IMAGEWARE SYSTEMS, INC.
The following discussion should be read in conjunction with our consolidated
financial statements and the related notes and other financial information
appearing elsewhere in this Annual Report on Form 10-K. Readers are also urged
to carefully review and consider the various disclosures made by us, which
attempt to advise interested parties of the factors which affect our business,
including (without limitation) the disclosures made under the captions
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Risk Factors", and in the audited consolidated financial
statements and related notes included in this Annual Report on Form 10-K.
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Table of Contents OverviewImageware Systems, Inc. ("Imageware ," the "Company," "we," "our") provides biometric solutions to identify, verify, and authenticate people based on their true identity, rather than on what keys and codes they have. A pioneer in the field,Imageware was the first multimodal biometric solution provider in history and holds dozens of patents, including some of the most cited patents in the industry. Our Cloud-based and on-premises solutions provide faster, more accurate identification to better secure communities, data, and assets. In fact, governments, law enforcement agencies, and public and private enterprises worldwide trustImageware with critical identity solutions which manage millions of identities every day. Our patented Imageware Biometric Engine® is one of the most accurate and fastest biometrics matching engines in the industry, capable of our patented biometrics fusion. We are a "biometrics first" company, leveraging unique human characteristics to provide unparalleled accuracy for identification while protecting your identity. Our product portfolio, called the Imageware Identity Platform, is built around three key areas: Enroll & Identify, Badge & Credential, and Authenticate. All of these areas are built on top of the Imageware Biometric Engine. The Platform is a fully-modular, customizable, and pre-integrated portfolio of capabilities to support state and local law enforcement, Federal agencies, and enterprises alike. Enroll & Identify
The Enroll & Identify area includes four key modules: Imageware Proof, Imageware Capture, Imageware Identify, and Imageware Investigate.
Imageware Proof enables an entity to prove someone's identity from their biometrics, government issued ID, and 3rd party databases (such as credit bureau data). Imageware Capture enables the fastest capture of biographic and biometric detail (such as face, fingerprint, palm print, iris, and SMT's) in the industry. Imageware Identify enables a user to identify someone from their biometrics in seconds. Imageware Investigate enables an officer to create digital lineups very quickly. Badge & Credential
The Badge & Credential area includes two key modules: Imageware Credential (formerly EPI Suite) and Imageware Digital ID. Imageware Credential enables a user to design, build, and print badges for access control systems. This includes tickets, smart badges, wristbands, Personal Identity Verification ("PIV") cards, and more. Imageware Digital ID is a decentralized identity service that enables self-sovereign identity underpinned by blockchain technology tied to biometrics.
Authenticate
The Authenticate area includes Imageware Authenticate, which enables users to
leverage multimodal biometrics hosted in a central server or cloud to log in to
services and applications from any device. Imageware Authenticate is easily
integrated into existing solutions leveraging OpenID Connect ("OIDC"), Security
Assertion Mark-up Language ("SAML"), or OAuth2 protocols, and includes a
software development kit ("SDK") for partners and customers to easily embed into
their existing applications.
Imageware Biometric Engine
The Imageware Biometric Engine® is a patented biometric identity and
authentication database built for multi-biometric enrollment, management and
authentication. It is hardware agnostic and can utilize different types of
biometric algorithms from any vendor. It allows different types of biometrics to
be operated at the same time on a seamlessly integrated platform. It is also
offered as an SDK, enabling developers and system integrators to implement
biometric solutions or integrate biometric capabilities, into existing
applications.
Imageware Law Enforcement
Our modules are leveraged across many industries and use cases with minimal
customization needed. One of the key areas includes our Law Enforcement 2.0
solution which enables state, local and Federal agencies to quickly capture,
archive, search, retrieve, and share digital images, fingerprints and other
biometrics, as well as criminal history records on a stand-alone, networked,
wireless or browser-based platform. Our Imageware Law Enforcement 2.0 solution
includes Imageware Capture, Imageware Identify, Imageware Investigate, Imageware
Credential, and Imageware Authenticate. Other modules can also be easily
leveraged as needed.
Recent Market Conditions
During
The pandemic has significantly impacted the economic conditions both inthe United States and worldwide, with accelerated effects inFebruary 2020 through the date of this Annual Report, as federal, state and local governments react to the public health crisis, creating significant uncertainties in both the worldwide andthe United States economies. The situation is rapidly changing and additional impacts to our business may arise that we are not aware of currently. We cannot predict whether, when or the manner in which the conditions surrounding COVID-19 will change including the timing of lifting any restrictions or office closure requirements. The full extent of COVID-19's impact on our operations and financial performance depends on future developments that are uncertain and unpredictable, including the duration and spread of the pandemic, its impact on capital and financial markets and any new information that may emerge concerning the severity of the virus, its spread to other regions as well as the actions taken to contain it, among others. In addition to the impact resulting from COVID-19, recent geopolitical conflicts, specifically the war inUkraine , may have an additional impact on purchasing decisions both inthe United States and worldwide, which creates additional uncertainties in both the worldwide andthe United States economies. These factors could affect our ability to obtain additional financing or consummate a strategic transaction, although no assurances can be given. -20-
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Critical Accounting Estimates
The discussion and analysis of our consolidated financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). The preparation of these consolidated financial statements in accordance with GAAP requires us to utilize accounting policies and make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies as of the date of the consolidated financial statements and the reported amounts of revenue and expense during a fiscal period. TheSEC considers an accounting policy to be critical if it is important to a company's financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. Significant estimates include the evaluation of our ability to continue as a going concern, the allowance for doubtful accounts receivable, assumptions used in the Black-Scholes model to calculate the fair value of share-based payments, fair value of Series D Preferred and financial instruments issued with and affected by the Series D Preferred Financing (defined below), fair value of financial instruments with and affected by the Series C Preferred (defined below), fair value of Series A Preferred (defined below), fair value of Series A-1 Preferred (defined below), assumptions used in the application of revenue recognition policies, assumptions used in the derivation of the Company's incremental borrowing rate used in the computation of the Company's operating lease liabilities and assumptions used in the application of fair value methodologies to calculate the fair value of pension assets and obligations. Actual results could differ from estimates. The following are our critical accounting policies because we believe they are both important to the portrayal of our financial condition and results of operations and require critical management judgments and estimates about matters that are uncertain. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected. Revenue Recognition. EffectiveJanuary 1, 2018 , we adopted Accounting Standards Codification ("ASC"), Topic 606, Revenue from Contracts with Customers ("ASC 606"), using the modified retrospective transition method. In accordance with ASC 606, revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. The core principle of the standard is that we should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve that core principle, we apply the following five step model: 1. Identify the contract with the customer; 2. Identify the performance obligation in the contract; 3. Determine the transaction price; 4. Allocate the transaction price to the performance obligations in the contract; and
5. Recognize revenue when (or as) each performance obligation is satisfied.
At contract inception, we assess the goods and services promised in a contract with a customer and identify as a performance obligation each promise to transfer to the customer either: (i) a good or service (or a bundle of goods or services) that is distinct or (ii) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. We recognize revenue only when we satisfy a performance obligation by transferring a promised good or service to a customer.
Determining the timing of the satisfaction of performance obligations as well as the transaction price and the amounts allocated to performance obligations requires judgement.
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We disclose disaggregation of our customer revenue by classes of similar products and services as follows:
? Software licensing and royalties; ? Sales of computer hardware and identification media; ? Services; and ? Post-contract customer support.
Software licensing and royalties
Software licenses consist of revenue from the sale of software for identity management applications. Our software licenses are functional intellectual property and typically provide customers with the right to use our software in perpetuity as it exists when made available to the customer. We recognize revenue from software licensing at a point in time upon delivery, provided all other revenue recognition criteria are met.
Royalties consist of revenue from usage-based arrangements and guaranteed minimum-based arrangements. We recognize revenue for royalty arrangements at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied.
Computer hardware and identification media
We generate revenue from the sale of computer hardware and identification media. Revenue for these items is recognized upon delivery of these products to the customer, provided all other revenue recognition criteria are met. Services
Services revenue is comprised primarily of software customization services, software integration services, system installation services and customer training. Revenue is generally recognized upon completion of services and customer acceptance provided all other revenue recognition criteria are met.
Post-contract customer support ("PCS")
PCS consists of maintenance on software and hardware for our identity management solutions. We recognize PCS revenue from periodic maintenance agreements. Revenue is generally recognized ratably over the respective maintenance periods provided no significant obligations remain. Costs related to such contracts are expensed as incurred.
Arrangements with multiple performance obligations
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. In addition to selling software licenses, hardware and identification media, services and post-contract customer support on a standalone basis, certain contracts include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on our best estimate of the relative standalone selling price. The standalone selling price for a performance obligation is the price at which we would sell a promised good or service separately to a customer. The primary methods used to estimate standalone selling price are as follows: (i) the expected cost-plus margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service and (ii) the percent discount off of list price approach. Contract costs We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We apply a practical expedient to expense costs as incurred for costs to obtain a contract when the amortization period is one year or less. Other items
We do not offer rights of return for our products and services in the normal course of business.
Sales tax collected from customers is excluded from revenue.
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Impairment ofGoodwill , Other Intangible and Long-Lived Assets. The Company accounts for its intangible assets under the provisions of ASC Topic 350, Intangibles -Goodwill and Other ("ASC 350"). In accordance with ASC 350, intangible assets with a definite life are analyzed for impairment under ASC 360-10-05 "Property, Plant and Equipment" and intangible assets with an indefinite life are analyzed for impairment under ASC 360 annually, or more often if circumstances dictate. The Company performs its annual simplified impairment test in the fourth quarter of each year. InDecember 2018 , the Company adopted the provisions of ASU 2017-04, "Intangibles -Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment". The provisions of ASU 2017-04 eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit's carrying amount over its fair value. Entities that have reporting units with zero or negative carrying amounts will no longer be required to perform a qualitative assessment assuming they pass the simplified impairment test.
The Company did not record any goodwill impairment charges for the years ended
The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. The Company's management currently believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change or demand for the Company's products under development will continue. Either of these could result in future impairment of long-lived assets. There are many management assumptions and estimates underlying the determination of an impairment loss, and estimates using different, but reasonable, assumptions could produce significantly different results. Significant assumptions include estimates of future levels of revenue and operating expense. Therefore, the timing and recognition of impairment losses by us in the future, if any, may be highly dependent upon our estimates and assumptions. There can be no assurance that goodwill impairment will not occur in the future. Stock-Based Compensation. AtDecember 31, 2021 and 2020, the Company had one stock-based compensation plan for employees and nonemployee directors, which authorizes the granting of various equity-based incentives including stock options and restricted stock. The Company estimates the fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC Topic 718, Compensation - Stock Compensation ("ASC 718"). The fair value of stock options granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense is reported in general and administrative, sales and marketing, engineering and customer service expense based upon the departments to which substantially all of the associated employees report and credited to additional paid-in capital. ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. For the years endedDecember 31, 2021 and 2020, the Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best measure of expected volatility is based on the historical weekly volatility of the Company's Common Stock. Historical volatility factors utilized in the Company's Black-Scholes computations for options granted during the years endedDecember 31, 2021 and 2020 ranged from 57% and 99%. The Company has elected to estimate the expected life of an award based upon theSEC approved "simplified method" noted under the provisions of Staff Accounting Bulletin Topic 14. The expected term used by the Company to value the grants issued in 2021 and 2020 as computed by this method ranged from 3.33 to 5.17 years. The effect of the difference between the actual historical expected life and the simplified method was immaterial. The interest rate used is the risk-free interest rate and is based uponU.S. Treasury rates appropriate for the expected term. Interest rates used in the Company's Black-Scholes calculations ranged from 1.37% to 2.58%% for the years endedDecember 31, 2021 and 2020. Dividend yield is zero, as the Company does not expect to declare any dividends on the Company's common shares in the foreseeable future. -23-
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In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has utilized an estimated annualized forfeiture rate ranging from approximately 5.0% to 10% for corporate officers, 4.1% to 10% for members of the Board of Directors and 15.0% to 25% for all other employees for options granted during the years endedDecember 31, 2021 and 2020. The Company reviews the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience. Income Taxes. The Company accounts for income taxes in accordance with ASC Topic 740, Accounting for Income Taxes ("ASC 740"). Deferred income taxes are recognized for the tax consequences related to temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for tax purposes at each year-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established when necessary, based on the weight of available evidence, if it is considered more likely than not that all or some portion of the deferred tax assets will not be realized. Income tax expense is the sum of current income tax plus the change in deferred tax assets and liabilities. ASC 740-10 requires a company to first determine whether it is more-likely-than-not (defined as a likelihood of more than fifty percent) that a tax position will be sustained based on its technical merits as of the reporting date, assuming that taxing authorities will examine the position and have full knowledge of all relevant information. A tax position that meets this more-likely-than-not threshold is then measured and recognized at the largest amount of benefit that is greater than fifty percent likely to be realized upon effective settlement with a taxing authority. We recognize and measure uncertain tax positions in accordance with GAAP, pursuant to which we only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Any tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. GAAP further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the quarter of such change. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense. We file annual income tax returns in multiple taxing jurisdictions around the world. A number of years may elapse before an uncertain tax position is audited and finally resolved. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, we believe that our analysis of income tax reserves reflects the most likely outcome. We adjust these reserves, if any, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. Significant judgment is required in evaluating the Company's uncertain tax positions and determining the Company's provision for income taxes. No assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in the Company's historical income tax provisions and accruals. The Company adjusts these items in light of changing facts and circumstances. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The Internal Revenue Code (the "Revenue Code") limits the availability of certain tax credits and net operating losses that arose prior to certain cumulative changes in a corporation's ownership resulting in a change of control of the Company. The Company's use of its net operating loss carryforwards and tax credit carryforwards will be significantly limited because the Company believes it underwent "ownership changes", as defined under Section 382 of the Revenue Code, in 1991, 1995, 2000, 2003, 2004, 2011, 2012, 2018 and 2020, though the Company has not performed a study to determine the limitation. The Company has reduced its deferred tax assets to zero relating to its federal and state research credits because of such limitations. The Company continues to disclose the tax effect of the net operating loss carryforwards at their original amount as the actual limitation has not yet been quantified. The Company has also established a full valuation allowance for substantially all deferred tax assets due to uncertainties surrounding its ability to generate future taxable income to realize these assets. Since substantially all deferred tax assets are fully reserved, future changes in tax benefits will not impact the effective tax rate. Management periodically evaluates the recoverability of the deferred tax assets. If it is determined at some time in the future that it is more likely than not that deferred tax assets will be realized, the valuation allowance would be reduced accordingly at that time. -24-
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Fair-Value Measurements. The Company accounts for fair value measurements in
accordance with ASC Topic 820, Fair Value Measurements and Disclosures ("ASC
820"), which defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about
fair value measurements.
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value. The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1 measurements) and the lowest priority to unobservable
inputs (Level 3 measurements). The three levels of the fair value hierarchy
under ASC 820 are described below:
Level 1- Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2- Applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3- Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).
Assessing the significance of a particular input to the fair value measurement requires judgment, considering factors specific to the asset or liability. Determining whether a fair value measurement is based on Level 1, Level 2, or Level 3 inputs is important because certain disclosures are applicable only to those fair value measurements that use Level 3 inputs. The use of Level 3 inputs may include information derived through extrapolation or interpolation which involves management assumptions as well as valuation techniques employing Monte Carlo simulation methodologies.
Lease Liabilities and Operating Lease Right-of-Use Assets
The Company is a party to certain contractual arrangements for office space
which meet the definition of leases under ASC Topic 842 - Leases ("ASC 842").
In accordance with ASC 842, the Company has determined that such arrangements
are operating leases and accordingly the Company has, as of January 1, 2019 ,
recorded operating lease right-of-use assets and related lease liability for the
present value of the lease payments over the lease terms using the Company's
estimated weighted-average incremental borrowing rate of approximately 14.5%.
The Company has utilized the practical expedient regarding lease and nonlease
components and has combined such items into a single combined component. The
Company has also utilized the practical expedient regarding leases of twelve
months or less and has excluded such leases from its computation of lease
liability and related right-of-use assets. The Company has also elected the
optional transition package of practical expedients which include:
A package of practical expedient to not reassess:
? Whether a contract is or contains a lease
? Lease classification ? Initial direct costs The company evaluates its operating lease right-of-use assets for impairment. As ofDecember 31, 2021 , and through the date of this report, management's review indicated that there was an impairment of an operating lease right-of-use asset and the Company recorded an impairment loss of approximately$333,000 . Impairment is based on the excess of the carrying amount over the fair value, based on market value when available, or expected future economic benefits to the company from the operating lease right-of-use asset and is recorded in the period in which the determination is made. Such amount is included in the Company's Consolidated Statement of Operations for the year ended December31, 2021 under the caption "General and administrative" expense.
For a detailed discussion on the application of these and other accounting
policies, see Note 2 to the Notes to the Consolidated Financial Statements for
the Year Ended
Comparison of Results for Fiscal Years Ended
Product Revenue
Twelve Months Ended
December 31,
Net Product Revenue 2021 2020 $ Change % Change
(dollars in thousands)
Software and royalties $ 383 $ 872 $ (489 ) (56 )%
Percentage of total net product revenue 45 % 39 %
Hardware and consumables $ 290 $ 84 $ 206 245 %
Percentage of total net product revenue 34 % 4 %
Services $ 181 $ 1,275 $ (1,094 ) (86 )%
Percentage of total net product revenue 21 % 57 %
Total net product revenue $ 854 $ 2,231 $ (1,377 ) (62 )%
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Software and royalty revenue decreased 56% or approximately$489,000 during the year endedDecember 31, 2021 as compared to the corresponding period in 2020. This decrease is attributable to lower identification project related revenue of approximately$442,000 and lower royalty revenue of approximately$110,000 offset by higher law enforcement project related revenue of approximately$33,000 and higher sales of boxed identity management software sold through our distribution channel of approximately$30,000 . The decrease in identification project related revenue is reflective of lower software licenses sold into identification projects during the year endedDecember 31, 2021 and the decrease in royalty revenue results primarily from lower reported usage from certain customers. The increase in boxed identity management software sold through our distribution channel reflects higher procurement from certain international customers and the increase in law enforcement software reflects the expansion of our installed base among existing customers.
Revenue from the sale of hardware and consumables increased approximately
Services revenue consists primarily of software integration services, system installation services and customer training. Such revenue decreased$1,094,000 during the year endedDecember 31, 2021 as compared to the corresponding period in 2020, due to a decrease in the service element of project related work completed during the year endedDecember 31, 2021 . We believe that the period-to-period fluctuations of identity management software revenue in project-oriented solutions are largely due to the timing of government procurement with respect to the various programs we are pursuing. Although no assurances can be given, based on management's current visibility into the timing of potential government procurements and potential partnerships and current pilot programs, we believe that we will see an increase in government procurement and implementations with respect to identity management initiatives; however, government procurement initiatives, implementations and pilots are frequently delayed and extended and we cannot predict the timing of such initiatives. As discussed more fully elsewhere in this Annual Report, the full extent of COVID-19's impact on our operations and financial performance depends on future developments that are uncertain and unpredictable, including the duration and spread of the pandemic, its impact on our ability to close sales transactions and on capital and financial markets and any new information that may emerge concerning the severity of the virus, its spread to other regions as well as the actions taken to contain it, among others. During the year endedDecember 31, 2021 , we have focused on strategically modernizing our modules within the Imageware Identity Platform, prioritized by market opportunities. We relaunched Imageware Authenticate (formerly GoVerify ID®) inFebruary 2021 . This relaunch includes a new container and microservices-based architecture along with refreshed mobile and desktop clients. We believe these updates will result in additional customers implementing our Imageware Authenticate solution. Additionally, we launched Imageware Capture, our first module of the Law Enforcement 2.0 solution inOctober 2021 and Imageware Investigate inDecember 2021 . These are the first of many modules that we plan to build and modernize throughout 2022 and beyond. Prior to releasing Imageware Investigate, we closed our largest software-as-a-service (SaaS) deal in company history with Imageware Investigate. Management believes that these initiatives will result in the expansion of our solutions into state & local law enforcement, federal government, and enterprises alike. Maintenance Revenue Twelve Months Ended December 31, Maintenance Revenue 2021 2020 $ Change % Change (dollars in thousands) Total maintenance revenue$ 2,618 $ 2,554 $ 64 3 % Maintenance revenue was approximately$2,618,000 for the year endedDecember 31, 2021 , as compared to approximately$2,554,000 for the corresponding periods in 2020. For the year endedDecember 31, 2021 , identity management maintenance revenue was approximately$1,385,000 as compared to$1,264,000 for the comparable period in 2020. The increase of$121,000 in identification software maintenance revenue for the year endedDecember 31, 2021 as compared to the corresponding period of 2020 is reflective of certain additional maintenance services provided by the Company during the year endedDecember 31, 2021 . For the year endedDecember 31, 2021 , law enforcement maintenance revenue was approximately$1,233,000 as compared to$1,290,000 for the comparable period in 2020. The decrease of$57,000 in law enforcement maintenance revenue for the year endedDecember 31, 2021 as compared to the corresponding period of 2020 reflects the expiration of certain maintenance contracts. -26-
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We anticipate growth of our maintenance revenue through the retention of
existing customers combined with the expansion of our installed base resulting
from the completion of project-oriented work; however, we cannot predict the
timing of this anticipated growth.
Cost of Product Revenue
Twelve Months Ended
December 31,
Cost of Product Revenue: 2021 2020 $ Change % Change
(dollars in thousands)
Software and royalties $ 28 $ 54 $ (26 ) (48 )%
Percentage of software and royalty
product revenue 7 % 6 %
Hardware and consumables $ 200 $ 52 $ 148 285 %
Percentage of hardware and consumables
product revenue 69 % 62 %
Services $ 94 $ 694 $ (600 ) (86 )%
Percentage of services product revenue 52 % 54 %
Total product cost of revenue $ 322 $ 800 $ (478 ) 60 %
Percentage of total product revenue 38 % 36 %
The cost of software and royalty product revenue decreased approximately $26,000
due to lower software and royalty revenue for the year ended December 31, 2021
of approximately $489,000 . In addition to changes in costs of software and
royalty product revenue caused by revenue level fluctuations, costs of products
can vary as a percentage of product revenue from period to period depending upon
level of software customization and third-party software license content
included in product sales during a given period.
The cost of product revenue for our hardware and consumable sales during the
year ended December 31, 2021 increased approximately $148,000 as compared to the
corresponding period in 2020 due primarily to higher hardware and consumable
product revenue of approximately $206,000 during the 2021 period.
The cost of services revenue decreased approximately $600,000 during the year
ended December 31, 2021 as compared to the corresponding period in 2020 due to
lower service revenue of approximately $1,094,000 . Although changes in costs of
services product revenue are sometimes caused by revenue level fluctuations,
costs of services can also vary as a percentage of service revenue from period
to period depending upon both the level and complexity of professional service
resources utilized in the completion of the service element.
Cost of Maintenance Revenue
Twelve Months Ended
Maintenance cost of revenue December 31,
(dollars in thousands) 2021 2020 $ Change % Change
Total maintenance cost of revenue $ 346 $ 448 $ (102 ) (23 )%
Percentage of total maintenance revenue 13 % 18 %
Cost of maintenance revenue decreased approximately $102,000 during the year
ended December 31, 2021 as compared to the corresponding period in 2020 despite
higher maintenance revenue of approximately $64,000 . This decrease is reflective
of lower maintenance labor costs incurred during the year ended December 31,
2021 as compared to the corresponding period in 2020 due primarily to the
headcount reductions in our customer support department and a reduction in fixed
maintenance costs.
Product Gross Profit
Twelve Months Ended
December 31,
Product gross profit 2021 2020 $ Change % Change
(dollars in thousands)
Software and royalties $ 355 $ 818 $ (463 ) (57 )%
Percentage of software and royalty
product revenue 93 % 94 %
Hardware and consumables $ 90 $ 32 $ 58 181 %
Percentage of hardware and consumables
product revenue 31 % 38 %
Services $ 87 $ 581 $ (494 ) (85 )%
Percentage of services product revenue 48 % 46 %
Total product gross profit $ 532 $ 1,431 $ (899 ) (63 )%
Percentage of total product revenue 62 % 64 %
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Software and royalty gross profit decreased 57% or approximately$463,000 for the year endedDecember 31, 2021 as compared to the corresponding period in 2020, due primarily to lower software and royalty revenue of approximately$489,000 combined with lower software and royalty cost of revenue of$26,000 for the same period. This revenue decrease with only a minimal decrease in software and royalty cost of revenue reflects low third-party software costs. In addition to changes in costs of software and royalty product revenue caused by revenue level fluctuations, costs of products can vary as a percentage of product revenue from period to period depending upon level of software customization and third-party software license content included in product sales during a given period. Hardware and consumables gross profit increased approximately$58,000 for the year endedDecember 31, 2021 , as compared to the 2020 period, due primarily to higher hardware and consumable revenue of approximately$206,000 combined with higher cost of hardware and consumable revenue of approximately$148,000 . These increases result from an increase in project related solutions containing hardware and consumable components. Services gross profit decreased approximately$494,000 for the year endedDecember 31, 2021 as compared to the corresponding period in 2020 due to lower service revenue of approximately$1,094,000 combined with lower service cost of revenue of$600,000 for the year endedDecember 31, 2021 as compared to the corresponding period in 2020. Although changes in costs of services product revenue are sometimes caused by revenue level fluctuations, costs of services can also vary as a percentage of service revenue from period to period depending upon both the level and complexity of professional service resources utilized in the completion of the service element. Maintenance Gross Profit Twelve Months Ended Maintenance gross profit December 31, (dollars in thousands) 2021 2020 $ Change % Change Total maintenance gross profit$ 2,272 $ 2,106 $ 166 8 % Percentage of total maintenance revenue 87 % 82 % Gross profit related to maintenance revenue increased 8% or approximately$166,000 for the year endedDecember 31, 2021 as compared to the corresponding period in 2020. This increase reflects higher maintenance revenue of approximately$64,000 combined with lower cost of maintenance revenue of approximately$102,000 . The increase in maintenance revenue results from the provision of certain additional maintenance services to a certain customer during the year endedDecember 31, 2021 . The decrease cost of maintenance revenues for the year endedDecember 31, 2021 as compared to the corresponding period in 2020 is due primarily to reductions in headcount in our customer support department and reductions in certain fixed maintenance costs. Maintenance gross profit can change from period to period depending upon both the level and complexity of labor resources utilized in the provision of the maintenance services. Operating Expense Twelve Months Ended December 31, Operating expense 2021 2020 $ Change % Change (dollars in thousands) General and administrative$ 6,151 $ 4,102 $ 2,049
50 % Percentage of total net revenue 177 % 86 % Sales and marketing
$ 2,892 $ 2,936 $ (44 ) (1 )% Percentage of total net revenue 83 % 61 %
Research and development
(22 )%
Percentage of total net revenue 128 % 119 %
Depreciation and amortization
(22 )%
Percentage of total net revenue 2 % 2 %
General and Administrative Expense
General and administrative expense is comprised primarily of salaries and other employee-related costs for executive, financial, and other infrastructure personnel. General legal, accounting and consulting services, insurance, occupancy and communication costs are also included with general and administrative expense.
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The dollar increase of approximately$2,049,000 in general and administrative expense for the year endedDecember 31, 2021 as compared to the corresponding period in 2020 is comprised of the following major components:
? Overall decrease in personnel related expense of approximately
to reductions in headcount of various senior management positions changes;
? Increases in professional services of approximately
higher legal fees of approximately
approximately
contractor and contract service expenses of approximately
reductions in patent-related legal and other fees of approximately
reductions in general corporate expense of
public relations fees of approximately $18,000 ;
? Increase in insurance related expense of approximately
higher director & officer insurance premiums, increases in licenses, dues and
subscription expense of approximately
approximately
miscellaneous expense offset by reductions in office related costs of
approximately
facility;
? Recognition of impairment loss on an operating lease right-of-use asset of
management's review indicated that there was an impairment of an operating
lease right-of-use asset and the Company recorded an impairment loss based on
the excess of the carrying amount over the fair value, based on market value
when available, or expected future economic benefits to the company from the
operating lease right-of-use asset.
? Increase in financing expense of approximately $829,000 ; and
? Increase in stock-based compensation expense related to options and restricted
stock units ("RSU's") of approximately $293,000 .
We continue to focus our efforts on achieving additional future operating
efficiencies by reviewing and improving upon existing business processes and
evaluating our cost structure. We believe these efforts will allow us to
continue to gradually decrease our level of general and administrative expense
expressed as a percentage of total revenue.
Sales and Marketing Expense
Sales and marketing expense consists primarily of the salaries, commissions,
other incentive compensation, employee benefits and travel expense of our sales,
marketing, and business development personnel.
The dollar decrease of approximately $44,000 during the year ended December 31,
2021 as compared to the corresponding period in 2020 is primarily comprised of
the following major components:
? Decrease in personnel related expense of approximately $269,000 driven
primarily by headcount reductions;
? Increase in contractor and contract services of approximately $148,000
resulting from reduced utilization of certain sales consultants of
approximately $150,000 offset by higher contract service expense of
approximately $298,000 ;
? Increase in travel, trade show expense and office related expense of
approximately $121,000 ;
? Increase in stock-based compensation expense of approximately
? Decrease in our
the shutdown of this sales office.
Research and Development Expense
Research and development expense consists primarily of salaries, employee benefits and outside contractors for new product development, product enhancements, custom integration work and related facility costs.
Research and development expense decreased approximately$1,245,000 for the year endedDecember 31, 2021 , as compared to the corresponding period in 2020, due primarily to the following major components:
? Decrease in personnel related expense of approximately
headcount reductions;
? Increase in contractor fees and contract services of approximately
? Decrease in rent, office related expense and engineering tools and supplies of
approximately $61,000 ; and
? Increase in stock based-compensation expense of approximately $205,000 .
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Depreciation and Amortization
During the year endedDecember 31, 2021 , depreciation and amortization expense decreased approximately$16,000 as compared to the corresponding period in 2020. The relatively small amount of depreciation and amortization reflects the relatively small property and equipment carrying value.
Interest (Income) Expense, Net
For the year endedDecember 31, 2021 , we recognized interest income of$0 and interest expense of$2,000 . Interest expense for the year endedDecember 31, 2021 was comprised of approximately$1,000 on our related party notes payable and approximately$1,000 in deferred financing fee amortization on our related party notes payable classified as interest expense. For the year endedDecember 31, 2020 , we recognized interest income of$2,000 and interest expense of$104,000 . Other (Income) Expense, Net For the year endedDecember 31, 2021 , we recognized other income of approximately$156,000 and other expense of approximately$82,000 . The primary components of other income were approximately$131,000 from the write-off of liabilities at amounts less than their carrying value and$25,000 from sublease income. Other expense for the year endedDecember 31, 2021 is comprised of approximately$82,000 from the write-off of abandoned furniture. For the year endedDecember 31, 2020 , we recognized approximately$2,000 in other expense related to late payment penalty fees.
(Gain) on Change in Fair Value of Derivative Liabilities
For the year endedDecember 31, 2021 , we recognized approximately$18,809,000 from the change in fair value of derivative liabilities arising from the Series D Financing. Such decrease was determined by management using fair value methodologies and is included as non-cash income under the caption "(Gain on change in fair value of derivative liabilities" in our consolidated statement of operations for the year endedDecember 31, 2021 . For the year endedDecember 31, 2020 , we recognized approximately$369,000 from the decrease of derivative liabilities arising from the consummation of the Series C Financing inSeptember 2019 . Such decrease was determined by management using fair value methodologies and is included as non-cash income under the caption "Change in fair value of derivative liabilities" in our consolidated statement of operations for twelve months endedDecember 31, 2020 . Also for the year endedDecember 31, 2020 , we recognized approximately$1,883,000 from the decrease in fair value of derivative liabilities arising from the Series D Financing. Such decrease was determined by management using fair value methodologies and is included as non-cash income under the caption "Change in fair value of derivative liabilities" in our consolidated statement of operations for the year endedDecember 31, 2020 .
(Gain) on Extinguishment of Debt
For the year endedDecember 31, 2021 , we recognized a gain on debt extinguishment from the forgiveness of our PPP Loan. InSeptember 2021 , we received notification from theSmall Business Administration ("SBA") that our Paycheck Protection Program ("PPP") Loan of$1,571,000 was forgiven in its entirety along with accrued unpaid interest of approximately$10,000 . Such gain is included in the caption "(Gain) on extinguishment of debt" in our consolidated statement of operations for the year endedDecember 31, 2021 .
Loss on Extinguishment of Derivative Liabilities
For the year endedDecember 31, 2021 , we recognized a net loss on the extinguishment of derivative liabilities of approximately$311,000 pursuant to the conversion of 646 shares of Series D Preferred into Common Stock. Such loss is included in the caption "Loss on extinguishment of derivative liabilities" in our consolidated statement of operations for the year endedDecember 31, 2021 . Income Tax Expense During the years endedDecember 31, 2021 and 2020, we recorded an expense for income taxes of$10,000 and$7,000 , respectively. These tax expenses relate to taxes on income generated in certain foreign jurisdictions offset by research and development tax credits generated in certain foreign jurisdictions. We have incurred consolidated pre-tax losses during the years endedDecember 31, 2021 , and 2020, and have incurred operating losses in all prior periods. Management has determined that it is more likely than not that a tax benefit from such losses will not be realized and has established a full valuation allowance for any tax benefits. Accordingly, we did not record a benefit for income taxes for these periods. -30-
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Liquidity, Capital Resources and Going Concern
Historically, our principal sources of cash have included proceeds from the
issuance of common and preferred stock and proceeds from the issuance of debt,
and, to a lesser extent, customer payments from the sale of our products. Our
principal uses of cash have included cash used in operations, product
development, and payments relating to purchases of property and equipment. We
expect that our principal uses of cash in the future will be for product
development, including customization of identity management products for
enterprise and consumer applications, further development of intellectual
property, development of Software-as-a-Service ("SaaS") capabilities for
existing products as well as general working capital requirements. Management
expects that, as our revenue grows, our sales and marketing and research and
development expense will continue to grow, albeit at a slower rate and, as a
result, we will need to generate significant net revenue to achieve and sustain
positive cash flows from operations. Historically the Company has not been able
to generate sufficient net revenue to achieve and sustain positive cash flows
from operations, and this condition is currently expected to continue for the
foreseeable future. As a result, the Company has been dependent on equity and
debt financings to satisfy its working capital requirements and continue as a
going concern. Due to the Company's deteriorating liquidity, management has
determined that there is substantial doubt about the Company's ability to
continue as a going concern.
At December 31, 2021 and 2020, we had negative working capital of $8,046,000 and
$19,349,000 , respectively. Included in our negative working capital as of
December 31, 2021 and 2020 are $5,292,000 and $24,128,000 , respectively, of
derivative liabilities which are not required to be settled in cash except in
the event of the consummation of a change of control or at any time after the
fourth anniversary of the Series D Preferred issuance, at which time the holders
of the Series D Preferred may require the Company to redeem in cash any or all
of the holder's outstanding Series D Preferred at an amount equal to the Series
D Liquidation Preference Amount. At December 31, 2021 the Liquidation Preference
Amount totaled $23,216,000 . Considering the financings consummated in 2020 and
2021, as well as our projected cash requirements, and assuming we are unable to
generate incremental revenue, our available cash will be insufficient to satisfy
our cash requirements in the near term, and for the next twelve months from the
date of this filing. At April 12, 2022 , cash on hand approximated $588,000 .
Based on the Company's rate of cash consumption during the year ended December
31, 2021 and the first quarter ended March 31, 2022 , the Company estimates it
will need additional capital in the second quarter of 2022 and its prospects for
obtaining that capital are uncertain. As a result of the Company's historical
losses, financial condition, and challenges raising additional capital given the
volatile capital markets, there is substantial doubt about the Company's ability
to continue as a going concern.
To address our working capital requirements, management has instituted several
cost cutting measures and has utilized cash proceeds available under the Credit
Facility with Nantahala and other lenders, as described below, and under the
purchase agreement with Lincoln Park Capital Fund, LLC ("Lincoln Park"), as
described below, to satisfy its working capital requirements ("LPC Purchase
Agreement"). In addition, as reported in the Company's Quarterly Report on Form
10-Q filed with the SEC on August 23, 2021 , on August 12, 2021 , the Company
retained an investment bank to initiate a review of available alternatives to
maximize shareholder value, which may include, among other alternatives, (i) a
merger, consolidation, or other business combination or a purchase involving all
or a substantial amount of the business, securities or assets of the Company,
and/or (ii) the private placement of securities to meet its working capital
requirements or otherwise as necessary in connection with the consummation of
any of the above transactions. Other than the LPC Purchase Agreement with
Lincoln Park and our Credit Facility with Nantahala, which are currently
restricted in our ability to access additional capital, there are currently no
financing arrangements to support our projected cash shortfall. We currently
have no other commitments to purchase additional debt and/or equity securities,
or other agreements, and no assurances can be given that we will be successful
in raising additional debt and/or equity securities, or entering into any other
transaction that addresses our ability to continue as a going concern. The
consummation of a transaction will involve substantial dilution to the Company's
stockholders.
In view of the matters described in the preceding paragraphs, recoverability of
a major portion of the recorded asset amounts shown in the accompanying
consolidated balance sheet is dependent upon continued operations of the
Company, which, in turn, is dependent upon the Company's ability to continue to
raise capital, generate positive cash flows from operations, or otherwise
consummate a transaction that addresses the Company's working capital
requirements. There is no assurance that the Company will be able to obtain
additional capital, consummate a transaction that addresses its liquidity
concerns, or operate at a profit or generate positive cash flows in the future.
Therefore, management's plans do not alleviate the substantial doubt of the
Company's ability to continue as a going concern.
The consolidated financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts and
classifications of liabilities that might be necessary should the Company be
unable to continue as a going concern.
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Table of ContentsDecember 2021 Credit Facility OnDecember 29, 2021 (the "Closing Date"), the Company entered into a Term Loan and Security Agreement (the "Agreement") with certain funds and separate accounts managed byNantahala Capital Management, LLC (collectively, "Nantahala"), as lenders, and the other lenders set forth on the signature pages thereto (together with Nantahala, the "Lenders"), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to$2,500,000 (the "Credit Facility"). All loans (each a "Loan", and collectively, the "Loans") under the Credit Facility will bear interest at a rate of 12% for the initial six months after the Closing Date, and at 17% thereafter until the maturity date of 12 months from the Closing Date (the "Maturity Date"). All amounts borrowed by the Company under the Credit Facility are secured by a first-priority lien on all the assets of the Company. On the Closing Date, the Company received in initial draw-downs on the Credit Facility of$600,000 . As ofApril 12, 2022 , the Company received two subsequent draw-down aggregating$1,050,000 . The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes. The Company may prepay amounts borrowed under the Credit Facility in whole or in part, at a price equal to 105% of the principal amount borrowed under the Credit Facility (including any interest capitalized thereon). Upon the occurrence of: (I) any Debt Issuances, Dispositions, or Equity Interests (each as defined in the Agreement), the Company must prepay the Loans in an aggregate amount equal to the lesser of (a) the outstanding principal balance outstanding under the Credit Facility (including any interest capitalized thereon), and (b) 100% of the Net Cash Proceeds (as defined in the Agreement) received thereunder; and (II) a Change of Control (as defined in the Agreement), the Company must prepay the Loans in an aggregate amount equal to the lesser of (y) the outstanding principal balance outstanding under the Credit Facility (including any interest capitalized thereon), and (z) 105% of the Net Cash Proceeds received in connection therewith. Pursuant to the Agreement, at any time after the Closing Date, each Lender shall have the right, but not the obligation, on mutually agreed upon terms, to exchange each such Lender's pro rata portion of shares of the Company's Series D Convertible Preferred Stock, par value$0.01 ("Series D Preferred") held by such Lender for a mutually agreed upon portion of any subsequent Delayed Draw Loan (as defined in the Agreement) (an "Exchange"). Upon the Company's receipt by a Lender of a notice stating a Lender's intent to participate in an Exchange, the Company is required to offer to all holders of Series D Preferred the opportunity, but not the obligation, to exchange each such holder's pro rata portion of shares of the Company's Series D Preferred held by such holder for participation in any subsequent Delayed Draw Loan, upon substantially similar terms as those provided in the applicable notice of Exchange by a Lender. The Agreement contains customary events of default (each an "Event of Default"). If an Event of Default occurs, all amounts due and payable under the Credit Facility shall incur interest at the current rate of interest plus 4%. The Agreement further contains: (i) customary representations, warranties and covenants of the Company, including among others, covenants by the Company regarding title to the Company's Assets, the Company's rights to its intellectual property, the Company's use of the proceeds received thereunder, tax liabilities, and status of the Company's material contracts; and (ii) customary indemnification provisions whereby the Company will indemnify the Lenders for certain losses arising out of inaccuracies in, or breaches of, the representations, warranties and covenants of the Company, and certain other matters. 2021 Lincoln Park Financing OnMay 17, 2021 (the "Execution Date"), the Company entered into a purchase agreement, dated as of the Execution Date (the "2021 LPC Purchase Agreement"), and a registration rights agreement, dated as of the Execution Date (the "Registration Rights Agreement"), withLincoln Park Capital Fund, LLC ("Lincoln Park"), pursuant to which Lincoln Park has committed to purchase up to$15,100,000 of the Company's Common Stock. Under the terms and subject to the conditions of the 2021 LPC Purchase Agreement, the Company has the right, but not the obligation, to sell to Lincoln Park, and Lincoln Park is obligated to purchase up to$15,100,000 worth of shares of Common Stock. Such sales of Common Stock by the Company, if any, will be subject to certain limitations, and may occur from time to time, at the Company's sole discretion, over the 24-month period commencing onJuly 23, 2021 , the date that the registration statement covering the resale of shares of Common Stock that have been and may be issued under the 2021 LPC Purchase Agreement, which was filed with theSEC pursuant to the Registration Rights Agreement, and was declared effective by theSEC and a final prospectus in connection therewith is filed and the other conditions set forth in the 2021 LPC Purchase Agreement are satisfied, all of which are outside the control of Lincoln Park (such date on which all of such conditions are satisfied, the "Commencement Date"). -32-
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Under the 2021 LPC Purchase Agreement, on any business day over the term of the
2021 LPC Purchase Agreement, the Company has the right, in its sole discretion,
to present Lincoln Park with a purchase notice (each, a "Purchase Notice")
directing Lincoln Park to purchase up to 250,000 shares of Common Stock per
business day ("Regular Purchase"), which (i) increases to up to 300,000 shares
in the event the price of the Company's Common Stock is not below $0.10 per
share, (ii) increases to 350,000 shares of Common Stock per Business Day in the
event the price of the Company's Common Stock is not below $0.25 per share, and
(iii) increases to 500,000 shares in the event the price of the Company's Common
Stock is not below $0.50 per share (in each case, subject to adjustment for any
reorganization, recapitalization, non-cash dividend, stock split, reverse stock
split or other similar transaction as provided in the 2021 LPC Purchase
Agreement). In each case, Lincoln Park's maximum commitment in any single
Regular Purchase may not exceed $500,000 . The parties may mutually agree to
increase the number of shares to be purchased by Lincoln Park pursuant to any
Regular Purchase up to 2,000,000 shares. The 2021 LPC Purchase Agreement
provides for a purchase price per Purchase Share (the "Purchase Price") equal to
the lesser of:
? The lowest sale price of the Company's Common Stock on the purchase date; and
? The average of the three lowest closing sale prices for the Company's Common
Stock during the fifteen consecutive business days ending on the business day
immediately preceding the purchase date of such shares.
In addition, on any date on which the Company submits a Purchase Notice to
Lincoln Park, the Company also has the right, in its sole discretion, to present
Lincoln Park with an accelerated purchase notice (each, an "Accelerated Purchase
Notice") directing Lincoln Park to purchase an amount of stock (the "Accelerated
Purchase") equal to up to the lesser of (i) three times the number of shares of
Common Stock purchased pursuant to such Regular Purchase; and (ii) 30% of the
aggregate shares of the Company's Common Stock traded during all or, if certain
trading volume or market price thresholds specified in the 2021 LPC Purchase
Agreement are crossed on the applicable Accelerated Purchase Date, the portion
of the normal trading hours on the applicable Accelerated Purchase Date prior to
such time that any one of such thresholds is crossed (such period of time on the
applicable Accelerated Purchase Date, the "Accelerated Purchase Measurement
Period"), provided that Lincoln Park will not be required to buy shares of
Common Stock pursuant to an Accelerated Purchase Notice that was received by
Lincoln Park on any business day on which the last closing trade price of the
Company's Common Stock on the OTC Markets (or alternative national exchange in
accordance with the 2021 LPC Purchase Agreement) is below $0.25 per share. The
parties may mutually agree to increase the number of shares to be purchased by
Lincoln Park pursuant to any Accelerated Purchase. The purchase price per share
of Common Stock for each such Accelerated Purchase will be equal to 95% of the
lesser of:
? The volume weighted average price of the Company's Common Stock during the
applicable Accelerated Purchase Measurement Period on the applicable
Accelerated Purchase Date; and
? The closing sale price of the Company's Common Stock on the applicable
Accelerated Purchase Date.
The Company may also direct Lincoln Park on any business day on which an
Accelerated Purchase has been completed and all of the shares to be purchased
thereunder have been properly delivered to Lincoln Park in accordance with the
2021 LPC Purchase Agreement, to purchase an amount of stock (the "Additional
Accelerated Purchase") equal to up to the lesser of (i) three times the number
of shares purchased pursuant to such Regular Purchase; and (ii) 30% of the
aggregate number of shares of the Company's Common Stock traded during a certain
portion of the normal trading hours on the applicable Additional Accelerated
Purchase date as determined in accordance with the 2021 LPC Purchase Agreement
(such period of time on the applicable Additional Accelerated Purchase date, the
"Additional Accelerated Purchase Measurement Period"). The parties may mutually
agree to increase the number of shares to be purchased by Lincoln Park pursuant
to any Additional Accelerated Purchase. Additional Accelerated Purchases will be
equal to 95% of the lower of:
? The volume weighted average price of the Company's Common Stock during the
applicable Additional Accelerated Purchase Measurement Period on the
applicable Additional Accelerated Purchase date; and
? The closing sale price of the Company's Common Stock on the applicable
Additional Accelerated Purchase date.
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The aggregate number of shares that the Company can sell to Lincoln Park under the 2021 LPC Purchase Agreement may in no case exceed that number which, together with Lincoln Park's then current holdings of Common Stock, exceed 4.99% of the Common Stock outstanding immediately prior to the delivery of the Purchase Notice. Lincoln Park has no right to require the Company to sell any shares of Common Stock to Lincoln Park, but Lincoln Park is obligated to make purchases as the Company directs, subject to certain conditions. There are no upper limits on the price per share that Lincoln Park must pay for shares of Common Stock.
The Company has agreed with Lincoln Park that it will not enter into any "variable rate" transactions with any third party for a period defined in the 2021 LPC Purchase Agreement.
The Company issued to Lincoln Park 1,000,000 shares of Common Stock as commitment shares in consideration for entering into the 2021 LPC Purchase Agreement on the Execution Date.
The 2021 LPC Purchase Agreement and the Registration Rights Agreement contain customary representations, warranties, agreements and conditions to completing future sale transactions, indemnification rights and obligations of the parties. The Company has the right to terminate the 2021 LPC Purchase Agreement at any time, at no cost or penalty, subject to the survival of certain provisions set forth in the 2021 LPC Purchase Agreement. During any "event of default" under the 2021 LPC Purchase Agreement, all of which are outside of Lincoln Park's control, Lincoln Park does not have the right to terminate the 2021 LPC Purchase Agreement; however, the Company may not initiate any regular or other purchase of shares by Lincoln Park, until such event of default is cured. In addition, in the event of bankruptcy proceedings by or against the Company, the 2021 LPC Purchase Agreement will automatically terminate. Actual sales of shares of Common Stock to Lincoln Park under the 2021 LPC Purchase Agreement will depend on a variety of factors to be determined by the Company from time to time, including, among others, market conditions, the trading price of the Common Stock and determinations by the Company as to the appropriate sources of funding for the Company and its operations. Lincoln Park has no right to require any sales by the Company but is obligated to make purchases from the Company as it directs in accordance with the 2021 LPC Purchase Agreement. Lincoln Park has covenanted not to cause or engage in any manner whatsoever, any direct or indirect short selling or hedging of the Company's shares. In connection with the execution of the 2021 LPC Purchase Agreement, the Company has agreed to sell, and Lincoln Park has agreed to purchase, 1,000,000 shares of Common Stock for a purchase price of$100,000 ("Original Purchase").
Due to the terms of the 2021 LPC Purchase Agreement as described above, management is not currently expecting the related proceeds from this agreement to be sufficient to sustain operations for an extended period of time.
Prior to entering into the 2021 LPC Purchase Agreement, the Company and Lincoln
Park terminated the previous agreement between the Company and Lincoln Park
entered into on
The Series D Preferred Stock Financing
OnNovember 12, 2020 andDecember 23, 2020 , the Company consummated private placements of 12,060 shares of its Series D Convertible Preferred Stock, par value$0.01 per share resulting in gross proceeds to the Company of$12.06 million , less fees and expenses. The gross proceeds include approximately$2.2 million in principal amount due and payable under the terms of certain term loans issued by the Company onSeptember 29, 2020 ("Bridge Notes"), which Bridge Notes were converted into Series D Preferred at Closing (the "Conversion"). The issuance of the Series D Preferred was made pursuant to securities purchase agreements, datedSeptember 28, 2020 (the "Purchase Agreement"), by and between the Company and certain accredited investors (the "Purchasers"), for the sale of the Series D Preferred at a purchase price of$1,000 per share of Series D Preferred. The holders of Series D Preferred may voluntarily convert their shares of Series D Preferred into shares of the Company's Common Stock at any time that is at least ninety days following the issuance date, at the conversion price calculated by dividing the Stated Value by the conversion price of$0.0583 per share of Common Stock, subject to adjustments as set forth in Section 5(e) of the Certificate of Designations, Preferences, and Rights of Series D Convertible Preferred Stock (the "Series D Certificate"). Dividends on shares of Series D Preferred will be paid prior to any junior securities and are to be paid at the rate of 4% of the Stated Value (as defined in the Series D Certificate) per share per annum in the form of shares of Series D Preferred. -34-
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On the fourth anniversary of the Issuance Date (as defined in the Series D Certificate), or in the event of the consummation of a Change of Control (as defined in the Series D Certificate), if any shares of Series D Preferred are outstanding, then each holder of Series D Preferred shall have the right (the "Holder Redemption Right"), at such holder's option, to require the Company to redeem all or any portion of such holder's shares of Series D Preferred at the Liquidation Preference Amount per share of Series D Preferred plus an amount equal to all accrued but unpaid dividends, if any, (such price, the "Holder Redemption Price"), which Holder Redemption Price shall be paid in cash. In connection with the sale of the Series D Preferred, we granted certain registration rights to the Investors with respect to the Conversion Shares and Dividend Shares, pursuant to a Registration Rights Agreement by and among us and the Investors. The registration statement registering the Conversion Shares and Dividend Shares was declared effective by theSEC onFebruary 12, 2021 . Operating Activities Net cash used in operating activities was approximately$7,737,000 during the year endedDecember 31, 2021 as compared to$8,009,000 during the year endedDecember 31, 2020 . During the year endedDecember 31, 2021 , net cash used in operating activities consisted of net income of$9,282,000 and an increase in working capital and other assets and liabilities of$589,000 . Those amounts in addition to approximately$17,608,000 of non-cash income, including$18,809,000 in income from the change in fair value of derivative liabilities and$1,581,000 in income from the extinguishment of debt offset by$1,528,000 in stock-based compensation,$56,000 in depreciation and amortization,$82,000 in non-cash expense from the disposal of fixed assets,$364,000 in non-cash expense from the write-off of deferred stock issuance costs,$311,000 in non-cash expense from the extinguishment of derivative liabilities,$333,000 from the recognition of an impairment loss of an operating lease right-of -use asset,$50,000 from the write-off of an abandoned patent and$58,000 from the issuance of common stock as compensation in lieu of cash. During the year endedDecember 31, 2021 , we generated cash of$139,000 from decreases in current assets offset by$44,000 from increases in our operating leases right-of-use assets and generated cash of$531,000 through increases in current liabilities and deferred revenue offset by increases of$37,000 in pension liability. Net cash used in operating activities was$8,009,000 during the year endedDecember 31, 2020 as compared to$11,267,000 during the year endedDecember 31, 2019 . During the year endedDecember 31, 2020 , net cash used in operating activities consisted of net loss of$7,253,000 and an increase in working capital and other assets and liabilities of$438,000 . Those amounts in addition to approximately$1,194,000 of non-cash income, including$2,252,000 in income from the change in fair value of derivative liabilities offset by$862,000 in stock-based compensation,$72,000 in depreciation and amortization and$124,000 from the application of rent deposits. Investing Activities Net cash used in investing activities during the year endedDecember 31, 2021 was$53,000 as compared to$0 for the corresponding period in 2020. For the year endedDecember 31, 2021 , we used cash of$53,000 to fund capital expenditures of computer hardware. Financing Activities Cash generated from financing activities for the year endedDecember 31, 2021 was approximately$572,000 , which consisted of approximately$600,000 received by the Company in the form of a draw-down from its Credit Facility, net of direct financing costs of$77,000 and$100,000 from the sale of 1,000,000 shares of Common Stock for$0.10 per share and used cash of approximately$51,000 for the payment of dividends on our Series B Preferred Stock. Cash generated from financing activities for the year endedDecember 31, 2020 was approximately$15,475,000 , which consisted of approximately$12,060,000 generated from the sale of 12,060 shares of Series D Preferred. Such amount includes$2,187,000 received by the Company in the form of aBridge Loan which was converted into shares of Series D Preferred before recognition of approximately$726,000 in cash direct stock issuance costs. We also generated cash of approximately$900,000 from the issuance of related party notes payable and generated cash of$1,571,000 from the issuance of the PPP Loan under the CARES Act. Also in the year endedDecember 31, 2020 , we generated cash of approximately$2,360,000 from the sales of 15,700,000 shares of Common Stock before recognition of approximately$64,000 in direct stock issuance costs. We used cash of approximately$575,000 to repay certain related party notes payable and used cash of approximately$51,000 for the payment of dividends on our Series B Preferred. -35-
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Table of Contents Real Property Leases Our corporate headquarters is located inSan Diego, California , where we now occupy approximately 500 square feet of office space at a cost of approximately$2,000 per month. We entered into this facility's lease inFebruary 2021 , with the new lease commencing onMarch 1, 2021 on a month-to-month basis. Prior to entering into our current lease agreement inJanuary 2021 , and moving our corporate headquarters to a new location, we occupied 8,511 square feet of office space inSan Diego , at a cost of approximately$28,000 per month. InJanuary 2021 , we entered in a subleasing agreement for our previously occupied corporate headquarters located inSan Diego, California . The term of the sublease commenced onApril 1, 2021 and expires onApril 30, 2025 , coterminous with the expiration of the Company's master lease. Sublease payments due the Company approximate$26,000 per month over the term of the sublease. Stock-Based Compensation Stock-based compensation related to equity options and restricted stock has been classified as follows in the accompanying consolidated statements of operations (in thousands): Year Ended December 31, 2021 2020 Cost of revenue $ 29$ 15 General and administrative 842 550 Sales and marketing 336 163 Research and development 321 134 Total$ 1,528 $ 862
Off-Balance Sheet Arrangements
AtDecember 31, 2021 , we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, special purpose or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we did not engage in trading activities involving non-exchange traded contracts. As a result, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have relationships and transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed elsewhere in this Annual Report.
Recently Issued Accounting Pronouncements
From time to time, new accounting pronouncements are issued by theFinancial Accounting Standards Board (the "FASB"), or other standard setting bodies, which are adopted by us as of the specified effective date. Unless otherwise discussed, the Company's management believes the impact of recently issued standards not yet effective will not have a material impact on the Company's consolidated financial statements upon adoption. See Note 2 to these consolidated financial statements for a detailed discussion of recently issued accounting pronouncements. Impact of Inflation The primary inflationary factor affecting our operations is labor costs, and we do not believe that inflation has materially affected earnings during the past four years. Substantial increases in costs and expense, particularly labor and operating expense, could have a significant impact on our operating results to the extent that such increases cannot be passed along to customers and end users. -36-
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