TMCnet News
IVEDA SOLUTIONS, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our audited and unaudited financial statements and associated notes appearing elsewhere in this report. Overview Iveda Solutions, Inc. began operations on January 24, 2005 under the name of IntelaSight, Inc. On October 15, 2009, IntelaSight became a wholly-owned subsidiary of Charmed Homes, Inc., which changed its name to Iveda Corporation. All Company operations were conducted through IntelaSight until December 31, 2010, at which time IntelaSight merged with and into Iveda Corporation and changed its name to Iveda Solutions. On April 30, 2011, the Company completed its acquisition of MegaSys . See "Item 1. Business - General." Unless otherwise noted, all references to "Iveda," "Company," "we," "us" and "our" hereafter in this section refer to the current business of Iveda Solutions, Inc. Iveda installs video surveillance equipment, primarily for security purposes, and provides video hosting, archiving and real-time remote surveillance services to a variety of businesses and organizations. The accompanying financial statements have been prepared assuming that Iveda will continue as a going concern. Iveda generated accumulated losses of approximately $15 million through December 31, 2012. 30 A multi-step plan was adopted by management to enable the Company to continue to operate and begin to report operating profits. The highlights of that plan are as follows: · The Board of Directors approved the Company to engage with a financial capital markets advisor in connection with a potential capital financial transaction to raise up to $30 million in long-term financing. · The Board of Directors also approved the Company to raise up to an aggregate amount of $3 million in bridge financing in advance of the long-term financing. · The Company established reseller distribution channels to increase the scope of the Company's marketing activities with low cost to the Company. · The Company signed a cooperation agreement with an R&D organization in Taiwan to develop new products and services. · The Company may evaluate and consider merger and/or acquisition activities. Application of Critical Accounting Policies We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations are discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations when such policies affect our reported or expected financial results. In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective, and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The material estimates for Iveda are that of the stock based compensation recorded for options and warrants issued and the income tax valuation allowance recorded for deferred tax assets. The fair values of options and warrants are determined using the Black-Scholes option-pricing model. Iveda has no historical data on the accuracy of these estimates. The estimated sensitivity to change is related to the various variables of the Black-Scholes option-pricing model stated below. The specific quantitative variables are included in the Notes to the Financial Statements. The estimated fair value of options and warrants is recognized as expense on the straight-line basis over the options' and warrants' vesting periods. The fair value of each option and warrant granted is estimated on the date of grant using the Black-Scholes option-pricing model with the expected life, dividend yield, expected volatility, and risk free interest rate weighted-average assumptions used for options and warrants granted. Expected volatility for 2011 and 2012 was estimated by using the Dow Jones U.S. Industry indexes sector classification methodology for industries similar to the Company. The risk-free rate for periods within the contractual life of the option and warrant is based on the U.S. Treasury yield curve in effect at the grant date. The expected life of options and warrants is based on the average of three public companies offering services similar to Iveda. Impairment of Long-Lived Assets We have a significant amount of property and equipment primarily consisting of leased equipment. The Company reviews the recoverability of the carrying value of long-lived assets using the methodology prescribed in ASC 360 "Property, Plant and Equipment." Recoverability of long-lived assets to be held and used is measured by a comparison of the carrying amount of an asset to the undiscounted future net operating cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying value of the assets exceeds their fair value. 31 Basis of Accounting and Going Concern Iveda's financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America. In addition, the accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. The Company generated accumulated losses of approximately $15 million through December 31, 2012 and has insufficient working capital and cash flows to support operations. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from this uncertainty. Revenue and Expense Recognition The Company recognizes revenue when persuasive evidence of an arrangement exists, title transfer has occurred, the price is fixed or readily determinable, and collectability is reasonably assured. The Company recognizes revenue in accordance with ASC 60, "Revenue Recognition." Sales are recorded net of sales returns and discounts, which are estimated at the time of shipment based upon historical data. Revenues from monitoring services are recognized when the services are provided. Expenses are recognized as incurred. Revenues from fixed-price equipment installation contracts are recognized on the percentage-of-completion method. The percentage completed is measured by the percentage of costs incurred to date to estimated total costs for each contract. This method is used because management considers expended costs to be the best available measure of progress on these contracts. Because of inherent uncertainties in estimating costs and revenues, it is at least reasonably possible that the estimates used will change. Contract costs include all direct material, subcontractors, labor costs, and equipment costs and those indirect costs related to contract performance. General and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Changes in estimated job profitability resulting from job performance, job conditions, contract penalty provisions, claims, change orders, and settlements are accounted for as changes in estimates in the current period. Profit incentives are included in revenues when their realization is reasonably assured. Claims are included in revenues when realization is probable and the amount can be reliably estimated. The liability, "Billings in excess of costs and estimated earnings on uncompleted contracts," represents billings in excess of revenues recognized. Stock-Based Compensation On January 1, 2006, the Company adopted the fair value recognition provisions of ASC 718, Share-Based Payment , which requires the recognition of an expense related to the fair value of stock-based compensation awards. The Company elected the modified prospective transition method as permitted by ASC 718. Under this transition method, stock-based compensation expense for the years ended December 31, 2011 and 2010 includes compensation expense for stock-based compensation granted on or after the date ASC 718 was adopted based on the grant-date fair value estimated in accordance with the provisions of ASC 718. The Company recognizes compensation expense on a straight-line basis over the requisite service period of the award. The fair value of stock-based compensation awards granted prior to, but not yet vested as of December 31, 2010 and 2009, were estimated using the "minimum value method" as prescribed by original provisions of ASC 718, Accounting for Stock-Based Compensation , therefore, no compensation expense is recognized for these awards in accordance with ASC 718. The Company recognized $248,072 and $515,419 of stock-based compensation expense for the years ended December 31, 2012 and 2011, respectively. 32 Acquisition of MegaSys On April 30, 2011, the Company acquired Sole-Vision Technologies, Inc. (doing business as MegaSys), a corporation organized under the laws of the Republic of China ("MegaSys"), pursuant to the share exchange agreement (the "Agreement") dated March 21, 2011 and a related side agreement of even date (the "Side Agreement"), by and among the Company, MegaSys, and the shareholders of MegaSys (the "MegaSys Shareholders"). Pursuant to the Agreement (i) the Company acquired 100% of the issued and outstanding shares of MegaSys Common Stock in exchange for the issuance to the MegaSys Shareholders of 1,700,000 shares of Common Stock of the Company (the "Exchange"), and (ii) MegaSys became a wholly owned subsidiary of Iveda. The Side Agreement provides that the MegaSys Shareholders are entitled to receive up to an additional 2,000,000 shares of Common Stock of the Company upon achievement by MegaSys of certain financial milestones set forth therein. The Exchange was approved by Taiwan's Foreign Investment Commission Agency. MegaSys is a Taiwanese company specializing in deploying video surveillance systems for airports, commercial buildings, government customers, data centers, shopping centers, hotels, banks, and Safe City initiatives in Taiwan and other neighboring countries. MegaSys integrates security surveillance products, software and services to provide integrated security solutions to the end user. Most of MegaSys's revenues are derived from one-time sales, which differs from Iveda's business model of on-going monitoring revenues. MegaSys does not own any proprietary technology or intellectual property other than certain trademarks in China and Taiwan used in its business. Management believes that the acquisition of MegaSys provides the following potential benefits to the Company's business: • MegaSys has an established presence and credibility in, and provides the Company with access to, the Asian market. • Management believes that the Company will be able to leverage MegaSys's relationships in Asia for cost-effective research and development of new product offerings and cost reduction of current product offerings. • Management expects to be able to source products directly using MegaSys's product sourcing expertise to enhance the Company's custom integration capabilities. • Management expects the Company will benefit from cost reductions for infrastructure equipment (servers, storage devices, network switches, and Super Wifi technologies) through a direct OEM relationship. • Management believes that MegaSys enhances the global distribution potential for Iveda's products and services. • MegaSys is expected to benefit from the Company's expertise in cloud-based video surveillance and access to the U.S. markets for its products. 33 The company does not expect to derive significant revenues from prior MegaSys customer installations. However, the prior MegaSys customer base helps to establish credibility for the Company to market its products and services in the Taiwanese and other Asian marketplaces. There can be no assurance that the Company will generate material future revenue from MegaSys's customers at the time of the Exchange. Results of Operations for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011 Net Revenue. We recorded net consolidated revenue of $3,608,998 for the year ended December 31, 2012, compared to $2,818,729 for the year ended December 31, 2011, an increase of $790,269 or 28%. In fiscal 2012, our recurring service revenue was $605,840 or 17% of consolidated net revenue, and our equipment sales and installation revenue was $2,815,150 or 78% of net revenue, compared to 617,437 or 22% of net revenue for recurring service and $2,081,923 or 74% of net revenue for equipment sales and installation revenue in 2011. Revenues in our U.S. operations were primarily derived from our recurring monthly service revenue, which represents 79% of U.S. net income. This material increase in total revenue in 2012 compared to the same period in 2011 is attributable primarily to increased equipment sales from our MegaSys subsidiary. Cost of Revenue. Total cost of revenue was $3,230,495 (89% of revenues; gross margin of 11%) for the year ended December 31, 2012, compared to $2,154,221 (76% of revenues; 24% gross margin) for the year ended December 31, 2011, an increase of $1,076,274 or 50%. The increase in cost of revenue and decrease of gross margin was primarily due to the increase of equipment sales and installation, which normally garner lower gross margin, combined with a $267,087 delay penalty for late completion of a project with New Taipei Police Station in Taiwan. This delay penalty was a reduction to revenue and in turn negatively impacted the gross margin percentage. This delay penalty is being contested with New Taipei Police Station and may be recouped during 2013, though currently there is no certainty of this outcome. Approximately 95% of MegaSys' revenue, with lower gross margin, was derived from equipment sales and installation. Operating Expenses. Operating expenses were $4,223,455 for the year ended December 31, 2012, compared to $5,049,966 for the year ended December 31, 2011, a decrease of $826,511 or 16%. The significant decrease in operating expenses was largely due to an impairment charge to goodwill during 2011 of $955,710. Without the goodwill charge in 2012 compared to 2011, operating expenses increased by $129,199, or 3%. The insignificant increase was attributable to professional fees associated with capital raises, general staffing expenses, and international travel expenses. Loss from Operations. Loss from operations decreased to $3,844,952 for the year ended December 31, 2012, compared to $4,385,458 for the year ended December 31, 2011, a decrease of $540,506 or 12%. The majority of this decrease was due to the one-time goodwill impairment charge in 2011. The majority of the loss, $3,416,026, was from our U.S. operations and the remaining $425,901 was from our operations in Taiwan. 34 Other Expense-Net. Other expense-net was $79,477 for the year ended December 31, 2012, compared to $30,566 for the year ended December 31, 2011, an increase of $48,911 or 160%. The expense-net increase is primarily in interest expense which relates to $79,759, offset by interest income of $806 and loss on foreign currency exchange of $524. Net Loss. Net loss was $3,841,927 for the year ended December 31, 2012, compared to $4,463,051 for the year ended December 31, 2011 The decrease of $ 621,124 or 14% in net loss was caused by a decrease of $955,710 in impairment goodwill charges, off-set by the insignificant increase in other operating expenses and the lower gross margin from MegaSys Taiwan equipment sales. Liquidity and Capital Resources As of December 31, 2012, we had cash and cash equivalents of $42,920 in our domestic business and $71,542 in our foreign business, compared to $341,570 in our domestic business and $508,794 in our foreign business as of December 31, 2011. This decrease in our cash and cash equivalents is primarily a result of timing differences in collections of accounts receivable, which were collectively $1,051,920 higher as of December 31, 2012 compared to December 31, 2011. There are no legal or economic factors that materially impact our ability to transfer funds between our domestic and foreign businesses. Net cash used in operating activities during the year ended December 31, 2012 was $3,327,703 and during the year ended December 31, 2011 was $2,108,913. Cash used in operating activities for the year ended December 31, 2012 consisted primarily of the net loss offset by approximately $248,072 in non-cash stock compensation and $123,940 in non-cash compensation. Our receivables increased significantly with our foreign entity recording their largest sales in the fourth quarter. Cash used in operating activities for the year ended December 31, 2011 consisted primarily of the net loss offset by approximately $515,419 in non-cash stock compensation and $518,000 in non-cash compensation. Net cash used by investing activities for the year ended December 31, 2012 was $338,825. Net cash provided by investing activities during the year ended December 31, 2011 was $586,993. Our net cash used by investing activities consisted for the year ended December 31, 2012 of increased capital expenditures to expand our infrastructure for a new major customer. Net cash provided by financing activities for the year ended December 31, 2012 was $2,918,602 and during the year ended December 31, 2011 was $2,039,922. Net cash provided in both periods consisted primarily of net proceeds from the sale of stock and proceeds from short-term borrowings, which were partially offset by principal payments on short term debt note obligations. At December 31, 2012, we had approximately $11,453,000 in net operating loss carryforwards available for federal and state income tax purposes. We did not recognize any benefit from these operating loss carryforwards, which federal operating loss carryforwards will expire beginning in 2025 through 2032. State net operating loss carryforwards will begin to expire in 2013. We have experienced significant operating losses since our inception. Our capital expenditures and working capital requirements will increase and other adjustments to our operating plan will be needed to respond to changes in competition or unexpected events. We believe that our cash on hand is not sufficient to meet our anticipated needs for working capital and capital expenditures. At December 31, 2012, we had cash and other current assets to meet working capital needs for only a limited period of time. We intend to seek to obtain additional working capital through debt and equity offerings. There can be no assurance that additional funds will be available on acceptable terms or on terms that do not adversely impact our existing shareholders or the price of our Common Stock. In the event that additional funds are not available on acceptable terms, we could be required to reduce the scope of, or cease, operations. 35 One customer in 2012 represented approximately 69% of total revenue and three customers in 2011 represented approximately 50% (26%, 14% and 10%) of total revenue. The accounts receivable from this customer was approximately 76% of total accounts receivable as of December 31, 2012. No other customers represented greater than 10% of total revenues in 2012 and 2011. Our U.S. operation has 47% of gross accounts receivable aged over 120 days at the year ended December 31, 2012. The terms for payment for our U.S. operations are "due upon receipt". Therefore, we have established an allowance for doubtful accounts of $22,554 to be recorded with respect to our U.S. operations. Our Taiwan operations, through MegaSys, have 21% of gross accounts receivables aged over 180 days at December 31, 2012. The payment terms vary based on the timing of the completion of the project. In general, payment takes place within one year of commencing the project, except that 5% of the total payment is retained and released one year after the completion of the project. Excluding such retained amounts, MegaSys provides an allowance for doubtful accounts for any receivables that will not be paid within one year. Management has set up a 5%, or $117,732, allowance for doubtful accounts as of the year ended December 31, 2012. Management deems the rest to be collectible based on the nature of the customer contracts and past experience with similar customers. Substantially all cash is deposited in two financial institutions, one in the United States and one in Taiwan. At times, amounts on deposit in the United States may be in excess of the FDIC insurance limit. Deposits in Taiwan financial institutions are insured by CDIC (Central Deposit Insurance Corporation) with maximum coverage of NTD 3 million. At times, amounts on deposit in Taiwan may be in excess of the CDIC insurance limit. The Company leases its office facilities under a non-cancelable operating lease expiring October 2016 that requires minimum monthly payments ranging from $8,669 to $10,836. Rent expense was $107,885 and $95,635 for the years ended December 31, 2012 and 2011, respectively. The Company also has two non-cancellable data center service agreements for approximately $7,298 and $2,575 per month, expiring September 2014. The company has a third non-cancellable data center service agreement for approximately $5,826, expiring March 2015. Data center services expense was $170,776 and $126,626 for the years ended December 31, 2012 and 2011, respectively, and is included as a component of Cost of Revenue in the Statement of Operations. Future minimum lease payments under these leases are as follows: 2013 $ 309,211 2014 $ 268,194 2015 $ 135,169 2016 $ 108,356 The Company has no off-balance sheet arrangements. 36 Inflation Management does not believe that the current levels of inflation in the United States have had a significant impact on the operations of the Company. Likewise, management does not believe that the current levels of inflation in Taiwan have had a significant impact on the operations of MegaSys. Recent Accounting Standards In October 2012, FASB has issued Accounting Standards Update (ASU) No. 2012-04, Technical Corrections and Improvements. This ASU make technical corrections, clarifications, and limited-scope improvements to various Topics throughout the Codification. The amendments in this ASU that will not have transition guidance will be effective upon issuance for both public entities and nonpublic entities. For public entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2012. For nonpublic entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2013. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In August 2012, FASB has issued Accounting Standards Update (ASU) No. 2012-03, Technical Amendments and Corrections to SEC Sections. This ASU amends various SEC paragraphs pursuant to SAB 114, SEC Release No. 33-9250, and ASU 2010-22, which amend or rescind portions of certain SAB Topics. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In July 2012, the FASB issued ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. The objective of the measure is to reduce the cost and complexity associated with performing an impairment test for indefinite-lived intangible assets and to make the impairment test similar to the recent changes for testing goodwill for impairment (ASU 2011-08). ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 and early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In December 2011, the Financial Accounting Standards Board ("FASB") issued ASU 2011-11, Balance Sheet (Topic 210) Disclosures about Offsetting Assets and Liabilities. The amendments in this update will enhance disclosures required by U.S. GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either ASC 210-20-45 or ASC 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either ASC 210-20-45 or ASC 815-10-45. This information will enable users of an entity's financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. The amendments in this Update are effective for annual periods for fiscal years beginning on or after January 1, 2013. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In September 2011, the FASB has issued Accounting Standards Update (ASU) No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity's financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. |