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IMAGEWARE SYSTEMS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(Edgar Glimpses Via Acquire Media NewsEdge)
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All
forward-looking statements included in this report are based on information
available to us as of the date hereof and we assume no obligation to update any
forward-looking statements. Forward-looking statements involve known or unknown
risks, uncertainties and other factors, which may cause our actual results,
performance or achievements, or industry results to be materially different from
any future results, performance or achievements expressed or implied by such
forward-looking statements. Factors that could cause or contribute to such
differences include but are not limited to those items discussed in our Annual
Report on Form 10-K for the year ended December 31, 2010, under "Risk Factors"
and in Item 1A of Part II of this Quarterly Report on Form 10-Q.
The following discussion of the financial condition and results of operations
should be read in conjunction with the condensed consolidated financial
statements included elsewhere within this Quarterly Report. Fluctuations in
annual and quarterly results may occur as a result of factors affecting demand
for our products such as the timing of new product introductions by us and by
our competitors and our customers' political and budgetary constraints. Due to
such fluctuations, historical results and percentage relationships are not
necessarily indicative of the operating results for any future period.
.
OVERVIEW
ImageWare Systems, Inc. is a pioneer and leader in the emerging market for
biometrically enabled software-based identity management solutions. Using those
human characteristics that are unique to us all, we create software that
provides a highly reliable indication of a person's identity. Our "flagship"
product is the patented IWS Biometric Engine®. Our products are used to manage
and issue secure credentials, including national IDs, passports, driver licenses
and access control credentials. Our products also provide law enforcement with
integrated mug shot, fingerprint LiveScan and investigative capabilities. We
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 we
address and all of the products are integrated into the IWS Biometric Engine.
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Recent Developments
New Software as a Service Business Model.
With the advent of cloud based computing, the proliferation of mobile devices
which allow for mobile transactions across wide geographical areas, the
emergence of inexpensive and reliable biometric capture devices and the need to
secure access to data, product and services, we believe that the market for
multi-biometric solutions will expand to encompass significant deployments of
biometric systems in the commercial and consumer markets. We therefore intend to
leverage the strength of our existing government clients who have deployed the
Company's products for large populations, as well as its foundational patent
portfolio in the field of multi-modal biometrics and the fusion of multiple
biometric algorithms, to address the commercial and consumer market. As part of
its marketing plan, we will offer new versions of our product suite on a
Software as a Service ("SaaS") model during 2012. This new business model, which
is intended to supplement our existing business model, will allow new commercial
and consumer clients to verify identity in order to access data, products or
services from mobile and desktop devices.
Additional Intellectual Property.
We are a pioneer in inventing the technology of using multi-biometrics on a
seamless and integrated platform, in addition to "fusing" multiple biometrics
into a common or fused score for greater reliability in authenticating identity.
We believe we have the foundational patents on the use of multiple biometrics
and fusing on such a platform and continue to be an IP leader in the space. It
is our belief that this intellectual property leadership will create a
sustainable competitive advantage. In addition to our eight issued U.S. and
foreign patents, we recently filed three new patent applications surrounding new
"Anonymous Matching" technologies. These technologies will allow biometric
matching for identity verification while protecting the privacy of an
individual. It is our belief that such technology will be critical to providing
biometric management solutions for the consumer market where privacy protection
has been a historical issue and barrier to biometric adoption.
Consummation of Financing.
On December 20, 2011, we consummated an equity financing resulting in gross
proceeds of $10.0 million ("Qualified Financing"), including the $750,000 of
promissory notes converted into the Qualified Financing. In connection with the
Qualified Financing, we issued 20.0 million shares of our common stock (the
"Shares"), and warrants to purchase 12,207,500 shares of our common stock
exercisable for $0.50 per share ("Warrants"). The Warrants expire five years
from the date of grant. The Company also issued 90,000 shares of common stock
and a Warrant exercisable for 45,000 shares of common stock in lieu of cash in
payment for legal fees related to the Qualified Financing.
As a result of the Qualified Financing, our Series C 8% Convertible Preferred
Stock ("Series C Preferred") and Series D 8% Convertible Preferred Stock
("Series D Preferred") was automatically converted into 11,768,525 shares of
common stock. In addition, in connection with the Qualified Financing, (i) the
anti-dilution provision contained in certain of our existing warrants were
amended resulting in such warrants no longer qualifying as derivative
liabilities; and (ii) a significant investor ("Investor") exchanged $4.5 million
principal amount of our convertible promissory notes ("Exchanged Notes"), and
accrued but unpaid interest on the Exchanged Notes and on an additional $2.25
million in promissory notes, into 9,774,559 shares of our common stock
("Exchange Shares"). The Investor also agreed to convert $750,000 principal
amount of additional promissory notes held by the Investor and invest the
proceeds into the Qualified Financing. We are obligated to file a registration
statement with the Securities and Exchange Commission on or before February 20,
2012 to register for resale the Shares and the common stock issuable upon
exercise of the Warrants.
Critical Accounting Policies and Estimates
The discussion and analysis of our consolidated financial condition and results
of operations are based on our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America, or U.S. GAAP. The preparation of these consolidated
financial statements in accordance with U.S. 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 expenses 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.
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Significant estimates include the allowance for doubtful accounts receivable,
calculation of the Company's tax provision, inventory obsolescence reserve,
deferred tax asset valuation allowances, accounting for loss contingencies,
recoverability of goodwill and acquired intangible assets and amortization
periods, assumptions used in the Black-Scholes model to calculate the fair value
of share based payments, assumptions used in the application of fair value
methodologies to calculate the fair value of derivative liabilities and revenue
and cost of revenues recognized under the percentage of completion method.
Actual results could differ from estimates.
Critical accounting policies are those that, in management's view, are most
important in the portrayal of our financial condition and results of operations.
Management believes there have been no material changes during the nine months
ended September 30, 2011 to the critical accounting policies discussed in the
Management's Discussion and Analysis of Financial Condition and Results of
Operations section of our Annual Report on Form 10-K for the year ended
December 31, 2010.
RESULTS OF OPERATIONS
This management's discussion and analysis of financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and related notes contained elsewhere in this Annual Report.
Three Months Ended September 30, 2011 Compared to the Three Months Ended
September 30, 2010.
Product Revenue
Three Months Ended
September 30,
Net Product Revenue 2011 2010 $ Change % Change
(dollars in thousands)
Software and royalties $ 275 $ 370 $ (95 ) (26 )%
Percentage of total net product revenue 89 % 48 %
Hardware and consumables $ 23 $ 21 $ 2 10 %
Percentage of total net product revenue 7 % 3 %
Services $ 12 $ 378 $ (366 ) (97 )%
Percentage of total net product revenue 4 % 49 %
Total net product revenue $ 310 $ 769 $ (459 ) (60 )%
Software and royalty revenue decreased 26% or $95,000 during the three months
ended September 30, 2011 as compared to the corresponding period in 2010. This
decrease is due to lower project-oriented revenue of our identity management
software solutions of approximately $73,000, lower revenue from our sales of
boxed identity management software through our distribution channel of
approximately $40,000 offset by higher revenue from identification software
royalties and license revenue of approximately $12,000 and higher revenue from
Law Enforcement software solutions of approximately $6,000.
Revenue from the sale of hardware and consumables did not increase significantly
during the three months ended September 30, 2011 as compared to the
corresponding period in 2010.
Services revenue is comprised primarily of software integration services, system
installation services and customer training. Such revenue decreased 97% or
approximately $366,000 during the three months ended September 30, 2011 as
compared to the corresponding period in 2010 due primarily to the completion of
the service element in certain contracts and software only project solutions not
requiring significant amounts of customization, integration or installation.
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. Based on management's current visibility into the timing of potential
government procurements, we believe that we will see a significant increase in
government procurement and implementations with respect to identity management
initiatives; however we cannot predict the timing of such initiatives.
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Maintenance Revenue
Three Months Ended
September 30,
Maintenance Revenue 2011 2010 $ Change % Change
(dollars in thousands)
Maintenance revenue $ 750 $ 653 $ 97 15 %
Maintenance revenue was $750,000 for three months ended September 30, 2011 as
compared to $653,000 for the corresponding period in 2010 representing a 15% or
$97,000 increase. Identity management maintenance revenue generated from
identification software solutions was $263,000 for the three months ended
September 30, 2011 as compared to $156,000 during the comparable period in
2010. The increase of $107,000 is due to higher maintenance revenues generated
from our biometric engine. Law enforcement maintenance revenues decreased
$10,000 for the three month period ended September 30, 2011 as compared to the
corresponding period in 2010 due to our the expiration of certain maintenance
contracts.
We anticipate growth of our maintenance revenue through the retention of
existing customers combined with the expansion of our installed base resulting
from the completion of project-oriented work, however we cannot predict the
timing of this anticipated growth.
Cost of Product Revenue
Three Months Ended
September 30,
Cost of Product Revenue: 2011 2010 $ Change % Change
(dollars in thousands)
Software and royalties $ 32 $ 36 $ (4 ) (11 )%
Percentage of software and royalty
product revenue 12 % 10 %
Hardware and consumables $ 18 $ 26 $ (8 ) (31 )%
Percentage of hardware and
consumables product revenue 78 % 124 %
Services $ 15 $ 187 $ (172 ) (92 )%
Percentage of services product
revenue 125 % 49 %
Total product cost of revenue $ 65 $ 249 $ (184 ) (74 )%
Percentage of total product revenue 21 % 32 %
The cost of software and royalty product revenue was relatively consistent when
comparing the three months ended September 30, 2011 to the same period in 2010.
The decrease in the cost of product revenue for our hardware and consumable
sales of 31% or $8,000 for the three months ended September 30, 2011 as compared
to the corresponding period in 2010 reflects a decrease in unit costs of
specific hardware and consumable needed to generate the related revenue.
The 92% or $172,000 decrease in the cost of services product revenue for the
three months ended September 30, 2011 as compared to the corresponding period of
2010 reflects lower software integration services and system installation
service revenue generated from project work during the three month period ended
September 30, 2011.
Cost of Maintenance Revenue
Three Months Ended
September 30,
Cost of Maintenance Revenue 2011 2010 $ Change % Change
(dollars in thousands)
Total maintenance cost of revenue $ 227 $ 198 $ 29
15 %
Percentage of total maintenance revenue 30 % 30 %
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Cost of maintenance revenue increased approximately $29,000 or 15% during the
three months ended September 30, 2011 as compared to the corresponding period in
2010. The increase in cost of maintenance revenue reflects a nearly identical
15% increase in maintenance revenues when comparing the three months ended
September 30, 2011 to the same period in 2010.
Product Gross Profit
Three Months Ended
September 30,
Product gross profit 2011 2010 $ Change % Change
(dollars in thousands)
Software and royalties $ 243 $ 334 $ (91 ) (27 )%
Percentage of software and royalty
product revenue 88 % 90 %
Hardware and consumables $ 5 $ (5 ) $ 10 200 %
Percentage of hardware and consumables
product revenue 22 % (24 )%
Services $ (3 ) $ 191 $ (194 ) (102 )%
Percentage of services product revenue (25 )% 51 %
Total product gross profit $ 245 $ 520 $ (275 ) (53 )%
Percentage of total product revenue 79 % 68 %
Software and royalty gross profit decreased by 27% or approximately $91,000 for
the three months ended September 30, 2011 from the corresponding period in 2010
due to lower software and royalty product revenue of approximately
$95,000. Costs of software products can also vary as a percentage of product
revenue from quarter to quarter depending upon product mix and third party
software licenses included in software solutions.
Services gross profit decreased $194,000 or more than 100% due to lower services
revenue of approximately $366,000 generated through project sales for the three
month period ending September 30, 2011 as compared to the corresponding period
in 2010 offset by a $172,000 decrease in related cost of service revenues over
the same periods.
Maintenance Gross Profit
Three Months Ended
September 30,
Maintenance gross profit 2011 2010 $ Change % Change
(dollars in thousands)
Total maintenance gross profit $ 523 $ 455 $ 68 15 %
Percentage of total maintenance revenue 70 % 70 %
Gross margins related to maintenance revenue increased $68,000 or 15% due to
higher maintenance revenues of approximately $97,000 offset by a $29,000
increase in maintenance cost of revenue. Maintenance gross profit as a
percentage of total maintenance revenue was consistent at 70% year over year.
Operating Expense
Three Months Ended
September 30,
Operating expense 2011 2010 $ Change % Change
(dollars in thousands)
General and administrative $ 617 $ 512 $ 105 21 %
Percentage of total net revenue 58 % 36 %
Sales and marketing $ 343 $ 385 $ (42 ) (11 )%
Percentage of total net revenue 32 % 27 %
Research and development $ 683 $ 576 $ 107
19 %
Percentage of total net revenue 64 % 41 %
Depreciation and amortization $ 7 $ 13 $ (6 )
(46 )%
Percentage of total net revenue 1 % 1 %
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General and Administrative Expenses
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 $105,000 increase in such expense is primarily
comprised of the following major components:
· Increase in contract services expense of $122,000
due primarily to the audit work performed in the
third quarter of 2011 related to the audit and
related filings for fiscal year 2010
· Decrease in personnel related expense of
approximately $36,000
· Increase in stock based compensation of
approximately $15,000
Sales and Marketing
Sales and marketing expense consists primarily of the salaries, commissions,
other incentive compensation, employee benefits and travel expense of our sales,
marketing, business development and product management functions. The dollar
decrease of $42,000 during the three months ended September 30, 2011 as compared
to the corresponding period in 2010 is comprised of the following major
components:
· Decrease in personnel related expense of
approximately $34,000 due to reductions in headcount
and the consolidation of certain positions
· Decrease in rent, office related and other expense
of approximately $7,000
Research and Development
Research and development expense consists primarily of salaries, employee
benefits and outside contractors for new product development, product
enhancements, custom integration work and related facility costs. Such expense
increased $107,000 for the three months ended September 30, 2011 as compared to
the corresponding period in 2010. The increase is comprised of the following
major components:
· Increase in personnel expenditures of approximately
$64,000 combined with an increase in contractor and
contract services of $42,000 for a combined increase
of $106,000.
· Decrease in rent and office related costs of
approximately $12,000
· Increase in stock-based compensation of
approximately $9,000
.
Our level of expenditures in research and development reflects our belief that
to maintain our competitive position in markets characterized by rapid rates of
technological advancement, we must continue to invest significant resources in
new systems and software as well as continue to enhance existing products.
Depreciation and Amortization
During the three months ended September 30, 2011, depreciation and amortization
expense decreased $6,000 as compared to the corresponding period in 2010. The
decrease in depreciation and amortization expense reflects a decrease in the
carrying value of property and equipment from $36,000 as of September 30, 2010
to $22,000 as of September 30, 2011. The Company's amortization expense
consisted solely of amortization expense incurred on the Company's EPI trademark
and trade name intangible asset.
Interest Expense (Income), Net
For the three months ended September 30, 2011, we recognized interest income of
$0 and interest expense of $686,000. For the three months ended September 30,
2010, we recognized interest income of $0 and interest expense of
$60,000. Interest expense for the three months ended September 30, 2011 contains
the following components:
· Coupon interest of approximately $93,000 related to
our 6% secured convertible notes and 7% convertible
notes
· Accretion of note discount and beneficial conversion
feature classified as interest expense of
approximately $431,000 and $155,000, respectively
· Other interest expense of approximately $7,000
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Interest expense for the three months September 30, 2010 contains the following
components:
· Coupon interest of approximately $54,000 related to
our 7% convertible notes and 9% secured notes
payable
· Other interest expense of approximately $6,000
Change in Fair Value of Derivative Liabilities
For the three months ended September 30, 2011, we recognized non-cash income of
$6,955,000 compared to $506,000 for the corresponding period of 2010. This
income is related to the change in fair value of the Company's derivative
liabilities associated with the embedded conversion feature in our Series C
Preferred and Series D Preferred and the anti-dilution provisions in certain
warrants to purchase shares of our common stock. The derivative liabilities were
revalued using available market information and commonly accepted valuation
methodologies.
Other Expense (Income), Net
For the three months ended September 30, 2011, we recognized other income of
$10,000 and other expense of $0. For the three months ended September 30, 2010,
we recognized other income of $12,000 and other expense of $0. Other income for
the three months ended September 30, 2011 is comprised of approximately $6,000
from miscellaneous receipts and $4,000 from the negotiated settlement of certain
trade accounts payable at amounts less than their carrying value. Other income
for the three months ended September 30, 2010 contains approximately $12,000
from collections on previously derecognized receivables.
Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September
30, 2010.
Product Revenue
Nine Months Ended
September 30,
Net Product Revenue 2011 2010 $ Change % Change
(dollars in thousands)
Software and royalties $ 1,925 $ 1,516 $ 409 27 %
Percentage of total net product revenue 81 % 57 %
Hardware and consumables $ 183 $ 343 $ (160 ) (47 )%
Percentage of total net product revenue 8 % 13 %
Services $ 259 $ 781 $ (522 ) (67 )%
Percentage of total net product revenue 11 % 30 %
Total net product revenue $ 2,367 $ 2,640 $ (273 ) (10 )%
Software and royalty revenue increased 27% or $409,000 during the nine months
ended September 30, 2011 as compared to the corresponding period in 2010. The
increase is due primarily to higher sales of our biometric engine of
approximately $536,000 offset by lower Law Enforcement project-oriented revenue
of approximately $54,000, lower identification software royalties and license
revenues of approximately $53,000 and lower sales of our boxed identity
management software through our distribution channel of approximately $20,000.
Revenue from the sale of hardware and consumables decreased 47% or $160,000
during the nine months ended September 30, 2011 as compared to the corresponding
period in 2010. The decrease reflects lower revenue from project solutions
containing hardware and consumable components.
Services revenue is comprised primarily of software integration services, system
installation services and customer training. Such revenue decreased
approximately $522,000 during the nine months ended September 30, 2011 as
compared to the corresponding period in 2010 due to a higher percentage of
overall revenues being generated from software only sales and projects not
requiring customization, integration or installation services
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. Based on management's current visibility into the timing of potential
government procurements, we believe that we will see a significant increase in
government procurement and implementations with respect to identity management
initiatives; however we cannot predict the timing of such initiatives.
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Maintenance Revenue
Nine Months Ended
September 30,
Maintenance Revenue 2011 2010 $ Change % Change
(dollars in thousands)
Maintenance revenue $ 2,113 $ 1,961 $ 152 8 %
Maintenance revenue was $2,113,000 for the nine months ended September 30, 2011
as compared to $1,961,000 for the corresponding period in 2010. The increase of
$152,000 is primarily due to the increase in identity management software
project solutions revenue discussed above. Law enforcement maintenance revenue
did not change significantly year over year.
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
Nine Months Ended
September 30,
Cost of Product Revenue: 2011 2010 $ Change % Change
(dollars in thousands)
Software and royalties $ 101 $ 257 $ (156 ) (61 )%
Percentage of software and royalty
product revenue 5 % 17 %
Hardware and consumables $ 112 $ 267 $ (155 ) (58 )%
Percentage of hardware and consumables
product revenue 61 % 78 %
Services $ 158 $ 397 $ (239 ) (60 )%
Percentage of services product revenue 61 % 51 %
Total cost of product revenue $ 371 $ 921 $ (550 ) (60 )%
Percentage of total product revenue 16 % 35 %
The cost of software and royalty product revenue decreased 61% or $156,000
during the nine months ended September 30, 2011 as compared to the corresponding
period in 2010. This decrease relates to an uncharacteristically large
percentage of software revenue for the nine months ended September 30, 2011
being generated from software only project solutions not requiring significant
amounts of customization, integration or installation as compared to the
corresponding period in 2010.
The decrease in the cost of product revenue for our hardware and consumable
sales of $155,000 for the nine months ended September 30, 2011 as compared to
the corresponding period in 2010 reflects a nearly identical decrease in
hardware and consumable revenue for the nine months ended September 30, 2011 as
compared to the comparable period in 2010.
Cost of service revenue decreased $239,000 or 60% during the nine months ended
September 30, 2011 as compared to the corresponding period in 2010. That
decrease in costs is primarily driven by the corresponding decrease in service
revenue of 67% shown above.
Cost of Maintenance Revenue
Nine Months Ended
September 30,
Cost of Maintenance Revenue 2011 2010 $ Change % Change
(dollars in thousands)
Total maintenance cost of
revenue $ 674 $ 699 $ (25 ) (4 )%
Percentage of total
maintenance revenue 32 % 36 %
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Cost of maintenance revenue decreased $25,000 during the nine months ended
September 30, 2011 as compared to the corresponding period in 2010. That
decrease is not significant as a percentage of total maintenance revenues.
Product Gross Profit
Nine Months Ended
September 30,
Product gross profit 2011 2010 $ Change % Change
(dollars in thousands)
Software and royalties $ 1,824 $ 1,259 $ 565 45 %
Percentage of software and royalty
product revenue 95 % 83 %
Hardware and consumables $ 71 $ 76 $ (5 ) (7 )%
Percentage of hardware and consumables
product revenue 39 % 22 %
Services $ 101 $ 384 $ (283 ) (74 )%
Percentage of services product revenue 39 % 49 %
Total product gross profit $ 1,996 $ 1,719 $ 277 16 %
Percentage of total product revenue 84 % 65 %
Software and royalty gross profit increased by 45% or approximately $565,000 for
the nine months ended September 30, 2011 from the corresponding period in 2010
due to the combination of higher software and royalty product revenues of
approximately $409,000 and lower cost of software and royalty revenues of
$156,000. Costs of software products can vary as a percentage of product revenue
from quarter to quarter depending upon product mix and third party software
licenses included in software solutions.
Services gross profit decreased $283,000 due to lower services revenue of
approximately $522,000 for the nine month period ending September 30, 2011 as
compared to the corresponding period in 2010 due to the completion of the
service element in certain contracts. Offsetting this decrease were lower cost
of service revenues of approximately $239,000 for the nine months ended
September 30, 2011 as compared the corresponding period of 2010 due to the
incurrence of direct labor costs in excess of revenues generated on certain
contracts during this period.
Maintenance Gross Profit
Nine Months Ended
September 30,
Maintenance gross profit 2011 2010 $ Change % Change
(dollars in thousands)
Total maintenance gross profit $ 1,439 $ 1,262 $ 177 14 %
Percentage of total maintenance revenue 68 % 64 %
Gross margins related to maintenance revenue increased due to higher maintenance
revenue of approximately $152,000 combined with lower maintenance cost of
revenue of $25,000. The reduction in maintenance cost of revenue decrease is
reflective of lower personnel costs and contract services expenditures incurred
during the nine months ended September 30, 2011 period as compared to the
corresponding period of 2010.
Operating Expense
Nine Months Ended
September 30,
Operating expense 2011 2010 $ Change % Change
(dollars in thousands)
General and administrative $ 1,610 $ 1,888 $ (278 ) (15 )%
Percentage of total net revenue 36 % 41 %
Sales and marketing $ 1,076 $ 1,158 $ (82 ) (7 )%
Percentage of total net revenue 24 % 25 %
Research and development $ 1,995 $ 1,939 $ 56
3 %
Percentage of total net revenue 45 % 42 %
Depreciation and amortization $ 21 $ 39 $ (18 )
(46 )%
Percentage of total net revenue 0 % 1 %
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General and Administrative
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 expenses. The dollar decrease of $278,000 is comprised of the
following major components:
· Decrease in contract services expense of $143,000
due primarily to the more significant audit related
fees incurred in the first quarter of 2010 when
compared to 2011
· Decrease in personnel related expense of
approximately $123,000
· Decrease in Canadian operating expense of $51,000
· Decrease in rent and office related costs of
approximately $21,000
· Increase in financing fees of approximately $25,000
· Increase in stock based compensation of
approximately $16,000
· Increase in contract and other costs of
approximately $19,000
Sales and Marketing
Sales and marketing expense consists primarily of the salaries, commissions,
other incentive compensation, employee benefits and travel expenses of our
sales, marketing, business development and product management functions. The
dollar decrease of $82,000 during the nine months ended September 30, 2011 as
compared to the corresponding period in 2010 is comprised of the following major
components:
· Decrease in personnel related expense of
approximately $95,000 due to reductions in headcount
and the consolidation of certain positions
· Increase in stock-based compensation of
approximately $13,000
Research and Development
Research and development expense consists primarily of salaries, employee
benefits and outside contractors for new product development, product
enhancements and custom integration work. Such expenses increased only
moderately by $56,000 for the nine months ended September 30, 2011 as compared
to the corresponding period in 2010. The increase is comprised of the following
major components:
· Increase in personnel expenditures of approximately $46,000
· Increase in contract services of $11,000
· Decrease in rent and office related costs of approximately $37,000
· Increase in stock-based compensation of approximately $26,000
· Increase in trade and trade show costs of approximately $10,000
.
Our level of expenditures in research and development reflects our belief that
to maintain our competitive position in markets characterized by rapid rates of
technological advancement, we must continue to invest significant resources in
new systems and software as well as continue to enhance existing products.
Depreciation and Amortization
During the nine months ended September 30, 2011, depreciation and amortization
expense decreased $18,000 as compared to the corresponding period in 2010. The
decrease in depreciation and amortization expense reflects a decrease in the
carrying value of property and equipment from $41,000 as of December 31, 2010 to
$19,000 as of September 30, 2011. The Company's amortization expense
consisted solely of amortization expense incurred on the Company's EPI trademark
and trade name intangible asset.
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Interest Expense (Income), Net
For the nine months ended September 30, 2011, we recognized interest income of
$0 and interest expense of $1,955,000. For the nine months ended September 30,
2010, we recognized interest income of $0 and interest expense of
$636,000. Interest expense for the nine months ended September 30, 2011 contains
the following components:
· Coupon interest of approximately $261,000 related to
our 6% secured convertible notes and 7% convertible
notes
· Accretion of note discount and beneficial conversion
feature classified as interest expense of
approximately $1,252,000 and $424,000, respectively
· Other interest expense of approximately $18,000
Interest expense for the nine months September 30, 2010 contains the following
components:
· Coupon interest of approximately $176,000 related to
our 7% convertible notes and 9% secured notes
payable
· Accretion of note discount classified as interest
expense of approximately $431,000
· Other interest expense of approximately $29,000
Change in Fair Value of Additional Financing Obligation
The change in fair value of financing obligation during the nine months ended
September 30, 2010 resulted in non-cash income of $553,000. As that financing
obligation was settled in fiscal 2010 there is no corresponding impact for the
nine months ended September 30, 2011.
Change in Fair Value of Derivative Liabilities
For the nine months ended September 30, 2011, we recognized a non-cash income of
$4,268,000 compared to non-cash income of $4,183,000 for the corresponding
period of 2010. This income is related to the change in fair value of the
Company's Derivative Liabilities associated with the embedded conversion feature
in our Series C and Series D Preferred Stock and the anti-dilution provisions in
certain warrants to purchase shares of our common stock. The Derivative
Liabilities were revalued using available market information and commonly
accepted valuation methodologies.
Other Expense (Income), Net
For the nine months ended September 30, 2011, we recognized other income of
$19,000 and other expense of $0. For the nine months ended September 30, 2010,
we recognized other income of $313,000 and other expense of $0. Other income for
the nine months ended September 30, 2011 is comprised of approximately $16,000
from miscellaneous receipts at our German sales office and $3,000 from the
negotiated settlement of certain trade accounts payable at amounts less than
their carrying value. Other income for the nine months ended September 30, 2010
contains approximately $280,000 from the reduction of previously accrued
liquidated damages due to the expiration of the statue of limitations, $10,000
for the application of forfeiture account balances of the Company's 401(k) plan
against the accrued employer match, $2,000 from the negotiated settlement of
certain trade accounts payable at amounts less than their carrying value, and
$21,000 in income on previously derecognized accounts receivables.
Income Tax Expense
Income tax expense was $6,000 for the nine months ended September 30, 2011
compared to $201,000 for the same period in 2010. The decrease of $195,000 is
primarily due to an adjustment we recorded during the second quarter of 2010
related to our transfer pricing tax position with respect to our operations in
Canada. That adjustment related to an examination conducted by the Canadian
Revenue Agency for the tax years 2001 to 2008. The adjustment recorded in 2010
reflects the cumulative impact, including estimated interest and penalties.
LIQUIDITY AND CAPITAL RESOURCES
On December 20, 2011, we consummated an equity financing resulting in gross
proceeds of $10.0 million ("Qualified Financing"), including the $750,000 of
promissory notes converted into the Qualified Financing. In connection with the
Qualified Financing, we issued 20.0 million shares of our common stock (the
"Shares"), and warrants to purchase 12,207,500 shares of our common stock
exercisable for $0.50 per share ("Warrants"), which number includes 2,207,500
shares issuable upon exchange of warrants issued to MDB Capital Group in
consideration for acting as placement agent in connection with the Qualified
Financing. The Warrants expire five years from the date of grant. The Company
also issued 90,000 shares of common stock and a Warrant exercisable for 45,000
shares of common stock in lieu of cash in payments for legal fees related to the
Qualified Financing.
As a result of the Qualified Financing, our Series C 8% Convertible Preferred
Stock ("Series C Preferred") and Series D 8% Convertible Preferred Stock
("Series D Preferred") was automatically converted into 11,768,525 shares of
common stock. In addition, in connection with the Qualified Financing, (i) the
anti-dilution provision contained in certain of the Company's existing warrants
were amended resulting in such warrants no longer qualifying as derivative
liabilities; and (ii) a significant investor ("Investor") exchanged $4.5 million
principal amount of convertible promissory notes of the Company ("Exchanged
Notes"), and accrued but unpaid interest on the Exchanged Notes and on an
additional $2.25 million in promissory notes, into 9,774,559 shares of the
Company's common stock ("Exchange Shares"). The Investor also agreed to convert
$750,000 principal amount of additional promissory notes held by the Investor
and invest the proceeds into the Qualified Financing. We are obligated to file a
registration statement with the Securities and Exchange Commission on or before
February 20, 2012 to register for resale the Shares and the common stock
issuable upon exercise of the Warrants.
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The net proceeds from the Qualified Financing, approximately $9.2 million, will
be used for (i) the customization of identity management products for enterprise
and consumer applications; (ii) further development of intellectual property;
(iii) development of SaaS capabilities for existing products; (iv) the payment
of $1.5 million principal amount of convertible promissory notes; and (v) for
working capital and general corporate purposes.
At September 30, 2011, our principal sources of liquidity consisted of cash and
cash equivalents of $267,000 and accounts receivable, net of $305,000. As of
September 30, 2011, we had negative working capital of $4,093,000 which included
$1,473,000 of deferred revenue. Historically, our principal sources of cash have
included customer payments from the sale of our products, proceeds from the
issuance of common and preferred stock and proceeds from the issuance of debt.
Our principal uses of cash have included cash used in operations, payments
relating to purchases of property and equipment and repayments of borrowings. We
expect that our principal uses of cash in the future will be for operations,
working capital and capital expenditures. We expect that, as our revenues grow,
our sales and marketing and research and development expenses will continue to
grow and, as a result, we will need to generate significant net revenues to
achieve profitability.
Management believes that the Company's current cash and cash equivalents will be
sufficient to meet working capital and capital expenditure requirements for at
least the next 12 months from the date of the filing of this Quarterly Report
and that the Company will have sufficient liquidity to fund its business and
meet its contractual obligations over a period beyond the next 12 months.
Operating Activities
We used net cash of $968,000 in operating activities for the nine months ended
September 30, 2011 compared to net cash use of $1,045,000 during the same period
in the prior year. During the nine months ended September 30, 2011, net cash
used in operating activities primarily consisted of net income of $1.1 million
and a net decrease in working capital and other assets and liabilities of
$291,000. Those amounts were offset by $2.3 million, net of non-cash costs
including a $4.3 million unrealized gain related to the change in value of our
derivative liabilities, $1.7 million in amortization of debt related costs and
$240,000 is stock based compensation. The decrease in working capital and other
assets of $291,000 for the nine months ended September 30, 2011 was primarily
driven by an increase of $399,000 in deferred revenue, a $261,000 increase in
accrued expenses and a $241,000 decrease in billings in excess of costs and
estimated earnings on uncompleted contracts. Net working capital and other
assets and liabilities decreased $865,000 during the nine months ended September
30, 2010. That decrease was primarily driven by an increase in accrued expenses
of $356,000, an increase in accounts payable of $214,000 and a decrease in
accounts receivable, net of $247,000.
Investing Activities
There was relatively no activity in our cash flows from investing activities.
Financing Activities
We generated cash of $1.2 million from financing activities for the nine months
ended September 30, 2011 compared to the generation of $750,000 for the same
period in the prior year. The $1.2 million generated during the nine months
ended September 30, 2011 was primarily driven from the $655,000 proceeds related
to the exercise of 1,310,000 common stock warrants and $500,000 from the
issuance of notes payable. For the nine months ended September 30, 2010, we
generated cash of $500,000 from the exercise of 1,000,000 common stock warrants
and generated cash of $250,000 from the issuance of secured notes payable.
Debt
At September 30, 2011, we had approximately $6.1 million in outstanding debt,
exclusive of any debt discounts, and another $0.4 million in related accrued
interest.
9% Secured Promissory Note
In February 2009, we entered into a secured promissory note (the "Note"), for
$5,000,000 with a third-party lender ("the Lender"). The Note secures a credit
facility for a total of up to $5,000,000. The initial advance under the Note was
$1,000,000. Subsequent advances are subject to the discretion of the Lender. The
note bears interest at 5.0% per annum on the outstanding principal and interest
and are due on June 30, 2010. We will also pay the Lender additional financing
fees (the "Additional Financing Obligation") on the maturity date or such
earlier date as may be required under the terms of the note equal to the greater
of $400,000 or an amount equal to 2,000,000 multiplied by the average of the
closing prices for the common stock of the Company for the ten trading day
period immediately preceding the date of such interest payment.
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In conjunction with the issuance of the Note, we issued a warrant to purchase
4,500,000 shares of our common stock. The warrant has an exercise price $0.50
per share and may be exercised at any time from February 12, 2009 until February
12, 2014. Additionally, we entered into a Registration Rights Agreement
requiring us to provide certain registration rights to the Lender relative to
the 4,500,000 shares of our common stock issuable pursuant to the warrant.
We recorded the Note and Additional Financing Obligation net of a discount equal
to the fair values allocated to the various financial instruments issued to the
Lender. The warrants issued in conjunction with the Note contained anti-dilution
provisions, which require derivative liability classification. We estimated the
fair value of the warrants using a Monte-Carlo simulation, which resulted in
note discount from the issuance of the warrants of approximately $562,000. We
recorded the Additional Financing Obligation equal to the fair values of the
additional financing component using the Black-Scholes option-pricing model,
which resulted in additional note discount of approximately $169,000. In
addition, we accreted the $400,000 minimum payment to interest expense over the
term of the agreement.
The Note is secured by all our assets. Under the terms of the Note, the entire
outstanding balance together with all accrued interest shall be payable on (i)
the maturity date (June 30, 2010), (ii) a change of control transaction, (iii)
our receipt of proceeds from the sale of equity or equity linked securities in
excess of $2,500,000, (iv) our receipt of proceeds from the issuance of any type
of additional debt instruments, or (v) upon the occurrence of an event of
default under the terms of the Note.
In June 2009, we and the Lender agreed to amend the Note ("Amendment No. 1")
whereby we received a waiver of default and extension of certain date sensitive
covenants contained in the Note. As consideration for the waiver and extension,
we issued to the Lender warrants to purchase 1,000,000 shares of our common
stock at an exercise price of $0.50 per share. Such warrants may be exercised
at any time from June 9, 2009 until June 9, 2014. In conjunction with the June
2009 waiver and extension, the interest rate on the Note was changed to 9% per
annum, retroactive to February 2009.
We evaluated the waiver of default and interest rate change under ASC 470-50,
Debtor's Accounting for a Modification or Exchange of Debt Instruments, (ASC
470-50) to determine if the modification was substantial. We determined that,
because the change in fair value of the debt instruments was greater than 10% of
the present value of the cash flows between the modified debt instruments and
original debt instruments, the debt modification was substantial and therefore
we accounted for the modification as a debt extinguishment. Accordingly, we
recorded the new debt instrument at fair value and recorded a loss on debt
extinguishment of approximately $750,000 during 2009. The loss on debt
extinguishment of $750,000 includes approximately $132,000 of unamortized
deferred financing fees written off due to the debt extinguishment. We recorded
the new debt instruments net of a discount equal to the fair values allocated to
the various financial instruments issued to the Lender. We estimated the fair
value of the warrants using a Monte-Carlo simulation, which resulted in a note
discount from the issuance of the warrants of approximately $188,000. We are
accreting the note discount and the Additional Financing Obligation discount
using the effective interest rate method over the life of the Note.
In June 2009, we and the Lender further amended the Note ("Amendment No. 2")
whereby the Lender advanced us an additional $350,000 and amended certain terms
of the Note. As consideration for the additional advance, we issued to the
Lender warrants to purchase 700,000 shares of our common stock at an exercise
price of $0.50 per share. Such warrants may be exercised at any time from June
22, 2009 until June 22, 2014.
We recorded Amendment No. 2 net of a discount equal to the fair value allocated
to warrants. We estimated the fair value of the warrants using a Monte-Carlo
simulation analysis, which resulted in a note discount from the issuance of the
warrants of approximately $238,000.
In October 2009, we and the Lender further amended the Note ("Amendment No. 3")
whereby the Lender agreed to make additional advances in an aggregate amount up
to $1,000,000 ("Third Amendment Advance") to only be used for the purpose of
compromising certain of our outstanding vendor payables or for paying for the
audit of our financial statements. The amendment calls for us to repay the
lender in full the amount of any and all Third Amendment Advances, together with
all accrued and unpaid interest thereon, on or before January 31, 2010. On
October 5, 2009, the Lender made an advance of $300,000 to us pursuant to these
provisions. As consideration for the additional advance, we issued to the
Lender warrants to purchase 200,000 shares of our common stock at an exercise
price of $0.60 per share. Such warrants may be exercised at any time from
October 5, 2009 until October 5, 2014. As additional consideration, we assigned
certain patents related to discontinued product lines to the Lender with the
condition that we would participate in future proceeds generated from efforts by
the Lender to monetize the patents.
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We recorded the Amendment No. 3 borrowing net of a discount equal to the fair
value allocated to warrants and the patent assignment. The warrants issued in
conjunction with the Third Amendment Advance contained anti-dilution provisions,
which require derivative liability classification. We estimated the fair value
of the warrants using a Monte-Carlo simulation analysis, which resulted in note
discount from the issuance of the warrants of approximately $105,000. We
estimated the fair value of the patent assignment to be $0 based on the
unsuccessful attempt to monetize the patents.
On November 4, 2009, we and the Lender amended the Note ("Amendment No. 4")
whereby the Lender made an additional $350,000 advance (the "Additional
Advance") under the Note. As consideration for the Additional Advance, we
executed an assignment of all accounts receivable (the "Assignment of
Receivables") whereby we assigned to the Lender all of our rights, title and
interest in all accounts receivable as of the date of Amendment No. 4. In
December 2009, we paid back the $350,000 advance plus accrued interest.
In December 2009, the Lender advanced an additional $325,000 under Amendment No.
3. In December 2009, the Lender added approximately $12,000 in legal fees to the
principal balance of the note.
In February 2010, we and the Lender further amended the Note ("Amendment No. 5")
whereby the Lender extended the due date of amounts due on January 31, 2010 to
March 15, 2010.
In March 2010, we and the Lender further amended the Note ("Amendment No. 6")
whereby the Lender made an additional advance of $250,000 under the Note. As
consideration for the advance, we will pay the Lender additional interest on the
maturity date or such earlier date as may be required under the terms of the
Note in an amount equal to 200,000 multiplied by the average of the closing
prices of our common stock for the ten trading day period immediately preceding
the date of the payment of such interest payment. As additional consideration
for making the advance, we assigned to the Lender its rights, title and interest
in and to fifty percent of certain after-cost proceeds that may be received in
connection with our prosecution of certain commercial tort claims (including,
but not limited to, claims related to the infringement of our intellectual
property). In conjunction with Amendment No. 6, the interest rate on the Note
was changed to 10% per annum, retroactive to February 2009. Also in conjunction
with Amendment No. 6, the Lender extended the due dates of amounts due on March
15, 2010 to June 30, 2010.
In conjunction with Amendments No. 5 and No. 6, the Lender added an aggregate of
$15,000 to the note principal during 2010.
We recorded the borrowing under Amendment No. 6 net of a discount equal to the
fair value of the change in the additional interest obligation of approximately
$140,000. We estimated the fair value of the change in the additional interest
obligation using the Black-Scholes option pricing model using the following
assumptions: term of 0.3 years, a risk free interest rate of 0.20%, a dividend
yield of 0%, and volatility of 107%.
Amendments Nos. 2 through 6 were evaluated under ASC 470-50, Debtor's Accounting
for a Modification or Exchange of Debt Instruments, (ASC 470-50) to determine if
the modification was substantial. Based on such analysis, we determined that
such amendments were not substantial.
In June 2010, we did not repay the outstanding note principal and interest due
under the terms of the Note, which were due on June 30, 2010. In August 2010, we
further amended the Note ("Amendment No. 7") whereby the Lender extended the
maturity date to September 15, 2010. The Note was further amended to allow us a
60 day grace period beyond September 15, 2010 if, prior to September 15, 2010,
we can deliver a customer contract (or contracts) sufficient to generate
aggregate revenue of not less than $25 million. In conjunction with the
amendment, we agreed to pay a $50,000 amendment fee (such fee to be added to the
principal balance of the Note as of the date of the amendment). We also agreed
to amend the clause in the Note requiring us to pay additional interest on the
Note equal to the greater of $400,000 or an amount equal to 2,200,000 times the
average of the five highest closing prices for our common stock from February
12, 2009 to the maturity date of the Note. The additional interest will,
however, not exceed $2,200,000. Prior to the amendment this payment was based
upon the average of the 10 daily closing prices immediately preceding the date
of payment and had no upper limit.
We evaluated the Amendment No. 7 modification under ASC 470-50, Debtor's
Accounting for a Modification or Exchange of Debt Instruments, (ASC 470-50) to
determine if the modification was substantial. We determined that because the
change in fair value of the debt instruments was greater than 10% of the present
value of the cash flows between the modified debt instruments and original debt
instruments, the debt modification was substantial and therefore we accounted
for the modification as a debt extinguishment. Accordingly, we recorded the new
debt instrument at fair value and recorded a loss on debt extinguishment of
approximately $1,763,000 during 2010.
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On October 6, 2010, we entered into a Settlement Agreement (the "Agreement")
with the Lender whereby we agreed to pay the Lender the sum of $4,703,465
(consisting of outstanding principal, interest, amounts due under the terms of
the Additional Financing Obligation and legal fees) in three payments to be made
in the amount of $1,567,821 due on or before October 8, 2010; $1,567,822 due on
or before November 30, 2010; and a third and final payment of $1,567,822 due on
or before December 30, 2010. Interest continued to accrue at a rate of 18% per
annum on the outstanding indebtedness until the date of payment. The Lender
retained a first priority security interest in our assets pursuant to the terms
of the Note. The Company made the scheduled installment payments in accordance
with the Agreement with the final payment being made on December 8, 2010.
6% Secured Convertible Promissory Notes
On October 5, 2010, we entered into a new, two year unsecured convertible 6%
note ("Convertible Note No. 1") in the amount of $2,000,000 purchased by an
existing shareholder. Convertible Note No. 1 is convertible into common shares
at $0.50 per share. In conjunction with the issuance of the Convertible Note No.
1, we issued warrants to purchase 1,000,000 shares of common stock with an
exercise price of $0.50.
We recorded Convertible Note No. 1 net of a discount equal to the fair value
allocated to the warrants of approximately $408,000. We utilized the services of
an independent valuation firm, Vantage Point Advisors, Inc., to perform the
Monte-Carlo simulations used to arrive at the estimate of fair value. The
convertible notes also contained a beneficial conversion feature, which resulted
in an additional debt discount of $408,000. The beneficial conversion amount was
measured using the accounting intrinsic value, i.e. the excess of the aggregate
fair value of the common stock into which the debt is convertible over the
proceeds allocated to the security. We will accrete the note discount and
beneficial conversion feature over the life of the note using the effective
interest rate method.
On November 5, 2010, we entered into a new, two year unsecured convertible 6%
note ("Convertible Note No. 2") in the amount of $2,000,000 purchased by the
same shareholder. Convertible Note No. 2 is convertible into common shares at
$0.50 per share. In conjunction with the issuance of Convertible Note No. 2, we
issued warrants to purchase 5,000,000 shares of common stock with an exercise
price of $0.50.
We recorded Convertible Note No. 2 net of a discount equal to the fair value
allocated to the warrants of approximately $2,000,000. The Company estimated the
fair value of the warrants to be approximately $2,074,000 using a Monte-Carlo
simulation performed by an independent valuation firm, Vantage Point Advisors,
Inc. We also recorded an additional $74,000 in financing expense based on the
fair value of the warrants as the grant date fair value of the warrants exceeded
the face amount of the convertible note. We will accrete the note discount over
the life of the note using the effective interest rate method.
On December 8, 2010, we entered into a new, two year unsecured convertible 6%
note ("Convertible Note No. 3") in the amount of $1,500,000 purchased by the
same shareholder. Convertible Note No. 3 is convertible into common shares at
$0.50 per share. In conjunction with the issuance of Convertible Note No. 3, we
issued warrants to purchase 2,250,000 shares of common stock with an exercise
price of $0.50.
We recorded Convertible Note No. 3 net of a discount equal to the fair value
allocated to the warrants of approximately $830,000. We utilized the services of
an independent valuation firm, Vantage Point Advisors, Inc., to perform the
Monte-Carlo simulations used to arrive at the estimate of fair value. The
convertible notes also contained a beneficial conversion feature, which resulted
in an additional debt discount of $671,000. The beneficial conversion amount was
measured using the accounting intrinsic value, i.e. the excess of the aggregate
fair value of the common stock into which the debt is convertible over the
proceeds allocated to the security. We will accrete the note discount and
beneficial conversion feature over the life of the note using the effective
interest rate method.
On December 8, 2010, we entered into a security agreement with the Lender of
Convertible Notes Nos. 1 through 3 (collectively the "6% Convertible Notes")
whereby Company granted the 6% Convertible Note holder a first priority lien on
and security interest in all our assets.
In June 2011, we entered into a new, two year secured convertible 6% note
("Convertible Note No. 4") in the amount of $500,000 purchased by the existing
holder of the 6% Convertible Notes. Convertible Note No. 4 is convertible into
common shares at $1.25 per share and is due June 9, 2013. In conjunction with
the issuance of Convertible Note No. 4, we issued warrants to purchase 300,000
shares of common stock with an exercise price of $1.25. The Warrant terminates,
if not previously exercised, two years from the date of issuance, or June 9,
2013. The Warrant contains a cashless exercise provision allowing the Lender to
exercise the Warrant without tendering the exercise price of the Warrant,
subject to a reduction of the number of shares of common stock issuable upon
exercise of the Warrant.
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We recorded Convertible Note No. 4 net of a discount equal to the fair value
allocated to the warrants of approximately $188,000. The Company utilized the
services of an independent valuation firm, Vantage Point Advisors, Inc., to
perform the Monte-Carlo simulations used to arrive at the estimate of fair
value. The convertible notes also contained a beneficial conversion feature,
which resulted in an additional debt discount of $188,000. The beneficial
conversion amount was measured using the accounting intrinsic value, i.e. the
excess of the aggregate fair value of the common stock into which the debt is
convertible over the proceeds allocated to the security. The Company will
accrete the note discount and beneficial conversion feature over the life of the
note using the effective interest rate method.
7% Convertible Promissory Notes to Related Parties
On November 14, 2008, we entered into a series of convertible promissory notes
(the "Related-Party Convertible Notes"), aggregating $110,000 with certain
officers and members of our Board of Directors. The Related-Party Convertible
Notes bear interest at 7.0% per annum and were due February 14, 2009. The
principal amount of the Related-Party Convertible Notes plus accrued but unpaid
interest is convertible at the option of the holder into our common stock. The
number of shares into which the Related-Party Convertible Notes are convertible
shall be calculated by dividing the outstanding principal and accrued but unpaid
interest by $0.55 (the "Conversion Price").
In conjunction with the issuance of the Related-Party Convertible Notes, we
issued an aggregate of 149,996 warrants to the note holders to purchase our
common stock. The warrants have an exercise price of $0.55 per share and may be
exercised at any time from November 14, 2008 until November 14, 2013.
We, in 2008, initially recorded the convertible notes net of a discount equal to
the fair value allocated to the warrants of approximately $13,000. We estimated
the fair value of the warrants using the Black-Scholes option pricing model
using the following assumptions: term of 5 years, a risk free interest rate of
2.53%, a dividend yield of 0%, and volatility of 96%. The convertible notes also
contained a beneficial conversion feature, which resulted in an additional debt
discount of $12,000. The beneficial conversion amount was measured using the
accounting intrinsic value, i.e. the excess of the aggregate fair value of the
common stock into which the debt is convertible over the proceeds allocated to
the security. We have accreted the beneficial conversion feature over the life
of the note.
We did not repay the Related-Party Convertible Notes on the due date. In August
2009, we received, from the Related-Party Convertible Note holders, a waiver of
default and extension to January 31, 2010 of the maturity date of the
Related-Party Convertible Notes. As consideration for the waiver and note
extension, we issued, to the Related-Party Convertible Note holders, an
aggregate of 150,000 warrants to purchase shares of our common stock. The
warrants have an exercise price of $0.54 per share and expire on August 25,
2014. We did not repay the notes on January 31, 2010 and is currently seeking an
additional waiver of default from the holders of the Related-Party Convertible
Notes.
The warrants issued in conjunction with the August 2009 waiver of default
contain anti-dilution provisions, which require derivative liability
classification. We recorded the grant date fair value of the warrants using a
Monte-Carlo simulation analysis, which resulted in the recognition of expense of
approximately $52,000 included as a component of interest expense in our
consolidated statements of operations for the year ended December 31, 2009.
Contractual Obligations
Total contractual obligations and commercial commitments as of September 30,
2011 are summarized in the following table (in thousands):
Payment Due by Year
2011
Total (3 months) 2012 2013 2014 2015 Thereafter
9% secured
promissory note* $ - $ - $ - $ - $ - $ - $ -
7% related party
promissory note** 110 110 - - - - -
6% promissory note 6,000 - 5,500 500 - - -
Operating lease
obligations 773 104 431 238 - - -
Total $ 6,883 $ 214 $ 5,931 $ 738 $ - $ - $ -
* Note was settled in December 2010.
** Note had a maturity date of January, 2010. We did not repay the notes on
January 31, 2010 and we are currently seeking an additional waiver of default
from the holders of the Related-Party Convertible Notes.
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Real Property Leases
In December 2010, we entered into a new lease agreement and relocated our
corporate headquarters to Rancho Bernardo Road in San Diego, California. The
lease term commenced in December 2010 and ends on December 31, 2013. We are
obligated under the lease to pay base rent and certain operating costs and taxes
for the building. Aggregate base rent payable by us will be approximately
$54,000, $111,000 and $114,000 during the first, second and third years of the
lease, respectively. Our rent was abated at a rate of 50% for the first 12
months of the lease. Under the lease, we were required to provide a security
deposit in the amount of approximately $9,500.
In addition to the corporate headquarters lease in San Diego, California, we
also lease space in Ottawa, Province of Ontario, Canada; Portland, Oregon and
Mexico City, Mexico. Those contractual lease obligations, as well as the San
Diego lease, are included in the "contractual obligations" summary table above.
Stock-based Compensation
Stock-based compensation has been classified as follows in the accompanying
condensed consolidated statements of operations (in thousands, except per share
data):
Three Months Ended September 30, Nine Months Ended September 30,
2011 2010 2011 2010
Cost of revenues $ 1 $ 1 $ 4 $ 4
General and administrative 38 33 141 102
Sales and marketing 16 19 50 58
Research and development 15 7 45 20
Total $ 70 $ 60 $ 240 $ 184
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