purpose of satisfying certain obligations of the Company arising under (i) the Board Note, and (ii) the Second Board Note. Pursuant to the Debt Exchange Agreements and Release Agreements: (a) one-half of the Board Note Principal plus accrued interest, totaling approximately $232,000 was converted into 231.6 shares of Series D Preferred at a rate of $1,000 per share of Series D Preferred, with the remaining one-half of the Board Note Principal plus accrued interest, totaling approximately $232,000, to be paid to the Board Lender in cash out of proceeds of the Series D Financing, in full satisfaction of the Company's obligations under the Board Note; and (b) the entire Second Board Note Principal plus accrued interest, totaling approximately $103,000, was converted into 102.8 shares of Series D Preferred at a rate of $1,000 per share of Series D Preferred, in full satisfaction of the Company's obligations under the Second Board Note.
Professional Services Agreement
During the year ended December 31, 2020, the Company entered into professional services agreement with a firm affiliated with a member of the Company’s Board at the time the parties entered into the agreement. The Company made no payments pursuant to this agreement during the twelve months ended December 31, 2020 and has made approximately $34,000 during 2021. The Company has the right to terminate the agreement on thirty days written notice at any time.
Review, Approval or Ratification of Transactions with Related Persons
As provided in the charter of our Audit Committee, it is our policy that we will not enter into any transactions required to be disclosed under Item 404 of the SEC’s Regulation S-K unless the Audit Committee or another independent body of our Board first reviews and approves the transactions.
In addition, pursuant to our Code of Ethical Conduct and Business Practices, all employees, officers and directors of ours and our subsidiaries are prohibited from engaging in any relationship or financial interest that is an actual or potential conflict of interest with us without approval. Employees, officers and directors are required to provide written disclosure to the Chief Executive Officer as soon as they have any knowledge of a transaction or proposed transaction with an outside individual, business or other organization that would create a conflict of interest or the appearance of one.
| PRINCIPAL ACCOUNTING FEES AND SERVICES |
The Audit Committee of Imageware Systems, Inc.’s Board of Directors has engaged Baker Tilly US, LLP (“Baker Tilly”) as the independent registered public accounting firm for the Company and its subsidiaries for the fiscal year ended December 31, 2021. The Audit Committee regularly reviews and determines whether any non-audit services provided by Baker Tilly potentially affects its independence with respect to the Company. The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services provided by Baker Tilly. Pre-approval is generally provided by the Audit Committee for up to one year, is detailed as to the particular service or category of services to be rendered and is generally subject to a specific budget. The Audit Committee may also pre-approve additional services or specific engagements on a case-by-case basis. Management provides annual updates to the Audit Committee regarding the extent of any services provided in accordance with this pre-approval. To date, all services performed by Baker Tilly have been pre-approved by the Audit Committee in accordance with this policy.
On June 20, 2021, the Board of Directors of Imageware Systems, Inc., notified Mayer Hoffman McCann P.C. (“MHM”), the Company’s independent registered public accounting firm, that it would be dismissing MHM effective immediately following the Company’s filing of its Quarterly Report on Form 10-Q for the quarter ending June 30, 2021. Prior to June 20, 2021, the Audit Committee had engaged Mayer Hoffman McCann P.C. (“MHM”) as the independent registered public accounting firm for the Company. The Company filed its Quarterly Report on Form 10-Q for the quarter ending June 30, 2021 on August 23, 2021.
On October 13, 2021, the Board of Directors of Imageware Systems, Inc. approved the engagement of Baker Tilly as the Company's independent registered public accounting firm for the Company's fiscal year ended December 31, 2021.
During the fiscal year ended December 31, 2020 and the subsequent interim period through August 23, 2021, there were (i) no disagreements within the meaning of Item 304(a)(1)(iv) of Regulation S-K between the Company and MHM on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, of which, if not resolved to MHM’s satisfaction, would have caused MHM to make reference thereto in their reports, and (ii) no “reportable events” within the meaning of Item 304(a)(1)(v) of Regulation S-K.
Substantially all of MHM’s personnel, who work under the control of MHM shareholders, are employees of wholly-owned subsidiaries of CBIZ, Inc., which provides personnel and various services to MHM in an alternative practice structure.
The following table sets forth the aggregate fees billed, or expected to be billed, by Baker Tilly with respect to audit and non-audit services for the Company during the year ended December 31, 2021, and the aggregate fees billed by MHM with respect to audit and non-audit services for the Company during the year ended December 31, 2020, and the subsequent interim periods in 2021 before the change in auditors became effective:
| Fiscal Year Ended |
||||||||||||
| 2021 |
2021 | 2020 |
||||||||||
| Baker Tilley | MHM | MHM | ||||||||||
| Audit fees |
$ | 102,600 | $ | 187,000 | $ | 291,000 | ||||||
| Audit-related fees |
- | - | - | |||||||||
| Tax fees |
- | - | - | |||||||||
| All other fees |
- | - | - | |||||||||
| Total Fees |
$ | 102,600 | $ | 187,000 | $ | 291,000 | ||||||
The Audit Committee of the Company’s Board of Directors approved all fees described above.
| ITEM 15. |
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
| (a) |
The following documents are filed as part of this Annual Report: |
| Exhibit No. |
Description |
|
| Agreement and Plan of Merger, dated October 27, 2005 (incorporated by reference to Annex A to the Company’s Definitive Proxy Statement on Schedule 14A, filed November 15, 2005). |
||
| Certificate of Incorporation (incorporated by reference to Annex B to the Company’s Definitive Proxy Statement on Schedule 14A, filed November 15, 2005). |
||
| Certificate of Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed October 14, 2011). |
||
| Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K, filed February 16, 2017). |
||
| Certificate of Designations, Preferences and Rights of the Series E Convertible Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed February 2, 2015). |
||
| Certificate of Designations, Preferences and Rights of the Series F Convertible Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed September 9, 2016). |
||
| Certificate of Designations, Preferences and Rights of the Series G Convertible Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed December 30, 2016). |
||
| Amendment No. 1 to the Certificate of Designations, Preferences and Rights of the Series E Convertible Preferred Stock (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K, filed December 30, 2016). |
||
| Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed September 19, 2017). |
||
| Certificate of Elimination of the Series E Convertible Preferred Stock, Series F Convertible Preferred Stock and Series G Convertible Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed October 19, 2017). |
||
| Certificate of Amendment to Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed February 13, 2018). |
||
| Certificate of Designations, Preferences, and Rights of Series C Convertible Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Amendment No. 1 to the Certificate of Designations, Preferences, and Rights of Series A Convertible Preferred Stock (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Amended and Restated Certificate of Incorporation of Imageware Systems, Inc., dated November 12, 2020 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Amended and Restated Certificate of Designations, Preferences, and Rights of Series A Convertible Preferred Stock of Imageware Systems, Inc., dated November 12, 2020 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Amended and Restated Certificate of Designations, Preferences, and Rights of Series A-1 Convertible Preferred Stock of Imageware Systems, Inc., dated November 12, 2020 (incorporated by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Amended and Restated Certificate of Designations, Preferences, and Rights of Series C Convertible Preferred Stock of Imageware Systems, Inc., dated November 12, 2020 (incorporated by reference to Exhibit 3.4 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Certificate of Designations, Preferences, and Rights of Series D Convertible Preferred Stock of Imageware Systems, Inc., dated November 12, 2020 (incorporated by reference to Exhibit 3.5 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Amended and Restated Certificate of Designations, Preferences, and Rights of Series D Convertible Preferred Stock of Imageware Systems, Inc (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated December 30, 2020). |
||
| Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Imageware Systems, Inc., dated April 21, 2021 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, dated April 26, 2021). |
| Form of Amendment to Warrant, dated March 21, 2012, (incorporated by reference to Exhibit 4.16 to the Company's Annual Report on Form 10-K, filed April 4, 2012). |
| Form of Warrant, dated September 10, 2018 (incorporated by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Employment Agreement, dated September 27, 2005, between the Company and S. James Miller (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed September 30, 2005). |
||
| Form of Indemnification Agreement entered into by the Company with its directors and executive officers (incorporated by reference to Exhibit 10.4 to the Company’s Registration Statement on Form SB-2 (No. 333-93131), filed December 20, 1999, as amended). |
||
| Amended and Restated 1999 Stock Plan Award (incorporated by reference to Appendix B of the Company’s Definitive Proxy Statement on Schedule 14A, filed November 21, 2007). |
||
| Form of Stock Option Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed July 14, 2005). |
||
| 2001 Equity Incentive Plan (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-QSB, filed November 14, 2001). |
||
| Securities Purchase Agreement, dated September 25, 2007, by and between the Company and certain accredited investors (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed September 26, 2007). |
||
| Office Space Lease between I.W. Systems Canada Company and GE Canada Real Estate Equity, dated July 25, 2008 (incorporated by reference to Exhibit 10.39 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Form of Securities Purchase Agreement, dated August 29, 2008 by and between the Company and certain accredited investors (incorporated by reference to Exhibit 10.40 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Change of Control and Severance Benefits Agreement, dated September 27, 2008, between Company and Charles Aubuchon (incorporated by reference to Exhibit 10.41 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Change of Control and Severance Benefits Agreement, dated September 27, 2008, between Company and David Harding (incorporated by reference to Exhibit 10.42 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| First Amendment to Employment Agreement, dated September 27, 2008, between the Company and S. James Miller (incorporated by reference to Exhibit 10.43 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Form of Convertible Note dated November 14, 2008 (incorporated by reference to Exhibit 10.45 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Second Amendment to Employment Agreement, dated April 6, 2009, between the Company and S. James Miller (incorporated by reference to Exhibit 10.50 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Office Space Lease between the Company and Allen W. Wooddell, dated July 25, 2008 (incorporated by reference to Exhibit 10.54 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Third Amendment to Employment Agreement, dated December 10, 2009, between the Company and S. James Miller (incorporated by reference to Exhibit 10.60 to the Company’s Annual Report on Form 10-K, filed February 24, 2010). |
||
| Securities Purchase Agreement, dated December 12, 2011, by and between the Company and certain accredited investors (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed December 21, 2011). |
||
| Note Exchange Agreement, dated December 12, 2011, by and between the Company and certain accredited investors (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed December 21, 2011). |
||
| Fourth Amendment to Employment Agreement, dated March 10, 2011, between the Company and S. James Miller, (incorporated by reference to Exhibit 10.40 to the Company’s Annual Report on Form 10-K, filed January 17, 2012). |
||
| Fifth Amendment to Employment Agreement, dated January 31, 2012, between the Company and S. James Miller, Jr., (incorporated by reference to Exhibit 10.44 to the Company’s Annual Report on Form 10-K, filed April 4, 2012. |
||
| Employment Agreement, dated January 1, 2013, between the Company and Wayne Wetherell (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed March 7, 2013). |
||
| Employment Agreement, dated January 1, 2013, between the Company and David Harding (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed March 7, 2013). |
| Convertible Promissory Note dated March 27, 2013 issued by the Company to Neal Goldman (incorporated by reference to Exhibit 10.41 to the Company's Annual Report on Form 10-K, filed April 1, 2013). |
||
| Amendment to Convertible Promissory Note, dated March 12, 2014 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed March 13, 2014). |
||
| Note Exchange Agreement, dated January 29, 2015 (incorporated by reference to the Company’s Current Report on Form 8-K, filed February 2, 2015). |
||
| Sixth Amendment to Employment Agreement, by and between S. James Miller and the Company, dated November 1, 2013 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed November 7, 2013). |
||
| Seventh Amendment to Employment Agreement, by and between S. James Miller, Jr. and the Company, dated January 9, 2015 (incorporated by reference to the Company’s Current Report on Form 8-K, filed January 15, 2015). |
||
| Second Amendment to Employment Agreement, by and between Wayne Wetherell and the Company, dated January 9, 2015 (incorporated by reference to the Company’s Current Report on Form 8-K, filed January 15, 2015). |
||
| Second Amendment to Employment Agreement, by and between David E. Harding and the Company, dated January 9, 2015 (incorporated by reference to the Company’s Current Report on Form 8-K, filed January 15, 2015). |
||
| Amendment No. 3 to Convertible Promissory Note, dated December 8, 2014 (incorporated by reference to the Company’s Current Report on Form 8-K, filed December 10, 2014). |
||
| Third Amendment to Employment Agreement, by and between Wayne Wetherell and the Company, dated December 14, 2015 (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K, filed December 21, 2015). |
||
| Third Amendment to Employment Agreement, by and between David E. Harding and the Company, dated December 14, 2015 (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K, filed December 21, 2015). |
||
| Eighth Amendment to Employment Agreement, by and between S. James Miller and the Company, dated December 14, 2015 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K, filed December 21, 2015). |
||
| Amendment No. 4 to Convertible Promissory Note, dated March 8, 2016 (incorporated by reference to the Company's Current Report on Form 8-K, filed March 10, 2017). |
||
| Convertible Promissory Note, dated March 9, 2016 (incorporated by reference to the Company's Current Report on Form 8-K, filed March 10, 2017). |
||
| Form of Securities Purchase Agreement, dated September 7, 2016 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed September 9, 2016). |
||
| Amendment No. 5 to Convertible Promissory Note, dated January 23, 2017 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 10-K, filed January 26, 2017). |
||
| Form of Subscription Agreement for Series G Convertible Preferred Stock (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed December 30, 2016). |
||
| Form of Exchange Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed December 30, 2016). |
||
| Ninth Amendment to Employment Agreement, by and between James Miller, Jr. and the Company, dated October 20, 2016 (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, filed December 30, 2016). |
||
| Fourth Amendment to Employment Agreement, by and between Wayne Wetherell and the Company, dated October 20, 2016 (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K, filed December 30, 2016). |
||
| Fourth Amendment to Employment Agreement, by and between David E. Harding and the Company, dated October 20, 2016 (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K, dated December 30, 2016). |
||
| Amendment No. 2 to Convertible Promissory Note, dated May 10, 2017 (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed May 12, 2017). |
||
| Amendment No. 6 to Convertible Promissory Note, dated May 10, 2017 (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q, filed May 12, 2017). |
||
| Form of Subscription Agreement for Series A Convertible Preferred Stock (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed September 19, 2017). |
||
| Form of Exchange Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed September 19, 2017). |
| Fifth Amendment to Employment Agreement, by and between David E. Harding and the Company, dated February 7, 2018 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated February 13, 2018). |
||
| Tenth Amendment to Employment Agreement, by and between James Miller, Jr. and the Company, dated February 8, 2018 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated February 13, 2018). |
||
| Form of Securities Purchase Agreement for Series C Convertible Preferred Stock (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Form of Registration Rights Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Placement Agency Agreement, by and between the Company and Northland Capital Markets (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Form of Exchange Agreement (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K, filed September 13, 2018). |
||
| Eleventh Amendment to Employment Agreement, by and between James Miller, Jr. and the Company, dated January 31, 2019 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated February 1, 2019). |
||
| Sixth Amendment to Employment Agreement, by and between David Harding and the Company, dated January 31, 2019 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated February 1, 2019). |
||
| Securities Purchase Agreement by and between the Company and Triton, dated February 20, 2020 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated February 27, 2020. |
||
| Employment Agreement between the Company and Kristin Taylor, dated April 10, 2020 (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K, filed April 15, 2020). |
||
| Purchase Agreement, by and between Imageware Systems, Inc. and Lincoln Park Capital Fund, LLC, dated April 28, 2020 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated April 30, 2020). |
||
| Registration Rights Agreement, by and between Imageware Systems, Inc. and Lincoln Park Capital Fund, LLC, dated April 28, 2020 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated April 30, 2020). |
||
| Note Payable Agreement by and between Imageware Systems, Inc. and COMERICA BANK, dated April 30, 2020 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated May 11, 2020). |
||
| Consulting Agreement by and between Imageware Systems, Inc. and S. James Miller, dated November 13, 2020 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Debt Exchange Agreement and Satisfaction and Release by and between Imageware Systems, Inc. and S. James Miller, dated November 12, 2020 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Debt Exchange Agreement and Satisfaction and Release by and between Imageware Systems, Inc. and Neal Goldman, dated November 12, 2020 (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, dated November 18, 2020). |
||
| Letter Agreement, dated January 7, 2021 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated January 8, 2021). |
||
| Purchase Agreement, by and between Imageware Systems, Inc. and Lincoln Park Capital Fund, LLC, dated May 17, 2021 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated May 21, 2021). |
||
| Registration Rights Agreement, by and between Imageware Systems, Inc. and Lincoln Park Capital Fund, LLC, dated May 17, 2021 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated May 21, 2021). |
||
| Amended and Restated Employment Agreement, by and between Kristin Taylor and the Company, dated June 4, 2021 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated June 8, 2021). |
||
| Amendment to the Imageware Systems, Inc. 2020 Omnibus Equity Incentive Plan (incorporated by reference to Exhibit 10.62 to the Company’s Annual Report on Form 10-K, filed with the SEC on April 5, 2021). |
||
| Loan and Security Agreement, dated December 29, 2021, among Imageware Systems, Inc., and certain funds and separate accounts managed by Nantahala Capital Management, LLC, and the other lenders set forth on the signature pages thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated January 4, 2022). |
||
| List of Subsidiaries (incorporated by referenced to Exhibit 21.1 to the Company’s Annual Report on Form 10-K filed February 24, 2010). |
||
| Consent of Independent Registered Public Accounting Firm. |
||
| 23.2 | Consent of Independent Registered Public Accounting Firm. | |
| Certification of CEO as Required by Rule 13a-14(a)/15d-14, filed herewith. |
||
| Certification of CFO as Required by Rule 13a-14(a)/15d-14, filed herewith. |
||
| Certification of CEO and CFO as Required by Rule 13a-14(a) and Rule 15d-14(b) (17 CFR 240.15d-14(b)) and Section 1350 of Chapter 63 of Title 18 of the United States Code, filed herewith. |
||
| 101.INS |
Inline XBRL Instance Document |
|
| 101.SCH |
Inline XBRL Taxonomy Extension Schema |
|
| 101.CAL |
Inline XBRL Taxonomy Extension Calculation Linkbase |
|
| 101.DEF |
Inline XBRL Taxonomy Extension Definition Linkbase |
|
| 101.LAB |
Inline XBRL Taxonomy Extension Label Linkbase |
|
| 101.PRE |
Inline XBRL Taxonomy Extension Presentation Linkbase |
|
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL Document and included in Exhibit 101) |
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, there unto duly authorized.
| Registrant
Date: April 14, 2022 |
Imageware Systems, Inc.
/s/ Kristin Taylor |
|
| Kristin Taylor |
||
| Chief Executive Officer (Principal Executive Officer) and President |
| Date: April 14, 2022 |
/s/ Jeffrey Hotze |
|
| Corporate Controller (Principal Financial and Accounting Officer) |
In accordance with the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
| Date: April 14, 2022 |
/s/ James Demitrieus |
|
| James Demitrieus |
||
| Director |
||
| Date: April 14, 2022 |
/s/ Douglas Morgan |
|
| Douglas Morgan |
||
| Director |
| Date: April 14, 2022 |
/s/ Lauren C. Anderson |
|
| Lauren C. Anderson |
||
| Director |
IMAGEWARE SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Imageware Systems, Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Imageware Systems, Inc. (the Company) as of December 31, 2021, the related consolidated statements of operations, comprehensive loss, changes in shareholders' deficit and cash flows for the year ended December 31, 2021, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021, and the results of its operations and its cash flows for the year ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Other Matter
The consolidated financial statements of the Company, as of and for the year ended December 31, 2020, were audited by other auditors, whose report dated April 2, 2021, expressed an unmodified opinion on those statements.
Substantial Doubt About the Company's Ability to Continue as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency, and has stated that substantial doubt exists about the Company's ability to continue as a going concern. Management's evaluation of the events and conditions and management's plans regarding these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Convertible Preferred Shares
Critical Audit Matter Description:
As described in Note 13 to the consolidated financial statements, the Company has previously issued Series D Convertible Preferred Stock which required the identification and assessment of the embedded features to be recognized separately and recorded at fair value. The Company determined that the embedded conversion option, redemption option and participating dividend feature contained in the Series D Convertible Preferred Stock were required to be recognized separately as derivative liabilities at fair value. The determination of fair value involved using complex valuation methodologies and significant assumptions including the expected volatility of the Company’s common stock and the probability of certain conditions or events occurring.
We identified auditing the Company’s evaluation of the accounting for the embedded features included in the Series D Convertible Preferred Stock, specifically the methods and assumptions used to estimate the fair value of the derivative liability as a critical audit matter.
How We Addressed the Matter in Our Audit:
The primary procedures we performed to address this critical audit matter included:
| ● |
Obtaining and reviewing the underlying Series D Convertible Preferred Stock agreements to understand the terms and conditions, economic substance, and identify embedded features requiring evaluation. |
| ● |
Obtaining an understanding of management’s process for developing the estimated fair value of the embedded features, including evaluation of the appropriateness of the method selected by the Company, identifying the significant assumptions used to determine the fair value estimate, and the application of those assumptions in the related method. |
| ● |
Testing the data and significant assumptions used in developing the fair value estimate, including procedures to determine whether the data was complete and accurate and sufficiently precise and whether management’s estimation of the probability of whether certain conditions or events were reasonable as of each valuation date. |
| ● |
Utilizing a valuation specialist assisting in evaluating the reasonableness of the valuation methodology used, and the underlying assumptions including the forecasted volatility of the Company’s common stock price to its historical volatility. |
/s/ BAKER TILLY US, LLP
We have served as the Company's auditor since 2021.
Irvine, California
April 14, 2022
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of:
Imageware Systems, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Imageware Systems, Inc. (“Company”) as of December 31, 2020, and the related consolidated statements of operations, comprehensive loss, shareholders’ deficit and cash flows for the year ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020, and the results of its operations and its cash flows for the year ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
Going Concern Uncertainty
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company does not generate sufficient cash flows from operations to maintain operations and, therefore, is dependent on additional financing to fund operations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1 to the financial statements. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Convertible Preferred Shares
As described further in Note 13 to the financial statements, the Company issued 22,863 shares of Series D Convertible Preferred Stock during the year ended December 31, 2020. The accounting for the transaction was complex, as it required the identification and assessment as to whether embedded features were required to be recognized separately and therefore, also were required to be recorded at fair value. The Company determined that the embedded conversion option, redemption option and participating dividend feature contained in the Series D Convertible Preferred Stock host instrument were required to be recognized separately as derivative liabilities at fair value. The determination of fair value involved using complex valuation methodologies that incorporate significant assumptions which include the expected volatility of the Company’s common stock and the probability of certain conditions or events occurring.
We identified auditing the Company’s evaluation of the accounting for the embedded features included in the Series D Convertible Preferred Stock and the methods and assumptions used to estimate the fair value of the resulting derivative liability as a critical audit matter. The principal consideration for this determination was the degree of judgment involved by management in determining if the host contract was more akin to debt or equity and the development of the assumptions necessary to estimate the fair value of the derivative liability which in turn led to significant auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence for the accounting and estimated fair value.
The primary procedures we performed to address this critical audit matter included:
| ● |
Reading the underlying Series D Convertible Preferred Stock agreements to understand the terms and conditions, economic substance, and identify embedded features requiring evaluation. |
| ● |
Testing management’s application of the relevant accounting guidance to assess if the embedded features require accounting as derivative financial instruments and applying our understanding of each. |
| ● |
Obtaining an understanding of management’s process for developing the estimated fair value, including understanding the reasons the method was selected by the Company, identifying the significant assumptions used to determine the fair value estimate, and the application of those assumptions in the related method, and evaluating the appropriateness of each. |
| ● |
Testing the data used in developing the fair value estimate, including procedures to determine whether the data was complete and accurate and sufficiently precise. |
| ● |
Evaluating the significant assumptions used in developing the fair value estimate, including: |
| o |
Evaluating whether management’s estimation of the probability of whether certain conditions or events were reasonable as of each valuation date. |
| o |
Comparing the forecasted volatility of the Company’s common stock price to its historical volatility. |
| ● |
Involving the use of valuation professionals with specialized skill and knowledge to assist in the evaluation of management’s process, selected method, and inputs and assumptions used in the method. |
Modification of Preferred Shares
As described in Note 2 and Note 14 to the financial statements, during the year ended December 31, 2020 the Company amended the terms of its Series A and Series A-1 Preferred Stock. In addition, the Company converted the Series C Preferred Stock into shares of Series D Preferred Stock. The accounting for the transactions was complex due to a lack of authoritative guidance on the accounting for preferred stock modifications and extinguishments within US GAAP. Additionally, the transactions required an estimation of the fair value of Series A, Series A-1, and Series D Preferred Stock.
We identified auditing the Company’s accounting for the modification of the Series A and A-1 preferred shares, the conversion of the Series C Preferred Stock into Series D Preferred Stock, and the corresponding fair value estimates of the Series A, Series A-1, and Series D Preferred Stock as a critical audit matter. The principal consideration for this determination was a combination of the lack of authoritative guidance on accounting for the modification or extinguishment of preferred shares and the judgment involved by management in developing the model and assumptions necessary to estimate of the fair value of the Series A, Series A-1, and Series D Preferred Stock. This in turn led to significant auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence related to management’s accounting conclusions and the reasonableness of the significant assumptions used by the Company to estimate each fair value and the application of those assumptions within the valuation methods.
The primary procedures we performed to address this critical audit matter included:
| ● |
Reading the underlying preferred share agreements to understand the terms, conditions and economic substance of the transactions. |
| ● |
Evaluating whether management’s selection and application of the relevant accounting guidance was reasonable and supportable, applying our understanding of the agreements. |
| ● |
Obtaining an understanding of management’s process for developing the estimated fair value of the Series A, Series A-1, and Series D Preferred Stock, including understanding the reasons the methods were selected by the Company, identifying the significant assumptions used to determine the fair value estimates and the application of those assumptions in the related models, and evaluating the appropriateness of each. |
| ● |
Testing the data used in developing the fair value estimates, including procedures to determine whether the data was complete and accurate and sufficiently precise. |
| ● |
Involving the use of valuation professionals with specialized skill and knowledge to assist in the evaluation of management’s process, selected methods, and inputs and assumptions used in the methods. |
/s/ Mayer Hoffman McCann P.C.
We served as the Company's auditor from 2011 to 2021.
San Diego, California
April 2, 2021
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
| December 31, | December 31, | |||||
| 2021 | 2020 | |||||
| ASSETS | ||||||
| Current Assets: | ||||||
| Cash and cash equivalents | $ | 1,202 | $ | 8,345 | ||
| Accounts receivable, net of allowance for doubtful accounts of $ and $ at December 31, 2021 and 2020, respectively. | 383 | 577 | ||||
| Inventory, net | 25 | 40 | ||||
| Other current assets | 215 | 196 | ||||
| Total Current Assets | 1,825 | 9,158 | ||||
| Property and equipment, net | 79 | 155 | ||||
| Other assets | 149 | 458 | ||||
| Operating lease right-of-use assets | 847 | 1,557 | ||||
| Intangible assets, net of accumulated amortization | — | 58 | ||||
| Goodwill | 3,416 | 3,416 | ||||
| Total Assets | $ | 6,316 | $ | 14,802 | ||
| LIABILITIES, MEZZANINE EQUITY AND SHAREHOLDERS’ DEFICIT | ||||||
| Current Liabilities: | ||||||
| Accounts payable | $ | 837 | $ | 1,007 | ||
| Deferred revenue | 1,204 | 903 | ||||
| Accrued expense | 1,518 | 1,130 | ||||
| Operating lease liabilities, current portion | 496 | 421 | ||||
| Derivative liabilities | 5,292 | 24,128 | ||||
| Note payable, current portion | 524 | 918 | ||||
| Total Current Liabilities | 9,871 | 28,507 | ||||
| Other long-term liabilities | — | 65 | ||||
| Note payable, net of current portion | — | 653 | ||||
| Operating lease liabilities, net of current portion | 802 | 1,297 | ||||
| Pension obligation | 1,976 | 2,531 | ||||
| Total Liabilities | 12,649 | 33,053 | ||||
| Mezzanine Equity: | ||||||
| Series D Convertible Redeemable Preferred Stock, $ par value, designated shares, shares issued and and shares outstanding at December 31, 2021 and December 31, 2020, respectively; liquidation preference $ and $ at December 31, 2021 and 2020, respectively. | 8,759 | 1,572 | ||||
| Shareholders’ Deficit: | ||||||
| Preferred stock, authorized shares: | ||||||
| Series A Convertible Redeemable Preferred Stock, $ par value; designated shares, shares issued and and shares outstanding at December 31, 2021 and 2020, respectively; liquidation preference $ and $at December 31, 2021 and 2020, respectively. | — | — | ||||
| Series A-1 Convertible Redeemable Preferred Stock, $ par value; designated shares, shares issued and and shares outstanding at December 31, 2021 and 2020, respectively; liquidation preference $ and $ at December 31, 2021 and 2020, respectively. | — | — | ||||
| Series B Convertible Redeemable Preferred Stock, $ par value; designated shares, shares issued and shares outstanding at December 31, 2021 and 2020, respectively; liquidation preference $ at December 31, 2021 and 2020, respectively. | 2 | 2 | ||||
| Common Stock, $ par value, shares authorized; and shares issued at December 31, 2021 and 2020, respectively, and shares and shares outstanding at December 31, 2021 and 2020, respectively. | 3,471 | 1,801 | ||||
| Additional paid-in capital | 187,148 | 193,652 | ||||
| Treasury stock, at cost shares | (64 | ) | (64 | ) | ||
| Accumulated other comprehensive loss | (1,396 | ) | (1,989 | ) | ||
| Accumulated deficit | (204,253 | ) | (213,225 | ) | ||
| Total Shareholders’ Deficit | (15,092 | ) | (19,823 | ) | ||
| Total Liabilities, Mezzanine Equity and Shareholders’ Deficit | $ | 6,316 | $ | 14,802 | ||
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
| Year Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenue: | ||||||||
| Product | $ | 854 | $ | 2,231 | ||||
| Maintenance | 2,618 | 2,554 | ||||||
| 3,472 | 4,785 | |||||||
| Cost of revenue: | ||||||||
| Product | 322 | 800 | ||||||
| Maintenance | 346 | 448 | ||||||
| Gross profit | 2,804 | 3,537 | ||||||
| Operating expense: | ||||||||
| General and administrative | 6,151 | 4,102 | ||||||
| Sales and marketing | 2,892 | 2,936 | ||||||
| Research and development | 4,461 | 5,706 | ||||||
| Depreciation and amortization | 56 | 72 | ||||||
| 13,560 | 12,816 | |||||||
| Loss from operations | (10,756 | ) | (9,279 | ) | ||||
| Interest expense, net | 2 | 102 | ||||||
| (Gain) on change in fair value of derivative liabilities | (18,809 | ) | (2,252 | ) | ||||
| (Gain) on extinguishment of debt | (1,581 | ) | — | |||||
| Loss on extinguishment of derivative liabilities, net | 311 | — | ||||||
| Other components of net periodic pension expense | 103 | 115 | ||||||
| Other (income) expense, net | (74 | ) | 2 | |||||
| Income (loss) before income taxes | 9,292 | (7,246 | ) | |||||
| Income tax expense | 10 | 7 | ||||||
| Net income (loss) | $ | 9,282 | $ | (7,253 | ) | |||
| Preferred dividends, deemed dividends and accretion | (8,116 | ) | (3,695 | ) | ||||
| Net income (loss) available to common shareholders | $ | 1,166 | $ | (10,948 | ) | |||
| Basic income (loss) per common share — see Note 2: | ||||||||
| Basic income (loss) per share available to common shareholders | $ | 0.00 | $ | (0.08 | ) | |||
| Basic weighted-average shares outstanding | 312,119,417 | 133,346,309 | ||||||
| Diluted income (loss) per common share — see Note 2: | ||||||||
| Diluted income (loss) per share available to common shareholders | $ | 0.00 | $ | (0.08 | ) | |||
| Diluted weighted-average shares outstanding | 320,656,728 | 133,346,309 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
| Year Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Net income (loss) | $ | 9,282 | $ | (7,253 | ) | |||
| Other comprehensive income (loss): | ||||||||
| Decrease (increase) in additional minimum pension liability | 518 | (97 | ) | |||||
| Foreign currency translation adjustment | 75 | (151 | ) | |||||
| Comprehensive income (loss) | $ | 9,875 | $ | (7,501 | ) | |||
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT
(In thousands, except share amounts)
| 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 | - | - | - | - | - | - | - | - | - | - | (6,806 | ) | - | - | (6,806 | ) | ||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense - options | - | - | - | - | - | - | - | - | - | - | 1,494 | - | - | 1,494 | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense - RSUs | - | - | - | - | - | - | 902,630 | 9 | - | - | (1 | ) | - | - | 8 | |||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense - warrants | - | - | - | - | - | - | - | - | - | - | 26 | - | - | 26 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of Common Stock for cash | - | - | - | - | - | - | 1,000,000 | 10 | - | - | 90 | - | - | 100 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of Common Stock as issuance costs for equity line of credit | - | - | - | - | - | - | 1,000,000 | 10 | - | - | 60 | - | - | 70 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock in lieu of cash | - | - | - | - | - | - | 921,218 | 9 | - | - | 49 | - | - | 58 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock pursuant to warrant exercise | - | - | - | - | - | - | 400 | 0 | - | - | - | - | - | 0 | ||||||||||||||||||||||||||||||||||||||||||
| Conversion of Series A Preferred to Common Stock | (14,911 | ) | (0 | ) | - | - | - | - | 74,562,000 | 746 | - | - | (745 | ) | - | - | (0 | ) | ||||||||||||||||||||||||||||||||||||||
| Conversion of Series A-1 Preferred to Common Stock | - | - | (14,782 | ) | (0 | ) | - | - | 73,910,000 | 739 | - | - | (739 | ) | - | - | 0 | |||||||||||||||||||||||||||||||||||||||
| Conversion of Series D Preferred to Common Stock | - | - | - | - | - | - | 11,149,123 | 110 | - | - | 851 | - | (5 | ) | 956 | |||||||||||||||||||||||||||||||||||||||||
| Recission of common shares | - | - | - | - | - | - | (2,817 | ) | (0 | ) | - | - | 0 | - | - | - | ||||||||||||||||||||||||||||||||||||||||
| Dividends on Series A preferred stock, $()/share | - | - | - | - | - | - | 1,911,587 | 19 | - | - | 113 | - | (132 | ) | (0 | ) | ||||||||||||||||||||||||||||||||||||||||
| Dividends on Series A-1 preferred stock, $()/share | - | - | - | - | - | - | 1,789,587 | 18 | - | - | 104 | - | (122 | ) | 0 | |||||||||||||||||||||||||||||||||||||||||
| Dividends on Series B preferred stock | - | - | - | - | - | - | - | - | - | - | - | - | (51 | ) | (51 | ) | ||||||||||||||||||||||||||||||||||||||||
| Dividends on Series D Preferred stock, $()/share | - | - | - | - | - | - | - | - | - | - | (999 | ) | - | - | (999 | ) | ||||||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | - | - | - | - | - | - | 75 | - | 75 | ||||||||||||||||||||||||||||||||||||||||||
| Additional minimum pension liability | - | - | - | - | - | - | - | - | - | - | - | 518 | - | 518 | ||||||||||||||||||||||||||||||||||||||||||
| Net income | - | - | - | - | - | - | - | - | - | - | - | - | 9,282 | 9,282 | ||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | - | $ | - | - | $ | - | 239,400 | $ | 2 | 347,240,045 | $ | 3,471 | (6,704 | ) | $ | (64 | ) | $ | 187,148 | $ | (1,396 | ) | $ | (204,253 | ) | $ | (15,092 | ) | ||||||||||||||||||||||||||||
| 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, 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 | - | - | - | - | - | - | - | - | - | - | (2,688 | ) | - | - | (2,688 | ) | ||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock net of financing costs | - | - | - | - | - | - | 15,700,000 | 157 | - | - | 2,103 | - | - | 2,260 | ||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | - | - | - | - | - | - | 1,883,248 | 19 | - | - | 843 | - | - | 862 | ||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock for financing facility | - | - | - | - | - | 2,500,000 | 25 | - | - | 375 | - | - | 400 | |||||||||||||||||||||||||||||||||||||||||||
| Modification of Series A Preferred Stock from issuance of Series A-1 Preferred Stock | (18,828 | ) | - | 18,828 | - | - | - | - | - | - | - | 1,849 | - | - | 1,849 | |||||||||||||||||||||||||||||||||||||||||
| Conversion of Series A Preferred to Common Stock | (3,728 | ) | - | 18,640,000 | 186 | (186 | ) | - | ||||||||||||||||||||||||||||||||||||||||||||||||
| Conversion of Series A-1 Preferred to Common Stock | - | - | (4,046 | ) | - | 19,016,452 | 190 | (190 | ) | - | ||||||||||||||||||||||||||||||||||||||||||||||
| Dividends on Series B preferred stock, $()/share | - | - | - | - | - | - | - | - | - | - | - | (51 | ) | (51 | ) | |||||||||||||||||||||||||||||||||||||||||
| Additional minimum pension liability | - | - | - | - | - | - | - | - | - | - | - | (97 | ) | - | (97 | ) | ||||||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | - | - | - | - | - | - | (151 | ) | - | (151 | ) | ||||||||||||||||||||||||||||||||||||||||
| Dividends on Series A preferred stock, $()/share | - | - | - | - | - | - | 1,388,876 | 14 | - | - | 104 | - | (1,967 | ) | (1,849 | ) | ||||||||||||||||||||||||||||||||||||||||
| Dividends on Series A-1 preferred stock, $()/share | - | - | - | - | - | - | 1,159,416 | 12 | - | - | 81 | - | (93 | ) | - | |||||||||||||||||||||||||||||||||||||||||
| Dividends on Series C preferred stock, $()/share | - | - | - | - | - | - | 6,455,149 | 65 | - | - | 625 | - | (690 | ) | - | |||||||||||||||||||||||||||||||||||||||||
| Dividends on Series D preferred stock, $()/share | - | - | - | - | - | - | - | - | - | - | (142 | ) | - | - | (142 | ) | ||||||||||||||||||||||||||||||||||||||||
| Deemed dividend from issuance of Series D preferred stock | - | - | - | - | - | - | - | - | - | - | (4,201 | ) | - | - | (4,201 | ) | ||||||||||||||||||||||||||||||||||||||||
| Net loss | - | - | - | - | - | - | - | - | - | - | - | - | (7,253 | ) | (7,253 | ) | ||||||||||||||||||||||||||||||||||||||||
| 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 | ) | ||||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| Year Ended December 31, | ||||||||
| Cash flows from operating activities | 2021 | 2020 | ||||||
| Net income (loss) | $ | 9,282 | $ | (7,253 | ) | |||
| Adjustments to reconcile net income (loss) to net cash used by operating activities: | ||||||||
| Depreciation and amortization | 56 | 72 | ||||||
| Loss on disposal of fixed assets | 82 | — | ||||||
| Loss on abandonment of patents | 50 | — | ||||||
| Loss on extinguishment of derivative liabilities | 311 | — | ||||||
| Deferred stock issuance costs | 364 | |||||||
| Stock-based compensation | 1,528 | 862 | ||||||
| Stock issued in lieu of cash as compensation for services | 58 | — | ||||||
| Application of rent deposit in lieu of cash payments | — | 124 | ||||||
| Gain on extinguishment of debt | (1,581 | ) | ||||||
| Gain from change in fair value of derivative liabilities | (18,809 | ) | (2,252 | ) | ||||
| Impairment loss on lease abandonment | 333 | — | ||||||
| Change in assets and liabilities | ||||||||
| Accounts receivable | 194 | 81 | ||||||
| Inventory | 14 | 576 | ||||||
| Other assets | (69 | ) | 33 | |||||
| Operating lease right-of-use assets | (44 | ) | (20 | ) | ||||
| Accounts payable | (170 | ) | 491 | |||||
| Accrued expense | 401 | (175 | ) | |||||
| Deferred revenue | 300 | (726 | ) | |||||
| Pension obligation | (37 | ) | 178 | |||||
| Total adjustments | (17,019 | ) | (756 | ) | ||||
| Net cash used by operating activities | (7,737 | ) | (8,009 | ) | ||||
| Cash flows from investing activities | ||||||||
| Purchase of property and equipment | (53 | ) | — | |||||
| Net cash used by investing activities | (53 | ) | — | |||||
| Cash flows from financing activities | ||||||||
| Proceeds from issuance of common stock, net | 100 | 2,296 | ||||||
| Proceeds from issuance of notes payable, net | 523 | 4,658 | ||||||
| Repayment of notes payable | — | (575 | ) | |||||
| Proceeds from issuance of preferred stock, net of issuance costs | — | 9,147 | ||||||
| Dividends paid to preferred stockholders | (51 | ) | (51 | ) | ||||
| Net cash provided by financing activities | 572 | 15,475 | ||||||
| Effect of exchange rate changes on cash and cash equivalents | 75 | (151 | ) | |||||
| Net (decrease) increase in cash and cash equivalents | (7,143 | ) | 7,315 | |||||
| Cash and cash equivalents at beginning of year | 8,345 | 1,030 | ||||||
| Cash and cash equivalents at end of year | $ | 1,202 | $ | 8,345 | ||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid for interest | $ | — | $ | 52 | ||||
| Cash paid for income taxes | $ | — | $ | — | ||||
| Summary of non-cash investing and financing activities: | ||||||||
| Issuance of common stock for financing facility | $ | 70 | $ | 400 | ||||
| Stock dividends on Series A Convertible Redeemable Preferred Stock | $ | 132 | $ | 1,849 | ||||
| Stock dividends on Series A-1 Convertible Redeemable Preferred Stock | $ | 122 | $ | 93 | ||||
| Stock dividends on Series C Convertible Redeemable Preferred Stock | $ | — | $ | 690 | ||||
| Stock dividends on Series D Convertible Redeemable Preferred Stock | $ | 999 | $ | 142 | ||||
| Conversion of Series A Convertible Redeemable Preferred Stock into Common Stock | $ | 745 | $ | 190 | ||||
| Conversion of Series A-1 Convertible Redeemable Preferred Stock into Common Stock | $ | 739 | $ | 186 | ||||
| Conversion of bridge loan into Series D Convertible Redeemable Preferred Stock | $ | — | $ | 2,187 | ||||
| Conversion of related party notes payable and accrued interest into Series D Convertible Redeemable Preferred Stock | $ | — | $ | 334 | ||||
| Recognition of derivative liabilities on preferred stock issuance | $ | 557 | $ | 26,011 | ||||
| Deemed dividend from holder on preferred stock extinguishment and modification | $ | — | $ | 6,136 | ||||
| Exchange of Series C Convertible Redeemable Preferred Stock for Series D Convertible Redeemable Preferred Stock | $ | — | $ | 10,000 | ||||
| Accretion of discount on Series C Convertible Redeemable Preferred Stock | $ | — | $ | 1,116 | ||||
| Accretion of discount on Series D Convertible Redeemable Preferred Stock | $ | 6,806 | $ | 1,572 | ||||
| Reduction in additional minimum pension liability | $ | 518 | $ | 97 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2021 AND 2020
1. DESCRIPTION OF BUSINESS AND OPERATIONS
Overview
As used in this 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 our patented 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 our Biometric Engine.
Liquidity, Going Concern and Management’s Plans
At December 31, 2021 and 2020, we had negative working capital of $8,046,000 and $19,349,000, respectively. Included in our negative working capital as of December 31, 2021 are $5,292,000 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 liquidation preference of the Series D. At December 31, 2021 the liquidation preference totaled $23,216,000.
Historically, our principal sources of cash have included proceeds from the issuance of common and preferred stock and proceeds from the issuance of debt, and, to a lesser extent, customer payments from the sale of our products. 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. As a result, the Company has been dependent on equity and debt financings to satisfy its working capital requirements and continue as a going concern.
To address our working capital requirements, management has instituted several cost cutting measures and has utilized cash proceeds available under the credit facility with certain funds and separate accounts managed by Nantahala Capital Management, LLC and other lenders (collectively, the “Lenders”), and under the purchase agreement with Lincoln Park Capital Fund, LLC (“Lincoln Park”) to satisfy its working capital requirements (“LPC Purchase Agreement”).
During 2021, the Company retained an investment bank to initiate a review of available alternatives to maximize shareholder value, which may include, among other alternatives, (i) a merger, consolidation, or other business combination or a purchase involving all or a substantial amount of the business, securities or assets of the Company, and/or (ii) the private placement of securities to meet its working capital requirements or otherwise as necessary in connection with the consummation of any of the above transactions. In the event the Company is unable to consummate one or more of the above transactions, the Company will not be able to continue as a going concern. The Company continues to evaluate indications of interest as well as options to address its projected working capital requirements, and those discussions are ongoing, including with the Company’s largest shareholder with whom the Company has entered a Term Loan and Security Agreement to provide up to $2,500,000 (the “LOC”). As of April 14, 2022 approximately $763,000 remains available under the LOC in such shareholder’s discretion.
To date the Board of Directors (“Board”) has not entered into any financing or other arrangements, other than the LOC, and no assurances can be given that we will be successful in raising additional capital through the issuance of debt and/or equity securities or entering into any other transaction that addresses our ability to continue as a going concern. The consummation of a transaction will likely involve substantial dilution to the Company’s stockholders and may result in the loss of your entire investment.
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 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The financial statements are prepared under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 105-10, Generally Accepted Accounting Principles, in accordance with accounting principles generally accepted in the U.S. (“GAAP”).
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The Company’s wholly-owned subsidiaries are: XImage Corporation, a California Corporation; Imageware Systems ID Group, Inc., a Delaware corporation (formerly Imaging Technology Corporation); I.W. Systems Canada Company, a Nova Scotia unlimited liability company; Imageware Digital Photography Systems, LLC, a Nevada limited liability company (formerly Castleworks LLC); Digital Imaging International GmbH, a company formed under German laws; and Image Ware Mexico S de RL de CV, a company formed under Mexican laws. All significant intercompany transactions and balances have been eliminated.
Operating Cycle
Assets and liabilities related to long-term contracts are included in current assets and current liabilities in the accompanying 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 consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expense during the reporting period. Significant estimates include the evaluation of our ability to continue as a going concern, the allowance for doubtful accounts receivable, assumptions used in the Black-Scholes model to calculate the fair value of share-based payments, fair value of Series D Preferred and financial instruments issued with and affected by the Series D Preferred Financing (defined below), fair value of financial instruments with and affected by the Series C Preferred (defined below), fair value of Series A Preferred (defined below), fair value of Series A-1 Preferred (defined below), assumptions used in the application of revenue recognition policies, assumptions used in the derivation of the Company’s incremental borrowing rate used in the computation of the Company’s operating lease liabilities, the determination of impairment of long-lived assets 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 6.
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 to 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.
Revenue Recognition
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; |
| ● | Computer hardware and identification media; |
| ● | Services; and |
| ● | Post-contract customer support. |
Software licensing and royalties
Software licenses consist of revenue from the sale of software for identity management applications. Our software licenses are functional intellectual property and typically provide customers with the right to use our software in perpetuity as it exists when made available to the customer. We recognize revenue from software licensing at a point in time upon delivery, provided all other revenue recognition criteria are met.
Royalties consist of revenue from usage-based arrangements and guaranteed minimum-based arrangements. We recognize revenue for royalty arrangements at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied.
Computer hardware and identification media
We generate revenue from the sale of computer hardware and identification media. Revenue for these items is recognized upon delivery of these products to the customer, provided all other revenue recognition criteria are met.
Services
Services revenue is comprised primarily of software customization services, software integration services, system installation services and customer training. Revenue is generally recognized upon completion of services and customer acceptance provided all other revenue recognition criteria are met.
Post-contract customer support (“PCS”)
Post contract customer support consists of maintenance on software and hardware for our identity management solutions. We recognize PCS revenue from periodic maintenance agreements. Revenue is generally recognized ratably over the respective maintenance periods provided no significant obligations remain. Costs related to such contracts are expensed as incurred.
Arrangements with multiple performance obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. In addition to selling software licenses, hardware and identification media, services and post-contract customer support on a standalone basis, certain contracts include multiple performance obligations. For such arrangements, we allocate 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 December 31, 2021 and 2020, we had recorded approximately $0 and $65,000, respectively in contract costs relating to capitalized commissions. During the year ended December 31, 2021 and 2020, we recognized approximately $65,000 and $53,000, respectively, of capitalized contract costs as expense. Such expense is included as a component of operating expense and is included under the caption “Sales and marketing” in our consolidated statement of operations for the years ended December 31, 2021 and 2020. We recorded no additional capitalized contract costs in the year ended December 31, 2021. We recognized approximately $438,000 of revenue during the year ended December 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 years ended December 31, 2021 and 2020:
| Year Ended December 31, | ||||||||
| Net Revenue | 2021 | 2020 | ||||||
| (dollars in thousands) | ||||||||
| Software and royalties | $ | 383 | $ | 872 | ||||
| Hardware and consumables | 290 | 84 | ||||||
| Services | 181 | 1,275 | ||||||
| Maintenance | 2,618 | 2,554 | ||||||
| Total net revenue | $ | 3,472 | $ | 4,785 | ||||
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 ASC 842. In accordance with ASC 842, the Company has determined that such arrangements are operating leases and accordingly the Company has, as of January 1, 2019, recorded operating lease right-of-use assets and related lease liability for the present value of the lease payments over the lease terms using the Company’s estimated weighted-average incremental borrowing rate of approximately 14.5%. The Company has utilized the practical expedient regarding lease and nonlease components and has combined such items into a single combined component. The Company has also utilized the practical expedient regarding leases of twelve months or less and has excluded such leases from its computation of lease liability and related right-of-use assets. The Company has also elected the optional transition package of practical expedients which include:
A package of practical expedient to not reassess:
| ● | Whether a contract is or contains a lease |
| ● | Lease classification |
| ● | Initial direct costs |
The Company evaluates its operating lease right-of-use assets for impairment. As of December 31, 2021, and through the date of this report, management’s review indicated that there was an impairment of an operating lease right-of-use asset and the Company recorded an impairment loss of approximately $333,000. Impairment is based on the excess of the carrying amount over the fair value, based on market value when available, or expected future economic benefits to the company from the operating lease right-of-use asset and is recorded in the period in which the determination is made. Such amount is included in the Company’s Consolidated Statement of Operations for the year ended December31, 2021 under the caption “General and administrative” expense.
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 simplified impairment test in the fourth quarter of each year. In December 2018, the Company adopted the provisions of Accounting Standards Update (“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 reporting unit, Identity Management, which at December 31, 2021, had a negative carrying amount of approximately $15,092,000. Based on the results of the Company’s impairment testing, the Company determined that its goodwill was impaired as of December 31, 2021 and December 31, 2020.
Intangible and Long-Lived Assets
Intangible assets are carried at their cost less any accumulated amortization. Any costs incurred to renew or extend the life of an intangible or long-lived asset are reviewed for capitalization. The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. As of December 31, 2021, and through the date of this Annual Report, the Company’s management believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company’s products under development will continue. Either of these could result in future impairment of long-lived assets.
Derivative Liabilities
The Company accounts for its derivative instruments under the provisions of ASC Topic 815, Derivatives and Hedging (“ASC 815”). Under the provisions of ASC 815, the Company identified embedded features within the Series D Preferred host contract that qualify as derivative instruments and require bifurcation.
On November 20, 2020, the Company consummated the Series D Financing, resulting in the sale of 11,560 shares of its Series D Preferred. The Company determined that the conversion option, redemption option and participating dividend feature contained in the Series D Preferred host instrument required bifurcation. The Company valued the bifurcatable features at fair value. Such liabilities aggregated approximately $26,011,000 at the November 20, 2020 inception date and are classified as current liabilities on the Company’s consolidated balance sheets under the caption “Derivative liabilities”. The excess of the derivative fair value over the carrying amount of the Series D Preferred was recorded as a deemed dividend of approximately $4,201,000. The Series D Preferred financing was approved by the Company’s Board of Directors to provide for an immediate need of capital, to allow the Company to continue as a going concern and to execute the Company’s business plan after consultation with several of the Company’s largest shareholders and a review of financing alternatives. The Company will revalue these features at each balance sheet date and record any change in fair value in the determination of period net income or loss. The change in fair value of such amounts are recorded in the caption “Change in fair value of derivative liabilities” in the Company’s consolidated statements of operations. For the year ended December 31, 2021, the Company recorded a decrease to its derivative liabilities using fair value methodologies of approximately $18,809,000 related to Series D embedded derivatives. As a result of this decrease, such liabilities aggregated approximately $5,292,000 at December 31, 2021.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The Company places its cash with high quality financial institutions and at times during the years ended December 31, 2021 and 2020, exceeded the FDIC insurance limits of $250,000. Sales are typically made on credit and the Company generally does not require collateral. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains an allowance for doubtful accounts. 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 presented net of an allowance for doubtful accounts of approximately $25,000 and $5,000 at December 31, 2021 and 2020, respectively.
For the year ended December 31, 2021, three customers accounted for approximately 51% or $1,787,000 of total revenue and had trade receivables of approximately $172,000 as of the end of the year. For the year ended December 31, 2020, two customers accounted for approximately 61% or $2,921,000 of total revenue and had trade receivables of approximately $250,000 as of the end of the year.
Stock-Based Compensation
At December 31, 2021, the Company had one stock-based compensation plan for employees and nonemployee directors, which authorizes the granting of various equity-based incentives including stock options, warrants and restricted stock.
The Company estimates the fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC Topic 718, Compensation – Stock Compensation (“ASC 718”). The fair value of stock options granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense is reported in operating expense based upon the departments to which substantially all of the associated employees report and credited to additional paid-in-capital.
ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best measure of expected volatility is based on the historical weekly volatility of the Company’s Common Stock. Historical volatility factors utilized in the Company’s Black-Scholes computations for options granted during the years ended December 31, 2021 and 2020 ranged from 57% to 99%. The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin Topic 14. The expected term used by the Company to value the grants issued during the years ended December 31, 2021 and 2020 ranged from 3.33 to 5.17 years. The difference between the actual historical expected life and the simplified method was immaterial. The interest rate used is the risk-free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for the years ended December 31, 2021 and 2020 ranged from 1.37 % to 2.58%. Dividend yield is zero as the Company does not expect to declare any dividends on the Company’s common shares in the foreseeable future.
In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has utilized an estimated annualized forfeiture rate ranging from approximately 5.0% to 10% for corporate officers, 4.1% to 10% for members for members of the Board of Directors and 15.0% to 25% for all other employees. The Company reviews the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.
The Company estimates the fair value of its warrants using a Black-Scholes option-pricing model, consistent with the provisions of ASC 718, “Compensation – Stock Compensation”. The fair value of warrants granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense related to warrants is reported in operating expense based upon the departments to which substantially all of the associated employees report and credited to additional paid-in-capital.
Restricted stock units (“RSUs”) are recorded at the grant date fair value with corresponding compensation expense recorded ratably over the requisite service period.
Stock-based compensation expense related to equity options, warrants and RSUs was approximately $1,528,000 and $862,000 for the years ended December 31, 2021 and 2020, respectively.
Income Taxes
The Company accounts for income taxes in accordance with ASC Topic 740, Accounting for Income Taxes, (“ASC 740”). Current income tax expense or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is computed for the expected future impact of differences between the financial reporting and tax bases of assets and liabilities and for the expected future tax benefit to be derived from tax credits and loss carryforwards. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
ASC 740 requires a company to first determine whether it is more-likely-than-not (defined as a likelihood of more than fifty percent) that a tax position will be sustained based on its technical merits as of the reporting date, assuming that taxing authorities will examine the position and have full knowledge of all relevant information. A tax position that meets this more-likely-than-not threshold is then measured and recognized at the largest amount of benefit that is greater than fifty percent likely to be realized upon effective settlement with a taxing authority. The amount accrued for uncertain tax positions was $0 at December 31, 2021 and 2020.
The Company’s uncertain tax position relative to unrecognized tax benefits and any potential increase in these liabilities relates primarily to the allocations of revenue and costs among the Company’s global operations and the impact of tax rulings made during the period affecting its tax positions. The Company’s existing tax positions could result in liabilities for unrecognized tax benefits. The Company recognizes interest and/or penalties related to uncertain tax positions in income tax expense. The amount of interest and penalties accrued as of December 31, 2021 and 2020 was $0.
Significant judgment is required in evaluating the Company’s uncertain tax positions and determining the Company’s provision for income taxes. No assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in the Company’s historical income tax provisions and accruals. The Company adjusts these items in light of changing facts and circumstances. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.
Foreign Currency Translation
The financial position and results of operations of the Company’s foreign subsidiaries are measured using the foreign subsidiary’s local currency as the functional currency. Revenue and expense of such subsidiaries have been translated into U.S. dollars at weighted-average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of shareholders’ equity, unless there is a sale or complete liquidation of the underlying foreign investments. The Company translates foreign currencies of its German, Canadian and Mexican subsidiaries. The cumulative translation adjustment, which is recorded in accumulated other comprehensive loss, increased approximately $75,000 for the year ended December 31, 2021 and decreased approximately $151,000 December 31, 2020.
Comprehensive Income (Loss)
Comprehensive loss consists of net gains and losses affecting shareholders’ deficit that, under generally accepted accounting principles, are excluded from net loss. For the Company, the only items are the cumulative translation adjustment and the additional minimum liability related to the Company’s defined benefit pension plan, recognized pursuant to ASC 715-30, “Compensation - Retirement Benefits - Defined Benefit Plans – Pension”.
Advertising Costs
The Company expenses advertising costs as incurred. The Company incurred approximately $48,000 and 5,000, respectively, in advertising expense during the years ended December 31, 2021 and December 31, 2020.
Income (Loss) Per Share
Basic income (loss) per common share is calculated by dividing net income (loss) available to common shareholders for the period by the weighted-average number of common shares outstanding during the period. Diluted income (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, stock options and warrants, calculated using the treasury stock and if-converted methods. For diluted income (loss) per share calculation purposes, the net income (loss) available to common shareholders is adjusted to add back any preferred stock dividends and any interest on convertible debt reflected in the consolidated statement of income (loss) for the respective periods.
The table below presents the computation of basic and diluted income (loss) per share:
| (Amounts in thousands except share and per share amounts) | Twelve Months Ended December 31, | |||||||
| 2021 | 2020 | |||||||
| Numerator for basic and diluted income (loss) per share: | ||||||||
| Net income (loss) | $ | 9,282 | $ | (7,253 | ) | |||
| Preferred dividends, deemed dividends and accretion | (8,116 | ) | (3,695 | ) | ||||
| Net income (loss) available to common shareholders | $ | 1,166 | $ | (10,948 | ) | |||
| Effective of dilutive securities: | ||||||||
| Preferred dividends, deemed dividends and accretion | — | — | ||||||
| Net income (loss) available to common shareholders after assumed conversions | 1,166 | (10,948 | ) | |||||
| Denominator for basic income (loss) per share – weighted-average shares outstanding | 312,119,417 | 133,346,309 | ||||||
| Effect of dilutive securities: | ||||||||
| Options | 5,750,000 | — | ||||||
| Warrants | 2,787,311 | — | ||||||
| Convertible preferred stock | — | — | ||||||
| Denominator for diluted income (loss) – adjusted weighted average shares and assumed conversions | 320,656,728 | 133,346,309 | ||||||
| Basic income (loss) per share available to common shareholders | $ | 0.00 | $ | (0.08 | ) | |||
| Diluted income (loss) per share available to common shareholders | $ | 0.00 | $ | (0.08 | ) | |||
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 December 31, 2021 | Common Share Equivalents at December 31, 2020 | ||||||
| Convertible redeemable preferred stock – Series A | — | 74,555,000 | ||||||
| Convertible redeemable preferred stock – Series A-1 | — | 73,910,000 | ||||||
| Convertible redeemable preferred stock – Series B | 46,631 | 46,029 | ||||||
| Convertible redeemable preferred stock – Series D | 398,222,985 | 392,166,023 | ||||||
| Stock options | 4,848,876 | 2,585,500 | ||||||
| Restricted stock units (“RSUs”) | 81,019,401 | 845,106 | ||||||
| Warrants | 3,150,000 | 753,775 | ||||||
| Total Potential Dilutive Securities | 487,287,893 | 544,861,433 | ||||||
Recently Issued Accounting Standards
From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies, which are adopted by us as of the specified effective date. Unless otherwise discussed, the Company’s management believes the impact of recently issued standards not yet effective will not have a material impact on the Company’s consolidated financial statements upon adoption.
FASB ASU No. 2019-12. In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740). The amendments in this update simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. Early adoption of the amendments is permitted. For public business entities, the amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
FASB ASU No. 2020-01. In January 2020, the FASB issued ASU 2020-01 “Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)-Clarifying the Interactions between Topic 321, Topic 323, and Topic 815”, to clarify the interaction of the accounting for equity securities under ASC 321 and investments accounted for under the equity method of accounting in ASC 323 and the accounting for certain forward contracts and purchased options accounted for under ASC 815. With respect to the interactions between ASC 321 and ASC 323, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting when applying the measurement alternative in ASC 321, immediately before applying or upon discontinuing the equity method of accounting. With respect to forward contracts or purchased options to purchase securities, the amendments clarify that when applying the guidance in ASC 815-10-15-141(a), an entity should not consider whether upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in ASC 323 or the fair value option in accordance with ASC 825. The ASU is effective for interim and annual reporting periods beginning after December 15, 2020. Early adoption is permitted, including adoption in any interim period. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
FASB 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.
3. FAIR VALUE ACCOUNTING
The Company accounts for fair value measurements in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below:
| Level 1 | Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. | |
| Level 2 | Applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data. | |
| Level 3 | Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity). |
The following table sets forth the Company’s financial assets and liabilities measured at fair value by level within the fair value hierarchy. As required by ASC 820, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
| Fair Value at December 31, 2021 | ||||||||||||||||
| ($ in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||
| Assets: | ||||||||||||||||
| Pension assets | $ | 1,689 | $ | — | $ | — | $ | |||||||||
| Totals | $ | 1,689 | $ | — | $ | — | $ | |||||||||
| Liabilities: | ||||||||||||||||
| Derivative liabilities | $ | 5,292 | $ | — | $ | — | $ | 5,292 | ||||||||
| Totals | $ | 5,292 | $ | — | $ | — | $ | 5,292 | ||||||||
| Fair Value at December 31, 2020 | ||||||||||||||||
| ($ in thousands) | Total | Level 1 | Level 2 | Level 3 | ||||||||||||
| Assets: | ||||||||||||||||
| Pension assets | $ | 1,881 | $ | — | $ | — | $ | 1,881 | ||||||||
| Totals | $ | 1,881 | $ | — | $ | — | $ | 1,881 | ||||||||
| Liabilities: | ||||||||||||||||
| Derivative liabilities | $ | 24,128 | $ | — | $ | — | $ | 24,128 | ||||||||
| Totals | $ | 24,128 | $ | — | $ | — | $ | 24,128 | ||||||||
The Company’s German pension plan is funded by insurance contract policies whereby the insurance company guarantees a fixed minimum return. The Company has determined that the pension assets are appropriately classified within Level 3 of the fair value hierarchy because they are valued using actuarial valuation methodologies which approximate cash surrender value that cannot be corroborated with observable market data. All plan assets are managed in a policyholder pool in Germany by outside investment managers. The investment manager is responsible for the investment strategy of the insurance premiums that Company submits and does not hold individual assets per participating employer. The German Federal Financial Supervisory oversees and supervises the insurance contracts.
As of December 31, 2021, the Company had embedded features contained in the Series D Preferred host instrument (issued in November 2020) that qualified for derivative liability treatment. The recorded fair market value of these features was approximately $5,292,000 at December 31, 2021 and are classified as a current liability in the consolidated balance sheet as of December 31, 2021. The fair value of the Company’s derivative liabilities are classified within Level 3 of the fair value hierarchy because they are valued using pricing models that incorporate management assumptions that cannot be corroborated with observable market data. The Company uses Monte-Carlo simulations and other fair value methodologies in the determination of the fair value of derivative liabilities. Considering the various path dependencies for the Series D Preferred Stock, Monte-Carlo simulations were deemed the most appropriate methodology.
As of December 31, 2020, the Company had embedded features contained in the Series D Preferred host instrument (issued in November 2020) that qualified for derivative liability treatment. The recorded fair market value of these features was approximately $24,128,000 at December 31, 2020 and are classified as a current liability in the consolidated balance sheet as of December 31, 2020. The fair value of the Company’s derivative liabilities are classified within Level 3 of the fair value hierarchy because they are valued using pricing models that incorporate management assumptions that cannot be corroborated with observable market data. The Company uses Monte-Carlo simulations and other fair value methodologies in the determination of the fair value of derivative liabilities. Considering the various path dependencies for the Series D Preferred Stock, Monte-Carlo simulations were deemed the most appropriate methodology.
Some of the aforementioned fair value methodologies are affected by the Company’s stock price as well as assumptions regarding the expected stock price volatility over the term of the derivative liabilities in addition to the probability of future events. Significant assumptions used in the application of fair value methodologies for the Series D Preferred are a risk-free rate of 0.26% to 0.97%, equity volatility of 98.0% to 118.10%, effective life of 4.0 years, and a preferred stock dividend rate of 4.0%. Additionally, management has made certain estimates regarding the timing of potential change of control events.
The Company monitors the activity within each level and any changes with the underlying valuation techniques or inputs utilized to recognize if any transfers between levels are necessary. That determination is made, in part, by working with outside valuation experts for Level 3 instruments and monitoring market related data and other valuation inputs for Level 1 and Level 2 instruments.
The reconciliations of Level 3 pension assets measured at fair value in 2021 and 2020 are presented below:
| ($ in thousands) | December 31, 2021 | December 31, 2020 | ||||||
| Pension assets: | ||||||||
| Fair value at beginning of year | $ | 1,881 | $ | 1,713 | ||||
| Return on plan assets | 24 | 92 | ||||||
| Company contributions and benefits paid, net | (79 | ) | (82 | ) | ||||
| Effect of rate changes | (137 | ) | 158 | |||||
| Fair value at end of year | $ | 1,689 | $ | 1,881 | ||||
The reconciliations of Level 3 derivative liabilities measured at fair value in 2021 and 2020 are presented below:
| ($ in thousands) | December 31, 2021 | December 31, 2020 | ||||||
| Derivative liabilities | ||||||||
| Fair value at beginning of year | $ | 24,128 | $ | 369 | ||||
| Derivative liability from issuance of Preferred Series D | 558 | 26,011 | ||||||
| Decrease in derivative liability from conversion of Preferred Series D | (585 | ) | — | |||||
| Change in fair value included in earnings | (18,809 | ) | (2,252 | ) | ||||
| Fair value at end of year | $ | 5,292 | $ | 24,128 | ||||
4. INTANGIBLE ASSETS AND GOODWILL
The carrying amounts of the Company’s patent intangible assets were $0 and $58,000 as of December 31, 2021 and 2020, respectively, which includes accumulated amortization of $610,000 and $601,000 as of December 31, 2021 and 2020, respectively. Amortization expense for patent intangible assets was $9,000 and 12,000 for the years ended December 31, 2021 and 2020, respectively. Due to a strategic realignment of its intellectual property, the Company abandoned it only remaining unamortized patent intangible asset during the year ended December 31, 2021. As of December 31, 2021, all patent intangible assets are fully amortized.
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 simplified 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 December 31, 2021, had a negative carrying amount of approximately $15,092,000. Based on the results of the Company's impairment testing, the Company determined that its goodwill was impaired during the years ended December 31, 2021 and 2020.
5. RELATED PARTIES
December 2021 Credit Facility with Nantahala Capital Management
On December 29, 2021 (the “Closing Date”), the Company entered into a Term Loan and Security Agreement (the “Agreement”) with certain funds and separate accounts managed by Nantahala Capital Management, LLC (collectively, “Nantahala”), as lenders, and other lenders set forth on the signature pages thereto (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2,500,000 (the “Credit Facility”). Nantahala collectively owns, or otherwise controls, approximately 37.3% of our issued and outstanding voting securities.
All loans (each a “Loan", and collectively, the “Loans”) under the Credit Facility will bear interest at a rate of 12% for the initial six months after the Closing Date, and at 17% thereafter until the maturity date of 12 months from the Closing Date (the “Maturity Date”). All amounts borrowed by the Company under the Credit Facility are secured by a first-priority lien on all the assets of the Company. On the Closing Date, the Company received in initial draw-down on the Credit Facility of $600,000. As of April 14, 2022, the Company received two subsequent draw-downs on the Credit Facility aggregating $1,050,000. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes.
The Company may prepay amounts borrowed under the Credit Facility in whole or in part, at a price equal to 105% of the principal amount borrowed under the Credit Facility (including any interest capitalized thereon), subject to additional prepayment terms pursuant to the Agreement, a copy of which is filed as an Exhibit to the Company’s Current Report on Form 8-K, filed with the SEC on January 4, 2022. In addition, pursuant to the Agreement, at any time after the Closing Date, each Lender shall have the right, but not the obligation, on mutually agreed upon terms, to exchange each such Lender’s pro rata portion of shares of the Company’s Series D Convertible Preferred Stock, par value $0.01 (“Series D Preferred”) held by such Lender for a mutually agreed upon portion of any subsequent Delayed Draw Loan (as defined in the Agreement) (an “Exchange”). Upon the Company's receipt by a Lender of a notice stating a Lender's intent to participate in an Exchange, the Company is required to offer to all holders of Series D Preferred the opportunity, but not the obligation, to exchange each such holder’s pro rata portion of shares of the Company's Series D Preferred held by such holder for participation in any subsequent Delayed Draw Loan, upon substantially similar terms as those provided in the applicable notice of Exchange by a Lender.
Notes Payable
Factoring Agreement
On February 12, 2020, the Company entered into a factoring agreement (the “Factoring Agreement”) with a former member of the Company’s Board of Directors (the “Factoring Lender”). Under the Factoring Agreement, the Company received $350,000 in proceeds (the “Factoring Principal”) in the form of a loan, bearing interest at a rate of 1% for every seven days until the Factoring Principal and accrued interest are paid in full, with a maturity date of March 4, 2020. Pursuant to the Factoring Agreement, repayment of the Factoring Principal and accrued interest was secured by certain of the Company’s trade accounts receivable approximating $500,000 (the “Factoring Collateral”). During the twelve months ended December 31, 2020, the Company recorded approximately $45,000 in interest expense related to the Factoring Agreement. In May 2020, the Company repaid $35,000 in accrued interest to the Factoring Lender. As a condition to the consummation of the Company's offer and sale (the “Closing”) of shares of its Series D Convertible Preferred Stock, par value $0.01 (the “Series D Financing”), the Factoring Lender agreed to settle the entire Factoring Principal plus accrued interest and release the Company from liabilities due under the Factoring Agreement in exchange for a one-time payment of $360,000 (the “Factoring Settlement”) to be made upon the Closing, and out of the proceeds, of the Series D Financing. On November 16, 2020, the Company fulfilled its obligation under the Factoring Settlement, thereby releasing it from its obligation under the Factoring Agreement.
Convertible Promissory Notes
During the year ended December 31, 2020, the Company received advances from a second former member of the Board of Directors (the “Board Lender”) in the aggregate amount of $450,000. On June 29, 2020, the Company executed a promissory note (the “Board Note”) in the favor of the Board Lender in the principal amount of $450,000 (the “Board Note Principal”), pursuant to which the Board Note Principal accrued simple interest at the rate of 5% per annum, and was convertible into shares of the Company's Common Stock at $0.16 per share of Common Stock at the election of the Board Lender. The Board Note was to mature on the earlier to occur of (i) October 13, 2020, or (ii) on such date that the Company consummates a debt and/or equity financing resulting in net proceeds to the Company of at least $3,000,000.
Also during the year ended December 31, 2020, the Company received advances from a third former member of the Board of Directors (the “Second Board Lender”) in the aggregate amount of $100,000. On June 29, 2020, the Company executed a promissory note (the “Second Board Note", and collectively with the Board Note, the “Board Notes”) in the principal amounts of $100,000 (the “Second Board Note Principal”), pursuant to which the Second Board Note Principal accrued simple interest at the rate of 5% per annum, and was convertible into shares of the Company’s Common Stock at $0.16 per share of Common Stock at the election of the Second Board Lender. The Second Board Note was to mature on the earlier to occur of (i) October 13, 2020, or (ii) on such date that the Company consummates a debt and/or equity financing resulting in net proceeds to the Company of at least $3,000,000.
On November 12, 2020, in connection with the Closing of the Series D Financing, the Board Lenders entered into (i) Debt Exchange Agreements (collectively, the “Debt Exchange Agreements”), and (ii) Satisfaction and Release Agreements (collectively, the “Release Agreements”), for the purpose of satisfying certain obligations of the Company arising under (i) the Board Note, and (ii) the Second Board Note. Pursuant to the Debt Exchange Agreements and Release Agreements: (a) one-half of the Board Note Principal plus accrued interest, totaling approximately $232,000 was converted into 231.6 shares of Series D Preferred at a rate of $1,000 per share of Series D Preferred, with the remaining one-half of the Board Note Principal plus accrued interest, totaling approximately $232,000, to be paid to the Board Lender in cash out of proceeds of the Series D Financing, in full satisfaction of the Company's obligations under the Board Note; and (b) the entire Second Board Note Principal plus accrued interest, totaling approximately $103,000, was converted into 102.8 shares of Series D Preferred at a rate of $1,000 per share of Series D Preferred, in full satisfaction of the Company's obligations under the Second Board Note.
Professional Services Agreement
During the year ended December 31, 2020, the Company entered into professional services agreement with a firm affiliated with a member of the Company’s Board at the time the parties entered into the agreement. The Company made no payments pursuant to this agreement during the twelve months ended December 31, 2020 and has made approximately $34,000 during 2021. The Company has the right to terminate the agreement on thirty days written notice at any time.
6. INVENTORY
Inventories of $25,000 as of December 31, 2021 were comprised of work in process of representing direct labor costs on in-process projects and finished goods of $18,000 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 $3,000.
Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value and required reserve levels.
7. PROPERTY AND EQUIPMENT
Property and equipment at consist of:
| ($ in thousands) | December 31, 2021 | December 31, 2020 | ||||||
| Equipment | $ | 1,050 | $ | 996 | ||||
| Leasehold improvements | 77 | 77 | ||||||
| Furniture | 11 | 257 | ||||||
| 1,138 | 1,330 | |||||||
| Less accumulated depreciation | (1,059 | ) | (1,175 | ) | ||||
| $ | 79 | $ | 155 | |||||
Total depreciation expense for the years ended December 31, 2021 and 2020 was approximately $47,000 and $60,000, respectively. During the year ended December 31, 2021, the Company wrote off approximately $82,000 in furniture. Such expense is included in the caption “Other (income) expense, net” in the Company’s 2021 Consolidated Statement of Operations.
8. ACCRUED EXPENSE
Principal components of accrued expense consist of:
| ($ in thousands) | December 31, 2021 | December 31, 2020 | ||||||
| Compensated absences | $ | 124 | $ | 182 | ||||
| Wages, payroll taxes and sales commissions | 60 | 13 | ||||||
| Customer deposits | 18 | 131 | ||||||
| Interest | 1 | 10 | ||||||
| Royalties | — | 72 | ||||||
| Pension and employee benefit plans | 10 | — | ||||||
| Accrued financing fees | 1,000 | 500 | ||||||
| Professional services | 94 | — | ||||||
| Income and sales taxes | 81 | 95 | ||||||
| Dividends | 50 | 49 | ||||||
| Other | 80 | 78 | ||||||
| $ | 1,518 | $ | 1,130 | |||||
9. NOTES PAYABLE AND LINE OF CREDIT
Bridge Loan
Concurrently with the execution of the Series D Purchase Agreement, the Company and certain Series D Preferred investors executed the Series D Bridge Loan Agreement (the “Bridge Loan”), pursuant to which each Investor signatory thereto agreed to the Bridge Loan, secured by all assets of the Company, in an amount equal to 20% of such Investor’s purchase commitment as set forth in the Purchase Agreement, which Bridge Loan, plus accrued interest, will roll into, and be used to purchase, Series D Preferred at Closing.
Pursuant to the Bridge Loan, the Company received proceeds of $2,187,000 in September 2020. The Bridge Loan bears interest at a fixed rate of 12% and is due and payable in arrears on the earlier of the Loan Conversion Date, as such term is defined in the Loan Agreement, or six months after the disbursement of the Bridge Loan. All amounts due and payable pursuant to the Bridge Loan are automatically convertible, without further action by the Investors, into shares of Series D Preferred at Closing at a purchase price of $1,000 for each share of Series D Preferred. The repayment of all amounts due under the terms of the Loan Agreement are secured by all assets of the Company. On November 12, 2020, contemporaneously with the closing of the Series D Preferred Financing, all amounts due under the Bridge Loan were converted into shares of Series D Preferred Stock.
PPP Loan
On May 4, 2020, the Company entered into a loan agreement (the “PPP Loan”) with Comerica Bank (“Comerica”) under the Paycheck Protection Program (the “PPP”), which is part of the CARES Act administered by the United States Small Business Administration (“SBA”). As part of the application for these funds, the Company in good faith, has certified that the current economic uncertainty made the loan request necessary to support the ongoing operations of the Company. This certification further requires the Company to take into account our current business activity and our ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. Under the PPP, the Company received proceeds of approximately $1,571,000. In accordance with the requirements of the PPP, the Company utilized the proceeds from the PPP Loan primarily for payroll costs, rent and utilities. The PPP Loan has a 1.00% interest rate per annum, matured on May 4, 2022 and was subject to the terms and conditions applicable to loans administered by the SBA under the PPP. Under the terms of PPP, all or certain amounts of the PPP Loan may be forgiven if they are used for qualifying expenses as described in the CARES Act. In July 2021, the Company filed an application with the SBA requesting loan forgiveness. In September 2021, the Company received notification that the PPP Loan was forgiven in its entirety. Accordingly, the Company recorded a gain on debt extinguishment for the amount of the PPP Loan of plus approximately $10,000 in accrued unpaid interest. Such amounts are recorded under the caption “(Gain) on extinguishment debt” in the Company’s Consolidated Statements of Operations for the year ended December 31, 2021.
At December 31, 2020, the Company has recorded the current portion of the PPP Loan of approximately $918,000 as a current liability under the caption “Notes payable, current portion” in its Consolidated December 31, 2020 balance sheet. The remaining portion of approximately $653,000 is recorded as a long-term liability under the caption “Note payable, net of current portion” in its Consolidated December 31, 2020 balance sheet.
December 2021 Credit Facility with Nantahala Capital Management
On December 29, 2021, the Company entered into a Term Loan and Security Agreement with certain funds and separate accounts managed by Nantahala Capital Management, LLC and other lenders (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2,500,000. Nantahala collectively owns, or otherwise controls, approximately 37.3% of our issued and outstanding voting securities.
On the Closing Date, the Company received in initial draw-down on the Credit Facility of $600,000. Subsequent to the initial draw-down and through April 12, 2022, the Company received two subsequent draw-downs aggregating $1,050,000. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes. As of April 12, 2022, there is approximatelyy $763,000 outstanding under the Credit Facility. For a more detailed description of this related party credit facility, see Note 5, Related Parties.
10. INCOME TAXES
The Company accounts for income taxes in accordance with ASC 740. Deferred income taxes are recognized for the tax consequences related to temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for tax purposes at each year-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established when necessary based on the weight of available evidence, if it is considered more likely than not that all or some portion of the deferred tax assets will not be realized. Income tax expense is the sum of current income tax plus the change in deferred tax assets and liabilities. The Company has established a valuation allowance against its deferred tax asset due to the uncertainty surrounding the realization of such asset.
The significant components of the income tax provision are as follows:
| ($ in thousands) | Year Ended December 31, | |||||||
| Current | 2021 | 2020 | ||||||
| Federal | $ | — | — | |||||
| State | — | — | ||||||
| Foreign | 10 | 7 | ||||||
| Deferred | ||||||||
| Federal | — | — | ||||||
| State | — | — | ||||||
| Foreign | — | — | ||||||
| $ | 10 | $ | 7 | |||||
The following is a schedule of the deferred tax assets and liabilities as of December 31, 2021 and 2020:
| ($ in thousands) | 2021 | 2020 | ||||||
| Deferred tax assets: | ||||||||
| Net operating loss carryforwards | $ | 25,643 | $ | 23,327 | ||||
| Stock based compensation | 43 | 1,626 | ||||||
| Reserves , loans and accrued expense | 313 | 421 | ||||||
| Gross deferred tax assets | 25,999 | 25,374 | ||||||
| Valuation allowance | 26,040 | (25,193 | ) | |||||
| Gross deferred tax assets after valuation allowance | 41 | 181 | ||||||
| Deferred tax liability - Intangible and fixed assets | (41 | ) | (181 | ) | ||||
| Net deferred tax liabilities | $ | — | — | |||||
A reconciliation of the provision for income taxes to the amount computed by applying the statutory income tax rates to loss before income taxes is as follows:
| 2021 | 2020 | |||||||
| Amounts computed at statutory rates | $ | 1,949 | $ | (1,415 | ) | |||
| State income tax, net of federal benefit | (584 | ) | (551 | ) | ||||
| Expiration of net operating loss carryforwards | (277 | ) | 620 | |||||
| Equity compensation | 1,482 | 170 | ||||||
| Non-deductible interest | (3,884 | ) | (581 | ) | ||||
| Foreign tax rate differential | 173 | 215 | ||||||
| Deferred tax adjustments and other | 287 | (1 | ) | |||||
| Net change in valuation allowance on deferred tax assets | 864 | 1,550 | ||||||
| $ | 10 | $ | 7 | |||||
The Company has established a valuation allowance against its deferred tax assets due to the uncertainty surrounding the realization of such assets.
At December 31, 2021, the Company had federal net operating loss carryforwards of approximately $59,809,000 that begin to expire in 2022. The Company has federal net operating losses of approximately $36,604,000 that arose after the 2017 tax year and will carryforward indefinitely, the utilization of which is limited to 80% of taxable income in any given year. The Company has net operating loss carryforwards of approximately $76,295,000 for the state of California that will begin to expire in 2035.
The Internal Revenue Code (the “Revenue Code”) limits the availability of certain tax credits and net operating losses that arose prior to certain cumulative changes in a corporation’s ownership resulting in a change of control of the Company. The Company’s use of its net operating loss carryforwards and tax credit carryforwards will be significantly limited because the Company believes it underwent “ownership changes”, as defined under Section 382 of the Revenue Code, in several years, though the Company has not performed a study to determine the limitation. The Company continues to disclose the tax effect of the net operating loss carryforwards at their original amount in the table above as the actual limitation has not yet been quantified. The Company has also established a full valuation allowance for substantially all deferred tax assets due to uncertainties surrounding its ability to generate future taxable income to realize these assets. Since substantially all deferred tax assets are fully reserved, future changes in tax benefits will not impact the effective tax rate. Management periodically evaluates the recoverability of the deferred tax assets. If it is determined at some time in the future that it is more likely than not that deferred tax assets will be realized, the valuation allowance would be reduced accordingly at that time.
Tax returns for the years 2017 through 2021 are subject to examination by taxing authorities. The Company and its subsidiaries are subject to U.S. federal and state income tax, and in the normal course of business, its income tax returns are subject to examination by the relevant taxing authorities. As of December 31, 2021, the 2017 – 2021 tax years remain subject to examination in the U.S. federal tax state and foreign jurisdictions. However, to the extent allowed by law, the taxing authorities may have the right to examine the period from 2001 through 2021 where net operating losses and income tax credits were generated and carried forward and make adjustments to the amount of the net operating loss and income tax credit carryforward amount. The Company is not currently under examination by federal, state, or foreign jurisdictions. The Company recognizes the tax benefit from an uncertain income tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. As of December 31, 2021 and 2020 the Company had no liability for unrecognized tax benefits. The Company’s policy is to record interest and penalties on uncertain tax positions as income tax expense. As of December 31, 2021, the Company has no accrued interest or penalties related to uncertain tax positions.
11. 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 December 31, 2021, such assets and liabilities aggregated approximately $847,000 and $1,298,000, respectively. The Company determined that it had no arrangements representing finance leases.
The Company evaluates its operating lease right-of-use assets for impairment. As of December 31, 2021, and through the date of this report, management’s review indicated that there was an impairment of an operating lease right-of-use asset and the Company recorded an impairment loss of approximately $333,000. Impairment is based on the excess of the carrying amount over the fair value, based on market value when available, or expected future economic benefits to the company from the operating lease right-of-use asset and is recorded in the period in which the determination is made. Such amount is included in the Company’s Consolidated Statement of Operations for the year ended December 31, 2021 under the caption “General and administrative” expense.
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.
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 year ended December 31, 2021, the Company recorded approximately $645,000 in lease expense using the straight-line method. For the twelve months ended December 31, 2020 the Company recorded approximately $657,000 in operating lease expense. 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 December 31, 2021 is 1.50 years. Cash payments under operating leases aggregated approximately $664,000 for the twelve months ended December 31, 2021 and are included in operating cash flows.
The Company’s lease liability was computed using the present value of future lease payments. The Company has utilized the practical expedient regarding lease and non-lease components and combined such components into a single combined component in the determination of the lease liability. The Company has excluded the lease of its office space in Mexico City, Mexico in the determination of the lease liability as of January 1, 2019 as its term is less than 12 months.
At December 31, 2021, future minimum undiscounted lease payments are as follows for the years ending:
| ($ in thousands) | ||||
| 2022 | $ | 653 | ||
| 2023 | 424 | |||
| 2024 | 387 | |||
| 2025 | 132 | |||
| Thereafter | — | |||
| Total | $ | 1,596 | ||
| Present Value effect on future minimum undiscounted lease payments at December 31, 2021 | 298 | |||
| Lease liability at December 31, 2021 | $ | 1,298 | ||
| Less current portion | 496 | |||
| Non-current lease liability at December 31, 2021 | $ | 802 |
12. CONTINGENT LIABILITIES
Employment Agreements
The Company has an employment agreement with its Chief Executive Officer, which expires on March 2, 2024. The Company may terminate the agreement with or without cause. Subject to the conditions and other limitations set forth in the employment agreement, the executive will be entitled to the following severance benefits if the Company terminates the executive’s employment without cause or in the event of an involuntary termination (as defined in the employment agreement) by the Company or by the executive:
Under the terms of the agreement, if employment is terminated by the Company without cause or there is a change of control, then the Executive shall be entitled to severance payments equal to the Executive’s annual salary and shall remain enrolled in the Company’s health, dental, and life insurance plans for the lesser of twelve (12) months or the remaining period prior to expiration of the Employment Period plus the Executive shall be entitled to any bonus due as of the effective date of such termination.
Litigation
There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of the Company or any of our subsidiaries, threatened against or affecting the Company, our Common Stock, any of our subsidiaries or of the Company’s or our subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.
13. MEZZANINE EQUITY
Series D Convertible Redeemable Preferred Stock
On November 12, 2020, the Company filed the Series D Certificate with the Secretary of State for the State of Delaware. Pursuant to the Series D Certificate, the Series D Preferred ranks senior to all Common Stock and all other present and future classes or series of capital stock, except for Series B Preferred, and upon liquidation will be entitled to receive the Liquidation Preference Amount (as defined in the Series D Certificate) plus any accrued and unpaid dividends, before the payment or distribution of the Company’s assets or the proceeds thereof is made to the holders of any junior securities. Additionally, 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. Holders of Series D Preferred shall vote together with holders of Common Stock on an as-converted basis, and not as a separate class, except (i) the holders of Series D Preferred, voting as a separate class, shall be entitled to elect two directors, (ii) the holders of Series D Preferred have the right to vote as a separate class regarding the waiver of certain protective provisions set forth in the Series D Certificate, and (iii) as otherwise required by law.
The holders of Series D Preferred may voluntarily convert their shares of Series D Preferred into 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 Series D Certificate. The shares of Common Stock issuable upon conversion of the Series D Preferred shall be subject to the following registration rights: (i) one demand registration starting three months after the Closing, (ii) two demand registrations starting one year after the Closing, and (iii) unlimited piggy-back and Form S-3 registration rights with reasonable and customary terms.
If, on any date that is at least five (5) years following the Issuance Date, (i) the Common Stock is registered pursuant to Section 12(b) or (g) under the Exchange Act; (ii) there are sufficient authorized but unissued shares of Common Stock (which have not otherwise been reserved or committed for issuance) to permit the issuance of all Common Shares issuable upon conversion of all outstanding shares of Series D Preferred; (iii) upon issuance, the Common Shares will be either (A) covered by an effective registration statement under the Securities Act, which is then available for the immediate resale of such Common Shares by the recipients thereof, and the Board reasonably believes that such effectiveness will continue uninterrupted for the foreseeable future, or (B) freely tradable without restriction pursuant to Rule l44 promulgated under the Securities Act without volume or manner-of-sale restrictions or current public information requirements, as determined by the counsel to the Company as set forth in a written opinion letter to such effect, addressed and acceptable to the Transfer Agent and the affected holders; and (iv) the VWAP of a share of Common Stock is greater than 300% of the Conversion Price (as defined in Section 5(d) below) then in effect for a period of at least twenty (20) Trading Days in any period of thirty (30) consecutive Trading Days, then the Company shall have the right, subject to the terms and conditions, to convert (a “Mandatory Conversion”) all, but not less than all, of the issued and outstanding shares of Series D Preferred into Common Stock.
On the fourth anniversary of the Issuance Date, or in the event of the consummation of a Change of Control, 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.
On November 12, 2020 (“Closing Date”), the Company consummated the Series D Financing, resulting in the sale of 11,560 shares of its Series D Preferred, resulting in gross proceeds to the Company of $11.56 million, less fees and expenses. 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 Note”), which Bridge Notes were converted into Series D Preferred at Closing (the “Conversion”). The issuance and sale of the Series D Preferred was made pursuant to that certain Securities Purchase Agreement, dated September 28, 2020 (the “Purchase Agreement”), by and between the Company and the Investors, for the purchase price of $1,000 per share of Series D Preferred. The Conversion and Series D Financing was undertaken pursuant to Section 3(a)(9) and/or Rule 506 promulgated under the Securities Act of 1933, as amended (the “Securities Act”). On December 23, 2020, the Company sold an additional 500 shares of Series D Preferred resulting in gross proceeds to the Company of $500,000 less fees and expenses.
On the Closing Date, the Company exchanged approximately $661,000 of liabilities of the Company for 661.3 shares of Series D Preferred, and received notice from the holders of a majority of the Series C Preferred (the “Series C Exchange Notice”) of their election to convert all of their shares of Series C Preferred into Series D Preferred, and further exercising their right to require all other holders of Series C Preferred to convert their shares of Series C Preferred into Series D Preferred (the “Series C Exchange”). Upon the consummation of the Series C Exchange in accordance with the terms of the Series C Exchange Notice, the Company issued an additional 10,000 shares of Series D Preferred in exchange for all 1,000 issued and outstanding shares of the Company’s Series C Preferred. The Company determined that the Series C Exchange was a modification of its Series C preferred stock. Using the fair value method, the Company concluded that the modification was significant and will apply the guidance in ASC 260-10-S99 for extinguishments. Under such guidance, the difference between the consideration paid (i.e. the fair value of the new or modified preferred shares) and the carrying value of the original preferred shares was recognized as a deemed dividend. Pursuant to such guidance the company recorded approximately $10,206,000 as a deemed dividend in the computation of Earnings Per Share.
During the year ended December 31, 2021, the Company issued an aggregate of 999 shares of Series D Preferred Stock as payment of dividends due to the Series D Preferred stockholders. During the year ended December 31, 2021, certain holders of Series D Preferred converted 646 shares of Series D into 11,149,123 shares of Common Stock which includes 70,221 shares of common stock issued for dividends up to the date of conversion.
Guidance for accounting for freestanding financial instruments that contain characteristics of both liabilities and equity are contained in ASC 480, Distinguishing Liabilities From Equity and Accounting Series Release 268 (“ASR 268”) Redeemable Preferred Stocks. The Company evaluated the provisions of the Series C Preferred and determined that the provisions of the Series C Preferred grant the holders of the Series C Preferred a redemption right whereby the holders of the Series C Preferred may, at any time after the third anniversary of the Series C Preferred issuance, require the Company to redeem in cash any or all of the holder’s outstanding Series C Preferred at an amount equal to the Liquidation Preference Amount (“Liquidation Preference Amount”). The Liquidation Preference Amount is defined as the greater of the stated value of the Series C Preferred plus any accrued unpaid interest or such amount per share as would have been payable had each such share been converted into Common Stock. In the event of a Change of Control, the holders of Series C Preferred shall have the right to require the Company to redeem in cash all or any portion of such holder’s shares at the Liquidation Preference Amount. The Company has concluded that because the redemption features of the Series C Preferred are outside of the control of the Company, the instrument is to be recorded as temporary or mezzanine equity in accordance with the provisions of ASR 268.
The Company noted that the Series D Preferred instruments were hybrid instruments that contain several embedded features. In November 2014, the FASB issued ASU 2014-16 to amend ASC 815, “Derivatives and Hedging”, (“ASC 815”) and require the use of the whole instrument approach (described below) to determine whether the nature of the host contract in a hybrid instrument issued in the form of a share is more akin to debt or to equity.
The whole instrument approach requires an issuer or investor to consider the economic characteristics and risks of the entire hybrid instrument, including all of its stated and implied substantive terms and features. Under this approach, all stated and implied features, including the embedded feature being evaluated for bifurcation, must be considered. Each term and feature should be weighed based on the relevant facts and circumstances to determine the nature of the host contract. This approach results in a single, consistent determination of the nature of the host contract, which is then used to evaluate each embedded feature for bifurcation. That is, the host contract does not change as each feature is evaluated.
The revised guidance further clarifies that the existence or omission of any single feature, including an investor-held, fixed-price, noncontingent redemption option, does not determine the economic characteristics and risks of the host contract. Instead, an entity must base that determination on an evaluation of the entire hybrid instrument, including all substantive terms and features.
However, an individual term or feature may be weighed more heavily in the evaluation based on facts and circumstances. An evaluation of all relevant terms and features, including the circumstances surrounding the issuance or acquisition of the equity share, as well as the likelihood that an issuer or investor is expected to exercise any options within the host contract, to determine the nature of the host contract, requires judgement.
Using the whole instrument approach, the Company concluded that the host instrument of the Series D Preferred were more akin to debt than equity as the majority of identified features contain more characteristics of debt.
The Company evaluated the identified embedded features of the Series D Preferred host instrument and determined that certain features meet the definition of and contained the characteristics of derivative financial instruments requiring bifurcation at fair value from the host instrument.
The Company has bifurcated from the Series D Preferred host instrument the conversion options, redemption option and participating dividend feature in accordance with the guidance in ASC 815. These bifurcated features aggregated approximately $26,011,000 at issuance and have been recorded as a discount to the Series D. During the years ended December 31, 2021 and 2020, the Company recorded the accretion of debt issuance costs and derivative liabilities aggregating approximately $6,806,000 and $1,572,000, respectfully, using the effective interest rate method as a deemed dividend.
The following table summarizes the share activity of Series D Preferred for each of the fiscal quarters during the year ended December 31, 2021:
| Series D Convertible Redeemable Preferred | ||||
| Total shares of Series D Preferred Stock - December 31, 2020 | 22,863 | |||
| Conversion of Series D Preferred into Common Stock | (354 | ) | ||
| Issuance of Series D Preferred as payment of dividends due | 248 | |||
| Total shares of Series D Preferred Stock - March 31, 2021 | 22,757 | |||
| Conversion of Series D Preferred into Common Stock | (50 | ) | ||
| Issuance of Series D Preferred as payment of dividends due | 251 | |||
| Total shares of Series D Preferred Stock - June 30, 2021 | 22,958 | |||
| Conversion of Series D Preferred into Common Stock | (242 | ) | ||
| Issuance of Series D Preferred as payment of dividends due | 249 | |||
| Total shares of Series D Preferred Stock - September 30, 2021 | 22,965 | |||
| Conversion of Series D Preferred into Common Stock | — | |||
| Issuance of Series D Preferred as payment of dividends due | 251 | |||
| Total shares of Series D Preferred Stock – December 31, 2021 | 23,216 | |||
The carrying value of the Company’s Series D Preferred was approximately $8,759,000 and $1,572,000 net of discount of approximately $14,458,000 and $21,291,000 as of December 31, 2021 and 2020, respectively.
14. EQUITY
The Company’s Certificate of Incorporation, as amended, authorizes the issuance of two classes of stock to be designated “Common Stock” and “Preferred Stock”. The Preferred Stock may be divided into such number of series and with the rights, preferences, privileges and restrictions as the Board of Directors may determine.
On June 9, 2020, the Company amended its Certificate of Incorporation to increase the number of shares of the Company’s Common Stock and the number of shares of the Company’s Preferred Stock authorized thereunder from an aggregate of 179 million to 350 million, consisting of 345 million shares of Common Stock and 5 million shares of Preferred Stock. On September 28, 2020, the Company received executed written consents from the requisite holders of the Company's voting securities, voting on an as-converted basis, approving an increase in the authorized number of shares of Common Stock from 345 million shares to 1.0 billion shares, with no change to the number of authorized shares of Preferred Stock, which action became effective October 13, 2020. On February 16, 2021, the Company received executed written consents from the requisite holders of the Company's voting securities, voting on an as-converted basis, approving an increase in the authorized number of shares of Common Stock from 1.0 billion shares to 2.0 billion shares, with no change to the number of authorized shares of Preferred Stock, which action became effective April 21, 2021.
As of December 31, 2021, we had 347,240,045 and 347,233,341 shares of Common Stock issued and outstanding, respectively. Our authorized but unissued shares of Common Stock are available for issuance without action by our shareholders. All shares of Common Stock now outstanding are fully paid and non-assessable.
Our Board of Directors has designated five series of Preferred Stock; (i) Series A Preferred, (ii) Series A-1 Preferred, (iii) Series B Preferred, (iv) Series C Preferred and (v) Series D Preferred. As of December 31, 2021, there were no shares of Series A Preferred outstanding, no shares of Series A-1 Preferred outstanding, 239,400 shares of series B Preferred outstanding, no shares of Series C Preferred outstanding, and 23,216 shares of Series D Preferred outstanding.
Series A Convertible Preferred Stock
On September 15, 2017, the Company filed the Certificate of Designations of the Series A Preferred with the Delaware Secretary of State (the “Series A Certificate”), designating 38,000 shares of the Company’s preferred stock, par value $0.01 per share, as Series A Preferred. The Company had 37,467 shares of Series A Preferred outstanding as of January 1, 2020.
During July 2020, the Company entered into the Series A Exchange Agreement with the Series A Holders, pursuant to which such Series A Holders exchanged 18,828 shares of Series A Preferred for an equivalent number of Series A-1 Preferred in consideration for their waiver of approximately $1,849,000 in dividends payable.
On September 28, 2020, the Company received executed written consents from (i) the requisite holders of the Company’s voting securities, voting on an as-converted basis, and (ii) the requisite holders of Series A Preferred, voting as a separate class, approving the Amended Series A Certificate, which, among other things, provides for (a) the automatic conversion of all Series A Preferred into Common Stock at a rate of 10% per month following the Closing of the Series D Financing, with the conversion price for such conversion reduced from $1.15 per share of Common Stock, to $0.20 per share of Common Stock, and (b) a reduction of the dividend rate from 8% of the stated Series A Liquidation Preference Amount if paid in cash and 10% of the stated Series A Liquidation Preference Amount if paid in Common Stock, to 4% of the Series A Liquidation Preference Amount, with the dividends being paid only in shares of Common Stock.
The Company had 0 and 14,911 shares of Series A Preferred outstanding as of December 31, 2021 and December 31, 2020, respectively. At December 31, 2021 and December 31, 2020, the Company had cumulative undeclared dividends of During the year ended December 31, 2021, the Company issued the holders of Series A Preferred 1,911,587 shares of Common Stock as payment of dividends due.
During the year ended December 31, 2021 the Company issued 74,562,000 shares of Common Stock upon the conversion of 14,911 shares of Series A Preferred Stock.
Series A-1 Convertible Preferred Stock
In July 2020, the Company filed the Series A-1 Certificate with the Secretary of State for the State of Delaware - Division of Corporations, designating 31,021 shares of the Company’s Preferred Stock as Series A-1 Preferred. Shares of Series A-1 Preferred accrue cumulative dividends and are payable quarterly beginning September 30, 2021 at a rate of 8% per annum if paid in cash, or 10% per annum if paid by the issuance of shares of the Company’s Common Stock.
Shares of Series A-1 Preferred rank senior to the Company’s Common Stock, pari-passu to the Company's Series A Preferred, and are subordinate and rank junior to Series B Preferred and Series D Preferred.
Each share of Series A-1 Preferred has a liquidation preference equal to the greater of (i) $1000 per share plus all accrued and unpaid dividends, or (ii) such amount per share as would have been payable had each such share been converted into Common Stock immediately prior to such liquidation, dissolution or winding up (the amount payable pursuant to the foregoing is referred to herein as the “Series A-1 Liquidation Preference Amount”) before any payment shall be made or any assets distributed to the holders of the Common Stock or any other classes and series of equity securities of the Company which by their terms rank junior to the Series A-1 Preferred.
Each share of Series A-1 Preferred was convertible into that number of shares of the Company’s Common Stock (“Series A-1 Conversion Shares”) equal to that number of shares of Series A-1 Preferred being converted multiplied by $1,000, divided by $0.65, or the conversion price as defined in the Series A-1 Certificate in effect as of the date the holder delivers to the Company their notice of election to convert. Holders of Series A-1 Preferred may elect to convert shares of Series A-1 Preferred into Common Stock at any time. In addition to the aforementioned holder conversion option, if the volume weighted average closing price (“VWAP”) of the Company’s Common Stock is at least $1.00 per share for 20 consecutive trading days, then the Company has the right to convert one-half of the issued and outstanding shares of Series A-1 Preferred into Common Stock. In the event of a Change of Control, the Company will have the option to redeem all issued and outstanding shares of Series A-1 Preferred for 115% of the Liquidation Preference per share.
During July 2020, the Company entered into an Exchange Agreement, Consent and Waiver (“Exchange Agreement”) with certain holders of its Series A Preferred (the “Series A Holders”), pursuant to which such Series A Holders exchanged 18,828 shares of Series A Preferred for an equivalent number of Series A-1 Preferred.
On September 28, 2020, the Company's holders of Common Stock and Preferred Stock voted to revise the Series A-1 Certificate by amending and restating the Series A-1 Certificate to, without limitation, provide for (i) the voluntary conversion of all outstanding shares of the Company's Series A-1 Preferred into shares of the Company’s Common Stock at a reduced conversion price of $0.20 per share of Common Stock, and (ii) the automatic conversion of all issued and outstanding shares of Series A Preferred and Series A-1 Preferred into shares of Common Stock at a rate of 10% per month, beginning on November 1, 2020, and ending on August 1, 2021, at the reduced conversion price of $0.20 per share of Common Stock.
The Company had 0 and 14,782 shares of Series A-1 Preferred outstanding as of December 30, 2021 and December 31, 2020, respectively. During the year ended December 31, 2021, the Company issued the holders of Series A-1 Preferred 1,789,587 shares of Common Stock as payment of dividends due.
During the year ended December 31, 2021, the Company issued 73,910,000 shares of Common Stock upon the conversion of 14,782 shares of Series A-1 Preferred.
Series B Convertible Redeemable Preferred Stock
The Company had 239,400 shares of Series B Convertible Preferred Stock (“Series B Preferred”) outstanding as of December 31, 2021 and 2020. At December 31, 2021 and 2020, the Company had cumulative undeclared dividends of approximately $8,000 ($0.03 per share), respectively. There were no conversions of Series B Preferred into Common Stock during the years ended December 31, 2021 and 2020. The Company paid dividends of approximately $51,000 to the holders of our Series B Preferred for each of the years ended December 31, 2021 and 2020.
Common Stock
The following table summarizes outstanding Common Stock activity for the following periods:
| Common Stock | ||||
| Shares outstanding at December 31, 2019 | 113,346,472 | |||
| Shares issued pursuant to payment of stock dividend on Series A Preferred | 1,388,876 | |||
| Shares issued pursuant to payment of stock dividend on Series A-1 Preferred | 1,159,416 | |||
| Shares issued as payment of stock dividend on Series C Preferred | 6,455,149 | |||
| Shares issued pursuant to Series A conversion to Common Stock | 18,640,000 | |||
| Shares issued pursuant to Series A-1 conversion to Common Stock | 19,016,452 | |||
| Shares issued to secure financing facility | 2,500,000 | |||
| Shares issued for cash | 15,700,000 | |||
| Shares issued pursuant to option exchange and RSU vesting | 1,883,248 | |||
| Shares outstanding at December 31, 2020 | 180,089,613 | |||
| Shares issued pursuant to payment of stock dividend on Series A Preferred | 1,911,587 | |||
| Shares issued pursuant to payment of stock dividend on Series A-1 Preferred | 1,789,587 | |||
| Shares issued pursuant to Series A conversion to Common Stock | 74,562,000 | |||
| Shares issued pursuant to Series A-1 conversion to Common Stock | 73,910,000 | |||
| Shares issued pursuant to Series D to Common Stock | 11,149,123 | |||
| Shares issued pursuant to warrant exercises | 400 | |||
| Recission of shares previously issued at holder request | (2,817 | ) | ||
| Shares issued to secure financing facility | 1,000,000 | |||
| Shares issued for cash | 1,000,000 | |||
| Shares issued as compensation in lieu of cash | 921,218 | |||
| Shares issued pursuant to option exchange and RSU vesting | 902,630 | |||
| Shares outstanding at December 31, 2021 | 347,233,341 | |||
Warrants
As of December 31, 2021, warrants to purchase 3,150,000 shares of Common Stock at prices ranging from $0.048 to $0.80 were outstanding. At December 31, 2021, 1,466,680 warrants are exercisable. All warrants expire at various dates between August 5, 2026 and August 5, 2028 with the exception of 150,000 warrants whose expiration date is 3 years from initial vesting, such vesting based on certain events. The intrinsic value of warrants outstanding at December 31, 2021 was $0.
The following table summarizes warrant activity for the following periods:
| Warrants | Weighted-Average Exercise Price | |||||||
| Balance at December 31, 2019 | 1,733,856 | $ | 0.14 | |||||
| Granted | — | |||||||
| Expired / Canceled | (980,081 | ) | $ | 0.15 | ||||
| Exercised | — | |||||||
| Balance at December 31, 2020 | 753,775 | 0.17 | ||||||
| Granted | 3,000,000 | 0.07 | ||||||
| Expired / Canceled | (603,375 | ) | 0.01 | |||||
| Exercised | (400 | ) | 0.01 | |||||
| Balance at December 31, 2021 | 3,150,000 | 0.10 | ||||||
In April 2021, the Company created an advisory board to the Board of Directors comprised of 3 individuals. As compensation for advisory board services, the Company granted an aggregate of 600,000 warrants with each member receiving warrants to purchase 200,000 shares of the Company’s Common Stock. Such warrants have an exercise price of $0.07 per share and will vest over a -year period beginning on April 19, 2021. In July 2021, the Company issued 400,000 warrants to a financial consultant. Such warrants have an exercise price of $0.06 per share and fully vested over a two-month period. In August 2021, the Company issued 200,000 and 1,800,000 warrants to a new advisory board member. Such warrants have an exercise price of $0.048 per share and $0.07 per share, respectively, and will vest over a one-year period beginning on August 5, 2021. During the year ended December 31, 2021, the Company recorded approximately $41,000 in expense related to the vesting of these warrants.
During the year ended December 31, 2021, 603,375 warrants were cancelled pursuant to the mandatory conversion of Series A Preferred Stock into Common Stock and 400 warrants were exercised at $0.01 per warrant.
15. STOCK-BASED COMPENSATION
Stock Options
As of December 31, 2020, the Company had one active stock-based compensation plan: the 2020 Omnibus Stock Incentive Plan (the “2020 Plan”).
2020 Omnibus Stock Incentive Plan
On June 9, 2020, pursuant to authorization obtained from the Company’s stockholders, the Company adopted the 2020 Omnibus Stock Incentive Plan (the “2020 Plan”). Such plan had been previously unanimously approved by the Company’s Board. The purposes of our 2020 Plan are to enhance our ability to attract and retain highly qualified officers, non-employee directors, key employees and consultants, and to motivate those service providers to serve the Company and to expend maximum effort to improve our business results by providing to those service providers an opportunity to acquire or increase a direct proprietary interest in our operations and future success. The 2020 Plan also will allow us to promote greater ownership in our Company by the service providers in order to align the service providers’ interests more closely with the interests of our stockholders. Awards granted under the 2020 Plan are designed to qualify for special tax treatment under Section 422 of the Code.
Pursuant to the adoption of the 2020 Plan, such plan will supersede and replace the Company’s 1999 Plan and no new awards will be granted under the 1999 Plan thereafter. Any awards outstanding under the 1999 Plan on the date of approval of the 2020 Plan will remain subject to the 1999 Plan. Upon approval of our 2020 Plan, all shares of Common Stock remaining authorized and available for issuance under the 1999 Plan and any shares subject to outstanding awards under the 1999 Plan that subsequently expire, terminate, or are surrendered or forfeited for any reason without issuance of shares will automatically become available for issuance under our 2020 Plan. As of December 31, 2021, there are approximately 63,747,077 shares available for issuance under the 2021 Plan.
The Company estimates the fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC 718. The fair value of stock options granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense is reported in operating expense based upon the departments to which substantially all the associated employees report and credited to additional paid-in-capital.
ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best measure of expected volatility is based on the historical weekly volatility of the Company’s Common Stock. Historical volatility factors utilized in the Company’s Black-Scholes computations for options granted during the years ended December 31, 2021 and 2020 ranged from 57% to The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin Topic 14. The expected term used by the Company to value the grants issued during the years ended December 31, 2021 and 2020 ranged from 3.33 to 5.17 years. The interest rate used is the risk-free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for the years ended December 31, 2021 and 2020 ranged from 1.37% to 2.58%. Dividend yield is as the Company does not expect to declare any dividends on the Company’s common shares in the foreseeable future.
In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has utilized an estimated annualized forfeiture rate ranging from approximately 5% to 10% for corporate officers, 4.1% to 10% for members of the Board of Directors and 15.0% to 25% for all other employees. The Company reviews the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.
A summary of the activity under the Company’s stock option plans is as follows:
| Options | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (Years) | ||||||||||
| Balance at December 31, 2019 | 7,204,672 | $ | 1.32 | 5.3 | ||||||||
| Granted | 2,450,000 | $ | 0.14 | |||||||||
| Expired/Cancelled | (7,069,172 | ) | $ | 1.33 | ||||||||
| Exercised | — | |||||||||||
| Balance at December 31, 2020 | 2,585,500 | $ | 0.19 | 9.2 | ||||||||
| Granted | 99,460,000 | 0.06 | ||||||||||
| Expired/Cancelled | (97,226,624 | ) | 0.06 | |||||||||
| Exercised | — | |||||||||||
| Balance at December 31, 2021 | 4,818,876 | 0.08 | 3.5 | |||||||||
During the year ended December 31, 2021, the Company issued an aggregate 99,460,000 options to purchase common stock at exercise prices of $0.030 to $0.070 and vest at various times through August 2024.
During the year ended December 31, 2021, the Company entered into exchange agreements with certain employees, officers, Board of Director members and non-employee contractors pursuant to which such persons exchanged 76,477,500 Common Stock purchase options for 76,477,500 Restricted Stock Units (RSUs). The Company determined that the exchange agreements are a modification of a share-based payment award under ASC 718. Accordingly, the Company computed any incremental compensation expense as a component of the total compensation cost to be measured at the modification date. Aggregate incremental compensation expense measured from the modifications of stock options was approximately $1,308,000. Such expense will be amortized over the requisite service period of the RSU agreements.
In addition to the aggregate 76,477,500 options exchanged, an additional 20,749,124 Common Stock purchase options expired unexercised during the year ended December 31, 2021.
During the years ended December 31, 2021 and 2020, there were no options exercised for cash.
At December 31, 2021, a total of 4,818,876 options were outstanding, of which 3,525,123 were exercisable at a weighted average price of $0.09 per share with a remaining weighted average contractual term of 3.46 years. The Company expects that, in addition to the 3,525,123 options that were exercisable as of December 31, 2021, another 1,293,753 will ultimately vest resulting in a combined total of 4,818,876. Those 4,818,876 shares have a weighted average exercise price of $0.08 and an aggregate intrinsic value of $0 as of December 31, 2021. Stock-based compensation expense related to equity options was approximately $896,000 and $263,000 for the years ended December 31, 2021 and 2020, respectively.
The weighted-average grant-date fair value per share of options granted to employees during the years ended December 31, 2021 and 2020 was $0.06 and $0.12, respectively. At December 31, 2021, the total remaining unrecognized compensation cost related to unvested stock options amounted to approximately $692,000, which will be amortized over the average remaining requisite service period of 2.75 years.
The intrinsic value of options exercised during the years ended December 31, 2021 and 2020 was The intrinsic value of options exercisable at December 31, 2021 and 2020 was The intrinsic value of options that vested during 2021 was The aggregate intrinsic value for all options outstanding as of December 31, 2021 and 2020 was
The Company periodically issues RSUs to certain employees which vest over time. When vested, each RSU represents the right to that number of shares of Common Stock equal to the number of RSUs granted. The grant date fair value for RSU’s is based upon the market price of the Company's Common Stock on the date of the grant. The fair value is then amortized to compensation expense over the requisite service period or vesting term.
A summary of the activity related to RSUs is as follows:
| RSUs | Weighted-Average Issuance Price | |||||||
| Balance at December 31, 2020 | 845,106 | $ | 0.14 | |||||
| Granted | 80,977,500 | |||||||
| Expired/Cancelled | (540,576 | ) | 0.13 | |||||
| Vested | (262,629 | ) | 0.08 | |||||
| Balance at December 31, 2021 | 81,019,401 | 0.13 | ||||||
During the year ended December 31, 2021, the Company granted an aggregate of 80,977,500 RSUs to certain officers, employees, members of the Company’s Board of Directors and certain non-employee contractors. Of these RSU grants, 76,477,500 were issued in exchange for options to purchase 76,477,500 shares of Common Stock held by such persons and 4,500,000 were new issuances to certain members of the Company’s Board of Directors. These RSUs vest 50% on April 1, 2022 with the remainder vesting monthly over a period of 18 months.
The Company determined that the exchange agreements are a modification of a share-based payment award under ASC 718. Accordingly, the Company computed any incremental compensation expense as a component of the total compensation cost to be measured at the modification date. Aggregate incremental compensation expense measured from the modifications of stock options was approximately $1,308,000. Such expense will be amortized over the requisite service period of the RSU agreements.
At January 1, 2021 the Company had 845,106 outstanding RSUs from previous issuances. During the year ended December 31, 2021, 262,629 of these previously issued RSUs vested with the remainder of such RSUs vesting at various times through February 8, 2022. During the year ended December 31, 2020, 2,164,351 RSUs vested.
Stock-based Compensation
Stock-based compensation related to warrants, equity options and RSUs has been classified as follows in the accompanying consolidated statements of operations (in thousands):
| Year Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Cost of revenue | $ | 29 | $ | 15 | ||||
| General and administrative | 842 | 550 | ||||||
| Sales and marketing | 336 | 163 | ||||||
| Research and development | 321 | 134 | ||||||
| Total | $ | 1,528 | $ | 862 | ||||
Common Stock Reserved for Future Issuance
The following table summarizes the Common Stock reserved for future issuance as of December 31, 2021:
| Common Stock | ||||
| Convertible preferred stock – Series B and Series D | 398,269,637 | |||
| Stock options outstanding | 4,818,876 | |||
| Restricted Stock Units | 81,019,401 | |||
| Warrants outstanding | 3,150,000 | |||
| Authorized for future grant under stock option plans | 63,747,077 | |||
16. EMPLOYEE BENEFIT PLAN
During 1995, the Company adopted a defined contribution 401(k) retirement plan (the “Plan”). All U.S. based employees aged 21 years and older are eligible to become participants after the completion of 60 day's employment. The Plan provides for annual contributions by the Company of 50% of employee contributions not to exceed 8% of employee compensation. Effective April 1, 2009, the Plan was amended to provide for Company contributions on a discretionary basis. Participants may contribute up to 100% of the annual contribution limitations determined by the Internal Revenue Service.
Employees are fully vested in their share of the Company’s contributions after the completion of five years of service. In 2019, the Company authorized contributions of approximately $184,000 for the 2019 plan year of which $138,000 was paid prior to December 31, 2019. There were no contributions authorized or made in the years ended December 31, 2021 and 2020.
17. PENSION PLAN
One of the Company’s dormant foreign subsidiaries maintains a defined benefit pension plan that provides benefits based on length of service and final average earnings. The following table sets forth the benefit obligation, fair value of plan assets, and the funded status of the Company’s plan; amounts recognized in the Company’s consolidated financial statements; and the assumptions used in determining the actuarial present value of the benefit obligations as of December 31:
| ($ in thousands) | 2021 | 2020 | ||||||
| Change in benefit obligation: | ||||||||
| Benefit obligation at beginning of year | $ | 4,412 | $ | 3,969 | ||||
| Service cost | — | — | ||||||
| Interest cost | 42 | 52 | ||||||
| Actuarial (gain) loss | (391 | ) | 113 | |||||
| Effect of exchange rate changes | (309 | ) | 370 | |||||
| Effect of curtailment | — | — | ||||||
| Benefits paid | (89 | ) | (92 | ) | ||||
| Benefit obligation at end of year | $ | 3,665 | $ | 4,412 | ||||
| Change in plan assets: | ||||||||
| Fair value of plan assets at beginning of year | $ | 1,881 | $ | 1,713 | ||||
| Actual return of plan assets | 24 | 92 | ||||||
| Company contributions | 10 | 10 | ||||||
| Benefits paid | (89 | ) | (92 | ) | ||||
| Effect of exchange rate changes | (137 | ) | 158 | |||||
| Fair value of plan assets at end of year | $ | 1,689 | $ | 1,881 | ||||
| Funded status | $ | (1,976 | ) | $ | (2,531 | ) | ||
| Unrecognized actuarial loss (gain) | 1,361 | 1,702 | ||||||
| Unrecognized prior service (benefit) cost | — | — | ||||||
| Additional minimum liability | (1,361 | ) | (1,702 | ) | ||||
| Unrecognized transition (asset) liability | — | — | ||||||
| Net amount recognized | $ | (1,976 | ) | $ | (2,531 | ) | ||
| Components of net periodic benefit cost are as follows: | ||||||||
| Service cost | $ | — | $ | — | ||||
| Interest cost on projected benefit obligations | 42 | 52 | ||||||
| Expected return on plan assets | (57 | ) | (55 | ) | ||||
| Amortization of prior service costs | — | — | ||||||
| Amortization of actuarial loss | 118 | 117 | ||||||
| Net periodic benefit costs | $ | 103 | $ | 114 | ||||
As of December 31, 2021, the following benefit payments are expected to be paid as follows (in thousands):
| 2022 | $ | 86 | |||||
| 2023 | $ | 93 | |||||
| 2024 | $ | 112 | |||||
| 2025 | $ | 120 | |||||
| 2026 | $ | 123 | |||||
| 2027 | — | 2031 | $ | 668 | |||
The Company made contributions to the plan of approximately $10,000 during the year ended December 31, 2021, and $10,000 during the year ended December 31, 2020. The company anticipates making contributions at similar levels during the next fiscal year.
In accordance with the Company’s adoption of ASU 2017-07, the components of net periodic pension expense is shown in the Company’s Consolidated Statement of Operations for the years ended December 31, 2021 and 2020 under “Other components of net periodic pension expense”.
The measurement date used to determine the benefit information of the plan was January 1, 2022.
18. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss is the combination of the additional minimum liability related to the Company’s defined benefit pension plan, recognized pursuant to ASC 715-30, “Compensation - Retirement Benefits - Defined Benefit Plans – Pension” and the accumulated gains or losses from foreign currency translation adjustments. The Company translates foreign currencies of its German, Canadian and Mexican subsidiaries into U.S. dollars using the period end exchange rate. Revenue and expense were translated using the weighted-average exchange rates for the reporting period. All items are shown net of tax.
As of December 31, 2021 and 2020, the components of accumulated other comprehensive loss were as follows:
| ($ in thousands) | 2021 | 2020 | ||||||
| Additional minimum pension liability | $ | (1,035 | ) | $ | (1,553 | ) | ||
| Foreign currency translation adjustment | (361 | ) | (436 | ) | ||||
| Ending balance | $ | (1,396 | ) | $ | (1,989 | ) | ||
19. SUBSEQUENT EVENTS
During the period from January 1, 2022 through April 14, 2022, the Company issued 729,401 shares of its Common Stock pursuant to the vesting of RSUs.
During the period from January 1, 2022 through April 14, 2022, the Company borrowed an additional $1,050,000 from its December 29, 2021 Credit Facility.
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