IMAGEWARE SYSTEMS, INC. Forward-Looking Statements
This Quarterly Report on Form 10-Q (this "Quarterly Report") contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All forward-looking statements included in this report are based on information available to us as of the date hereof and we assume no obligation to update any forward-looking statements. Forward-looking statements involve known or unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements, or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include but are not limited to those items discussed under "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 , and in Item 1A of Part II of this Quarterly Report. The following discussion of the financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements included elsewhere within this Quarterly Report. Fluctuations in annual and quarterly results may occur as a result of factors affecting demand for our products, such as the timing of new product introductions by us and by our competitors and our customers' political and budgetary constraints. Due to such fluctuations, historical results and percentage relationships are not necessarily indicative of the operating results for any future period. As used in this Quarterly Report, "we", "us", "our", "ImageWare", "ImageWare Systems", "IWS", or the "Company" refers toImageWare Systems, Inc. , aDelaware corporation, and all of its subsidiaries. Overview The Company is a pioneer and leader in biometric identification and authentication software. Using human characteristics that are unique to us all, the Company creates software that provides a highly reliable indication of a person's identity. The Company's products are used to manage and issue secure credentials, including national IDs, passports, driver licenses and access control credentials. The Company's products also provide law enforcement with integrated mugshot, fingerprint LiveScan and investigative capabilities. The Company also provides comprehensive authentication security software using biometrics to secure physical and logical access to facilities or computer networks or Internet sites. Biometric technology is now an integral part of all markets the Company addresses, and all the products leveraged by our patented IWS Biometric Engine®.
Critical Accounting Policies and Estimates
The discussion and analysis of our consolidated financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted 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.The Securities and Exchange Commission ("SEC") considers an accounting policy to be critical if it is important to a company's financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expense during the reporting period. Significant estimates include the evaluation of our ability to continue as a going concern, the allowance for doubtful accounts receivable, assumptions used in the Black-Scholes model to calculate the fair value of share based payments, fair value of financial instruments issued with and affected by the Series D Preferred Financing, assumptions used in the application of revenue recognition policies, and assumptions used in the application of fair value methodologies to calculate the fair value of pension assets and obligations. Critical accounting policies are those that, in management's view, are most important in the portrayal of our financial condition and results of operations. Management believes there have been no material changes during the three months endedSeptember 30, 2021 to the critical accounting policies discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year endedDecember 31, 2020 . - 30 -
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Table of Contents Results of Operations This management's discussion and analysis of financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes contained elsewhere in this Quarterly Report. Comparison of the Three Months EndedSeptember 30, 2021 to the Three Months EndedSeptember 30, 2020 Three Months Ended Net Product Revenue September 30, (dollars in thousands) 2021 2020 $ Change % Change Software and royalties$ 40 $ 587 $ (547 ) (93 )% Percentage of total net product revenue 28 % 32 % Hardware and consumables$ 20 $ 13 $ 7 54 % Percentage of total net product revenue 14 % 0 % Services$ 85 $ 1,258 $ (1,173 ) (93 )% Percentage of total net product revenue 58 % 68 % Total net product revenue$ 145 $ 1,858 $ (1,713 ) (92 )% Software and royalty revenue decreased approximately$547,000 during the three months endedSeptember 30, 2021 as compared to the corresponding period in 2020. This decrease is attributable to lower identification project related revenue of approximately$529,000 , lower law enforcement software revenue of approximately$5,000 , lower identification royalties of approximately$19,000 , offset by higher sales of boxed identity management software sold through our distribution channel of approximately$6,000 Revenue from the sale of hardware and consumables increased approximately$7,000 during the three months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due to an increase in consumables procurement by our law enforcement customers. Services revenue is comprised primarily of software integration services, system installation services and customer training. Such revenue decreased approximately$1,173,000 during the three months endedSeptember 30, 2021 as compared to the corresponding period of 2020 due to a decrease in the service element of project related work completed during the three months endedSeptember 30, 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 Quarterly 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 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 three months endedSeptember 30, 2021 , we have focused on strategically updating our products with the latest mobile and Cloud technology, prioritized by market opportunities. The first major update is the launch of the first module of the Law Enforcement 2.0 (LE 2.0) Platform, Imageware Capture, in September. We modernized the UI for law enforcement professionals, building the solution as a web-based Software as a Service (SaaS) product with a reactive design that can be accessed from any device anywhere. In addition, we have integrated Imageware Authenticate formerly GoVerify ID® into the LE 2.0 platform. This update is already resulting in additional customers implementing our Authenticate solution. We have focused on integrating the suite of products that comprise theImageware Identity Platform - this includes simplifying our portfolio overview, positioning, and branding. In addition, we plan to continue enhancing our Identity Platform products through 2022. This effort includes modernizing our Credential product (formerly EPI) for biometric smart badges. Management believes that these initiatives will result in the expansion of our solutions into both state/local law enforcement and federal agencies in addition to non-governmental sectors, including banking/financial services, insurance, telecommunications, healthcare, hospitality, and others. - 31 -
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Three Months Ended
Maintenance Revenue September 30,
(dollars in thousands) 2021 2020 $ Change % Change
Total maintenance revenue $ 633 $ 613 $ 20 3 %
Maintenance revenue was approximately $633,000 for the three months ended
September 30, 2021 , as compared to approximately $613,000 for the corresponding
period in 2020. Identity management maintenance revenue generated from
identification software solutions was approximately $334,000 for the three
months ended September 30, 2021 as compared to approximately $290,000 during the
comparable period in 2020. Law enforcement maintenance revenue was approximately
$299,000 and $323,000 for the three months ended September 30, 2021 and 2020,
respectively. The decrease of $24,000 in law enforcement software maintenance
revenue for the three months ended September 30, 2021 as compared to the
corresponding period of 2020 is reflective of the expiration of certain
maintenance contracts. The increase in our Identity Management maintenance
revenue of approximately $44,000 reflects the expansion of our installed base.
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.
Three Months Ended
Cost of Product Revenue September 30,
(dollars in thousands) 2021 2020 $ Change % Change
Software and royalties $ - $ 13 $ (13 ) (100 )%
Percentage of software and royalty
product revenue 0 % 2 %
Hardware and consumables $ 11 $ 9 $ 2 22 %
Percentage of hardware and consumables
product revenue 55 % 69 %
Services $ 58 $ 693 $ (635 ) (92 )%
Percentage of services product revenue 68 % 55 %
Total product cost of revenue $ 69 $ 715 $ (646 ) (90 )%
Percentage of total product revenue 48 % 38 %
The cost of software and royalty product revenue decreased approximately $13,000
due primarily to lower software and royalty revenue for the three months ended
September 30, 2021 of approximately $547,000 . The cost of software and royalty
product revenue as a percentage of software and royalty revenue decreased to 0%
during the three months ended September 30, 2021 as compared to 2% for the
corresponding 2020 period as the 2021 period contained revenue being comprised
of solutions containing no third-party software costs or software customization.
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 revenue for our hardware and consumables sales increased by
approximately
The cost of services revenue decreased approximately$635,000 during the three months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due to lower services revenue of$1,173,000 . In addition to changes in costs of services product revenue caused by revenue level fluctuations, costs of services can vary as a percentage of service revenue from period to period depending upon both the level and complexity of professional services resources utilized in the completion of the service element. Three Months Ended Maintenance Cost of Revenue September 30, (dollars in thousands) 2021 2020 $ Change % Change
Total maintenance cost of revenue
(29 )%
14 % 20 %
Cost of maintenance revenue decreased approximately $36,000 during the three
months ended September 30, 2021 as compared to the corresponding period in 2020
due to reductions in fixed maintenance costs through headcount reductions.
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Three Months Ended
Product Gross Profit September 30,
(dollars in thousands) 2021 2020 $ Change % Change
Software and royalties $ 40 $ 574 $ (534 ) (93 )%
Percentage of software and royalty
product revenue 100 % 98 %
Hardware and consumables $ 9 $ 4 $ 5 125 %
Percentage of hardware and consumables
product revenue 45 % 31 %
Services $ 27 $ 565 $ (538 ) (95 )%
Percentage of services product revenue 32 % 45 %
Total product gross profit $ 76 $ 1,143 $ (1,067 ) (93 )%
Percentage of total product revenue 52 % 62 %
Software and royalty gross profit decreased approximately $534,000 for the three
months ended September 30, 2021 from the corresponding period in 2020 due
primarily to lower software and royalty revenue of approximately $547,000 . 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.
Services gross profit decreased approximately $538,000 for the three months
ended September 30, 2021 as compared to the corresponding period in 2020 due to
lower service revenue of approximately $1,173,000 for the three months ended
September 30, 2021 as compared to the corresponding period in 2020 combined with
lower costs of service revenue of approximately $635,000 for the three months
ended September 30, 2021 as compared to the corresponding period in 2020. In
addition to changes in costs of services product revenue caused by revenue level
fluctuations, costs of services can 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.
Three Months Ended
Maintenance Gross Profit September 30,
(dollars in thousands) 2021 2020 $ Change % Change
Total maintenance gross profit $ 546 $ 490 $ 56 11 %
Percentage of total maintenance revenue 86 % 80 %
Gross profit related to maintenance revenue increased 11% or approximately
$56,000 for the three months ended September 30, 2021 as compared to the
corresponding period in 2020. This increase reflects higher maintenance revenue
of approximately $20,000 combined with lower cost of maintenance revenue of
approximately $36,000 . Higher maintenance revenue reflects the expansion of our
installed base and lower maintenance cost of revenue reflects reductions in
fixed maintenance costs through headcount reductions. Maintenance gross profit
can change from period to period depending upon both the level and complexity of
engineering service resources utilized in the provision of maintenance services.
Three Months Ended
Operating Expense September 30,
(dollars in thousands) 2021 2020 $ Change % Change
General and administrative $ 1,228 $ 953 $ 275 29 % Percentage of total net revenue 158 % 39 % Sales and marketing
$ 747 $ 615 $ 132 21 % Percentage of total net revenue 96 % 25 %
Research and development
(4 )%
Percentage of total net revenue 138 % 45 %
Depreciation and amortization
(39 )%
Percentage of total net revenue 1 % 1 %
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General and Administrative Expense
General and administrative expense is comprised primarily of salaries and other employee-related costs for executive, financial, and other infrastructure personnel. General legal, accounting and consulting services, insurance, occupancy and communication costs are also included with general and administrative expense. The dollar increase of approximately$275,000 during the three months endedSeptember 30, 2021 as compared to the corresponding period in 2020 is comprised of the following major components: ? Decrease in personnel related expense of approximately$124,000 ; ? Increase in professional services of approximately$119,000 from higher contract services of approximately$29,000 , higher contractor fees and
professional services of
related fees of approximately
of approximately $52,000 and lower legal fees of approximately $25,000 ;
? Increase in licenses, dues and other costs of approximately $53,000 ;
? Decrease in rent and office related expense of approximately
sublease of certain office facilities;
? Increase in insurances costs of approximately $54,000 ; and
? Increase in bad debt expense of approximately $25,000 .
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
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 functions. The dollar increase of
approximately $132,000 during the three months ended September 30, 2021 as
compared to the corresponding period in 2020 is primarily comprised of the
following major components:
? Decrease in personnel related expense of approximately $69,000 , driven
primarily by the effect of headcount reductions;
? Increase in contractor and contract services of approximately $87,000
resulting from decreased utilization of certain sales contractors of
approximately
and subscriptions of approximately $106,000 ;
? Increase in travel, trade show expense and office related expense including
demo equipment of approximately $86,000 ;
? Increase in stock-based compensation expense of approximately
? Decrease in our
due to headcount reductions at this location.
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Table of Contents Research and Development Research and development expense consists primarily of salaries, employee benefits and outside contractors for new product development, product enhancements, custom integration work and related facility costs. Such expense decreased approximately$44,000 for the three months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due primarily to the following major components: ? Decrease in personnel related expense of approximately$265,000 driven primarily by the effect of headcount decreases;
? Increase in contractor fees and contract services of approximately
resulting from the replacement of certain function with contract labor;
? Increase in stock based-compensation expense of approximately
? Increase in office related expense, engineering tools, supplies,
communications (including internet) and travel of approximately
Depreciation and Amortization
During the three months endedSeptember 30, 2021 and 2020, depreciation and amortization expense was approximately$11,000 and$18,000 , respectively. The relatively small amount of depreciation and amortization reflects the relatively small property and equipment carrying value.
Interest Expense (Income), Net
For the three months endedSeptember 30, 2021 , we recognized net interest expense of$0 . For the three months endedSeptember 30, 2020 , we recognized interest expense of$56,000 and interest income of approximately$0 . Interest expense for the three months endedSeptember 30, 2020 reflects interest incurred on a related party factoring agreement and certain related party notes payable.
Other (income) expense, net
During the three months endedSeptember 30, 2021 , we recognized other income of approximately$5,000 from the write-off of a deferred contract prepayment. During the three months endedSeptember 30, 2020 , we recognized other expense of approximately$3,000 from the recognition of a settlement fee on an outstanding obligation.
Change in Fair Value of Derivative Liabilities
For the three months endedSeptember 30, 2021 , we recognized income of approximately$1,342,000 from the decrease of derivative liabilities arising from the consummation of the Series D Financing inNovember 2020 . Such decrease was determined by management using fair value methodologies and is included as income under the caption "(Gain) on change in fair value of derivative liabilities" in our condensed consolidated statement of income (loss) for three months endedSeptember 30, 2021 . For the three months endedSeptember 30, 2020 , we recognized income of approximately$535,000 from the decrease of derivative liabilities arising from the consummation of the Series C Financing inSeptember 2018 . Such decrease was determined by management using fair value methodologies and is included as income under the caption "(Gain) on change in fair value of derivative liabilities" in our condensed consolidated statement of income (loss) for three months endedSeptember 30, 2020 . - 35 -
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(Gain) on Extinguishment of Derivative Liabilities and Debt
During the three months endedSeptember 30, 2021 , we recognized a gain on the extinguishment of derivative liabilities of approximately$35,000 pursuant to the conversion of 242 shares of Series D Preferred into Common Stock. Such gain is included in the caption "(Gain) on extinguishment of derivative liabilities and debt" in our condensed consolidated statement of income (loss) for three months endedSeptember 30, 2021 . During the three months endedSeptember 30, 2021 , we recognized a gain on debt extinguishment from the forgiveness of our PPP Loan. InSeptember 2021 , we received notification from the SBA that our 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 derivative liabilities and debt" in our condensed consolidated statement of income (loss) for three months endedSeptember 30, 2021 . Comparison of the Nine Months EndedSeptember 30, 2021 to the Nine Months EndedSeptember 30, 2020 Nine Months Ended Net Product Revenue September 30, (dollars in thousands) 2021 2020 $ Change % Change Software and royalties$ 301 $ 780 $
(479 ) (61 )% Percentage of total net product revenue 63 % 36 % Hardware and consumables
$ 76 $ 75 $ 1 1 % Percentage of total net product revenue 16 % 4 % Services$ 98 $ 1,274 $
(1,176 ) (92 )% Percentage of total net product revenue 21 % 60 % Total net product revenue
$ 475 $ 2,129 $ (1,654 ) (78 )% Software and royalty revenue decreased approximately$479,000 during the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020. This decrease is attributable to lower identification project related revenue of approximately$486,000 , lower royalty revenue of approximately$54,000 and lower law enforcement software revenue of approximately$4,000 offset by higher sales of boxed identity management software sold through our distribution channel of approximately$65,000 .The decrease in identification project related revenue is reflective of lower software licenses sold into identification projects during the nine months endedSeptember 30, 2021 and the increase in boxed identity management software sold through our distribution channel reflects higher procurement from certain international customers. The decrease in royalty revenue results primarily from lower reported usage from certain customers. Services revenue is comprised primarily of software integration services, system installation services and customer training. Such revenue decreased approximately$1,176,000 during the nine months endedSeptember 30, 2021 as compared to the corresponding period of 2020 due to a decrease in the service element of project related work completed during the nine months endedSeptember 30, 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 during 2021; 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 Quarterly 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 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 nine months ended
We launched Authenticate (formerly GoVerify ID ®) inFebruary 2021 . This relaunch included a new container and microservices-based architecture and refreshed mobile and desktop clients for seamless and quick integrations to applications and services. In addition, the first major update is the launch of the first module of the Law Enforcement 2.0 (LE 2.0) Platform,Imageware Capture, in September. We modernized the UI for law enforcement professionals, building the solution as a web-based Software as a Service (SaaS) product with a reactive design that can be accessed from any device anywhere. In addition, we have integrated Imageware Authenticate into the LE 2.0 platform. This update is already resulting in additional customers implementing our Authenticate solution. - 36 -
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We have focused on integrating the suite of products that comprise theImageware Identity Platform - this includes simplifying our portfolio overview, positioning, and branding. In addition, we plan to continue enhancing our Identity Platform products through 2022. This effort includes modernizing our Credential product (formerly EPI) for biometric smart badges. Management believes that these initiatives will result in the expansion of our solutions into both state/local law enforcement and federal agencies in addition to non-governmental sectors, including banking/financial services, insurance, telecommunications, healthcare, hospitality, and others. Nine Months Ended Maintenance Revenue September 30, (dollars in thousands) 2021 2020 $ Change % Change Total maintenance revenue$ 1,977 $ 1,870 $ 107 6 % Maintenance revenue was approximately$1,977,000 for the nine months endedSeptember 30, 2021 , as compared to approximately$1,870,000 for the corresponding period in 2020. Identity management maintenance revenue generated from identification software solutions was approximately$1,049,000 for the nine months endedSeptember 30, 2021 as compared to approximately$898,000 during the comparable period in 2020. Law enforcement maintenance revenue was approximately$928,000 as compared to approximately$972,000 during the comparable period in 2020. The increase of$151,000 in identification software maintenance revenue for the nine months endedSeptember 30, 2021 as compared to the corresponding period of 2020 is reflective of certain additional maintenance services provided by the Company during the nine months endedSeptember 30, 2021 . The decrease of approximately$44,000 in our law enforcement maintenance revenue reflects expiration of certain maintenance contracts. We anticipate growth of our maintenance revenue through the retention of existing customers combined with the expansion of our installed base resulting from the completion of project-oriented work; however, we cannot predict the timing of this anticipated growth. Nine Months Ended Cost of Product Revenue September 30, (dollars in thousands) 2021 2020 $ Change % Change Software and royalties$ 20 $ 40 $ (20 ) (50 )% Percentage of software and royalty product revenue 7 % 5 % Hardware and consumables$ 52 $ 46 $ 6 13 % Percentage of hardware and consumables product revenue 68 % 61 % Services$ 62 $ 695 $ (633 ) (91 )% Percentage of services product revenue 63 % 55 % Total product cost of revenue$ 134 $ 781 $ (647 ) (83 )% Percentage of total product revenue 28 % 37 % The cost of software and royalty product revenue decreased approximately$20,000 due primarily to lower software and royalty revenue for the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due to the 2021 period containing uncharacteristically low third-party software license costs and minimal levels of software customization. The cost of revenue for our hardware and consumables sales increased by approximately$6,000 for the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due to the 2021 period containing hardware and consumables with slightly higher costs of revenue than the corresponding period in 2020. - 37 -
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The cost of services revenue decreased approximately$633,0000 during the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due to lower services revenue of$1,176,000 . In addition to changes in costs of services product revenue caused by revenue level fluctuations, costs of services can 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. Nine Months Ended Maintenance Cost of Revenue September 30, (dollars in thousands) 2021 2020 $ Change % Change
Total maintenance cost of revenue
Cost of maintenance revenue decreased approximately$52,000 during the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 despite higher maintenance revenue of$107,000 . This decrease is reflective of lower maintenance labor costs incurred during the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due primarily to the composition of engineering resources used in the provision of maintenance services and reductions in headcount in our customer support department. Nine Months Ended Product Gross Profit September 30, (dollars in thousands) 2021 2020 $ Change % Change Software and royalties$ 281 $ 740 $ (459 ) (62 )% Percentage of software and royalty product revenue 93 % 95 % Hardware and consumables$ 24 $ 29 $ (5 ) (17 )% Percentage of hardware and consumables product revenue 32 % 39 % Services$ 36 $ 579 $ (543 ) (94 )% Percentage of services product revenue 37 % 45 % Total product gross profit$ 341 $ 1,348 $ (1,007 ) (75 )% Percentage of total product revenue 72 % 63 % Software and royalty gross profit decreased approximately$459,000 for the nine months endedSeptember 30, 2021 from the corresponding period in 2020 due primarily to lower software and royalty revenue of approximately$479,000 combined with lower software and royalty cost of revenue of$20,000 for the same period. 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 consumable gross profit decreased approximately$5,000 for the nine months endedSeptember 30, 2021 from the corresponding period in 2020 due primarily to lower hardware and consumable revenue of approximately$1,000 combined with higher cost of hardware and consumable revenue of approximately$6,000 . Services gross profit decreased approximately$543,000 for the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due to lower service revenue of approximately$1,176,000 for the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 combined with lower costs of service revenue of approximately$633,000 for the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020. In addition to changes in costs of services product revenue caused by revenue level fluctuations, costs of services can 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. - 38 -
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Nine Months Ended
Maintenance Gross Profit September 30,
(dollars in thousands) 2021 2020 $ Change % Change
Total maintenance gross profit $ 1,701 $ 1,542 $ 159 10 %
Percentage of total maintenance revenue 86 % 83 %
Gross profit related to maintenance revenue increased approximately $159,000 for
the nine months ended September 30, 2021 as compared to the corresponding period
in 2020. This increase reflects higher maintenance revenue of approximately
$107,000 combined with lower cost of maintenance revenue of approximately
$52,000 due to headcount reductions in our customer service department combined
with lower maintenance labor costs incurred during the same period due to the
composition of engineering resources used in the provision of maintenance
services.
Nine Months Ended
Operating Expense September 30,
(dollars in thousands) 2021 2020 $ Change % Change
General and administrative $ 4,147 $ 2,875 $ 1,272 44 % Percentage of total net revenue 169 % 72 % Sales and marketing
$ 2,217 $ 2,239 $ (22 ) (1 )% Percentage of total net revenue 90 % 56 %
Research and development
(23 )%
Percentage of total net revenue 141 % 113 %
Depreciation and amortization
(20 %
Percentage of total net revenue 2 % 1 %
General and Administrative Expense
General and administrative expense is comprised primarily of salaries and other employee-related costs for executive, financial, and other infrastructure personnel. General legal, accounting and consulting services, insurance, occupancy and communication costs are also included with general and administrative expense. The dollar increase of approximately$1,272,000 during the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 is comprised of the following major components: ? Decrease in personnel related expense of approximately$267,000 ;
? Increases in professional and contract services of approximately
which includes Board fees of approximately
approximately
corporate expense of approximately
of
investor relations fees of approximately
of approximately $64,000 ;
? Increase in travel, insurances, licenses, dues, rent, office related costs and
other of approximately $304,000 ;
? Increase in financing expense of approximately
write-off of unamortized deferred stock issuance costs;
? Increase in stock-based compensation expense related to options and warrants
of approximately $272,000 ; and
? Increase in bad debt expense of approximately $25,000 .
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.
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Table of Contents Sales and Marketing Sales and marketing expense consists primarily of the salaries, commissions, other incentive compensation, employee benefits and travel expense of our sales, marketing, and business development functions. The dollar decrease of approximately$22,000 during the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 is primarily comprised of the following major components: ? Decrease in personnel related expense of approximately$213,000 driven primarily by the effect of headcount reductions; ? Increase in contractor and contract services of approximately$72,000 resulting from decreased utilization of certain sales consultants of approximately$145,000 offset by higher contract service expense of approximately$217,000 ; ? Increase in travel, trade show expense and office related expense of approximately$84,000 ;
? Increase in stock-based compensation expense of approximately
? Decrease in ourMexico sales office expense and other of approximately$116,000 . Research and Development Research and development expense consists primarily of salaries, employee benefits and outside contractors for new product development, product enhancements, custom integration work and related facility costs. Such expense decreased approximately$1,047,000 for the nine months endedSeptember 30, 2021 as compared to the corresponding period in 2020 due primarily to the following major components: ? Decrease in personnel related expense of approximately$1,137,000 due primarily to headcount reductions;
? Decrease in contractor fees and contract services of approximately
? Increase in stock based-compensation expense of approximately
? Decrease in rent, office related expense and engineering tools and supplies of
approximately $1,000 .
Our level of expenditures in research and development reflects our belief that
to maintain our competitive position in markets characterized by rapid rates of
technological advancement, we must continue to invest significant resources in
new systems and software development as well as continue to enhance existing
products.
Depreciation and Amortization
During the nine months ended September 30, 2021 and 2020, depreciation and
amortization expense was approximately $43,000 and $54,000 , respectively. The
relatively small amount of depreciation and amortization reflects the relatively
small property and equipment carrying value.
Interest Expense, Net
For the nine months ended September 30, 2021 , we recognized interest expense of
approximately $0 and interest income of approximately $0 . For the nine months
ended September 30, 2020 , we recognized interest expense of approximately
$131,000 and interest income of approximately $0 . Interest expense of
approximately $131,000 for the nine months ended September 30, 2020 reflects
interest incurred on a related party factoring agreement and related party notes
payable.
Other (income) expense, net
During the nine months endedSeptember 30, 2021 , we recognized other income of approximately$5,000 from the write-off of a deferred contract prepayment. During the nine months endedSeptember 30, 2020 , we recognized other expense of approximately$3,000 from the recognition of a settlement fee on an outstanding obligation and$1,000 of miscellaneous expense. - 40 -
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Change in Fair Value of Derivative Liabilities
For the nine months endedSeptember 30, 2021 , we recognized income of approximately$16,558,000 from the decrease of derivative liabilities arising from the consummation of the Series D Financing inNovember 2020 . Such decrease was determined by management using fair value methodologies and is included as income under the caption "(Gain) on change in fair value of derivative liabilities" in our condensed consolidated statement of income (loss) for nine months endedSeptember 30, 2021 . For the nine months endedSeptember 30, 2020 , we recognized approximately$369,000 from the decrease of derivative liabilities arising from the consummation of the Series C Financing inSeptember 2018 . Such decrease was determined by management using fair value methodologies and is included as income under the caption "(Gain) on change in fair value of derivative liabilities" in our condensed consolidated statement of operations for nine months endedSeptember 30, 2020 . This decrease in derivative liabilities results primarily from the fair value methodologies including the high likelihood of the consummation of the Series D financing and conversion of the Series C host instrument containing the embedded derivatives.
(Gain) on Extinguishment of Derivative Liabilities and Debt
During the nine months endedSeptember 30, 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 "(Gain) on extinguishment of derivative liabilities and debt" in our condensed consolidated statement of income (loss) for nine months endedSeptember 30, 2021 . During the nine months endedSeptember 30, 2021 , we recognized a gain on debt extinguishment from the forgiveness of our PPP Loan. InSeptember 2021 , we received notification from the SBA that our 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 derivative liabilities and debt" in our condensed consolidated statement of income (loss) for nine months endedSeptember 30, 2021 .
LIQUIDITY, CAPITAL RESOURCES AND GOING CONCERN
Going Concern and Management's Plans
Historically, our principal sources of cash have included proceeds from the
issuance of common and preferred stock and proceeds from the issuance of debt,
and, to a lesser extent, customer payments from the sale of our products. Our
principal uses of cash have included cash used in operations, product
development, and payments relating to purchases of property and equipment. We
expect that our principal uses of cash in the future will be for product
development, including customization of identity management products for
enterprise and consumer applications, further development of intellectual
property, development of Software-as-a-Service ("SaaS") capabilities for
existing products as well as general working capital requirements. Management
expects that, as our revenue grows, our sales and marketing and research and
development expense will continue to grow, albeit at a slower rate and, as a
result, we will need to generate significant net revenue to achieve and sustain
positive cash flows from operations. Historically the Company has not been able
to generate sufficient net revenue to achieve and sustain positive cash flows
from operations. As a result, the Company has been dependent on equity and debt
financings to satisfy its working capital requirements and continue as a going
concern. 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 September 30, 2021 and December 31, 2020 , we had negative working capital of
$8,280,000 and $19,349,000 , respectively. Included in our negative working
capital as of September 30, 2021 are $7,486,000 of derivative liabilities which
are not required to be settled in cash except in the event of the consummation
of a change of control or at any time after the fourth anniversary of the Series
D Preferred issuance, at which time the holders of the Series D Preferred may
require the Company to redeem in cash any or all of the holder's outstanding
Series D Preferred at an amount equal to the Series D Liquidation Preference
Amount. At September 30, 2021 the Liquidation Preference Amount totaled
$22,965,000 . 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 for the next twelve months from the date of this filing. At
November 10, 2021 , cash on hand approximated $1,154,000 . Based on the Company's
rate of cash consumption in the first three quarters of 2021 and the last
quarter of 2020, the Company estimates it will need additional capital in the
first quarter of 2022 and its prospects for obtaining that capital are
uncertain. As a result of the Company's historical losses and financial
condition, there is substantial doubt about the Company's ability to continue as
a going concern.
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To address our working capital requirements, management has instituted several cost cutting measures and has utilized cash proceeds available under the purchase agreement withLincoln Park Capital Fund, LLC ("Lincoln Park") 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 theSecurities and Exchange Commission (the "SEC") onAugust 23, 2021 , onAugust 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, there are currently no financing arrangements to support our projected cash shortfall, and available capital under the LPC Purchase Agreement will be insufficient to address our working capital needs. 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 likely 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. However, the Company operates in markets that are emerging and highly competitive. There is no assurance that the Company will be able to obtain additional capital, 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 condensed 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. Operating Activities We used net cash of$6,764,000 in operating activities for the three months endedSeptember 30, 2021 as compared to net cash used of$4,979,000 during the comparable period in 2020. During the nine months endedSeptember 30, 2021 , net cash used in operating activities consisted of net income of$9,871,000 and an increase in working capital and other assets and liabilities of$284,000 . Those amounts are in addition to approximately$16,351,000 of non-cash income, including$16,558,000 in income from the change in fair value of derivative liabilities and$1,270,000 in income from the extinguishment of debt and derivative liabilities offset by$942,000 in stock-based compensation,$43,000 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, and$46,000 from the issuance of common stock as compensation in lieu of cash. During the nine months endedSeptember 30, 2021 , we used cash of$176,000 from increases in current assets combined with$31,000 from decreases in our operating leases right-of-use assets and used cash of$77,000 through decreases in current liabilities and deferred revenue. We used net cash of$4,979,000 in operating activities for the nine months endedSeptember 30, 2020 as compared to net cash used of$8,007,000 during the comparable period in 2019. During the nine months endedSeptember 30, 2020 , net cash used in operating activities consisted of net loss of$6,652,000 and a decrease in working capital and other assets and liabilities of$1,450,000 . Those amounts are in addition to approximately$223,000 of non-cash costs, including$449,000 in stock-based compensation,$54,000 in depreciation and amortization and$89,000 from the application of rent deposits offset by$369,000 in the change in fair value of derivative liabilities. During the nine months endedSeptember 30, 2020 , we generated cash of$813,000 from decreases in current assets offset by$13,000 from increases in our operating leases right-of-use assets and generated cash of$650,000 through increases in current liabilities and deferred revenue. Investing Activities Net cash used in investing activities during the nine months endedSeptember 30, 2021 was$48,000 as compared to$19,000 for the corresponding period in 2020. For the nine months endedSeptember 30, 2021 , we used cash of$48,000 to fund capital expenditures of computer hardware. - 42 -
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Table of Contents Financing Activities During the nine months endedSeptember 30, 2021 , we generated cash of approximately$100,000 from the sale of 1,000,000 shares of Common Stock for$0.10 per share and used cash of approximately$25,000 for the payment of dividends on our Series B Preferred Stock. During the nine months endedSeptember 30, 2020 , we generated cash of approximately$2,360,000 from the sale of 15,700,000 shares of Common Stock before recognition of approximately$64,000 in direct stock issuance costs. We generated cash of$900,000 from the issuance of related party notes payable and generated cash of$1,571,000 from the issuance of notes payable under the Paycheck Protection Program. We also generated cash of$2,187,000 from the issuance of notes payable pursuant to the Bridge Loan Financing portion of the Series D Financing. During the nine months endedSeptember 30, 2020 , we used cash of approximately$25,000 for the payment of dividends on our Series B Preferred Stock. Inflation
We do not believe that inflation has had a material impact on our historical operations or profitability.
Off-Balance Sheet Arrangements
AtSeptember 30, 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 Quarterly Report.
Recently Issued Accounting Standards
Please refer to the section "Recently Issued Accounting Standards" in Note 2 of our Notes to the unaudited Condensed Consolidated Financial Statements.
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