NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014 (Unaudited)
The accompanying unaudited interim condensed consolidated financial statements include the accounts of BIO-key International, Inc. and its wholly-owned subsidiary (collectively, the “Company”) and are stated in conformity with accounting principles generally accepted in the United States of America, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year. Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the financial statements have been condensed or omitted. Significant intercompany accounts and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all necessary adjustments, consisting only of those of a recurring nature, and disclosures to present fairly the Company’s financial position and the results of its operations and cash flows for the periods presented. The balance sheet at December 31, 2013 was derived from the audited financial statements, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America. These unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “Form 10-K”), filed with the SEC on March 31, 2014.
Recently Issued Accounting Pronouncements
Effective January 1, 2014, the Company adopted Accounting Standards Update No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). ASU 2013-11 is expected to reduce diversity in practice by providing guidance on the presentation of unrecognized tax benefits and will better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. The amendments in this update should be applied prospectively for annual and interim periods beginning after December 15, 2013. The adoption of ASU 2013-11 did not have a material effect on its consolidated financial statements.
Management does not believe that any recently issued, but not yet effective, accounting standard if currently adopted would have a material effect on the accompanying consolidated financial statements.
The Company has incurred significant losses to date and at March 31, 2014, had an accumulated deficit of approximately $55 million. In addition, broad commercial acceptance of the Company’s technology is critical to the Company’s success and ability to generate future revenues. At March 31, 2014, the Company’s total cash and cash equivalents were approximately $593,000, as compared to approximately $2,023,000 at December 31, 2013.
The Company has financed itself in the past through access to the capital markets by issuing secured and convertible debt securities, convertible preferred stock, common stock, and through factoring receivables. The Company currently requires approximately $460,000 per month to conduct operations, a monthly amount that it has been unable to achieve consistently through revenue generation.
If the Company is unable to generate sufficient revenue to meet its goals, it will need to obtain additional third-party financing to (i) conduct the sales, marketing and technical support necessary to execute its plan to substantially grow operations, increase revenue, and serve a significant customer base; and (ii) provide working capital. No assurance can be given that any form of additional financing will be available on terms acceptable to the Company, that adequate financing will be obtained by the Company, in order to meet its needs, or that such financing would not be dilutive to existing shareholders.
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern, and assumes continuity of operations, realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The matters described in the preceding paragraphs raise substantial doubt about the Company’s ability to continue as a going concern. Recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, and become profitable in its future operations. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.
3.
|
SHARE BASED COMPENSATION
|
The following table presents share-based compensation expenses for continuing operations included in the Company’s unaudited condensed consolidated statements of operations:
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
$
|
74,841
|
|
|
$
|
11,121
|
|
Research, development and engineering
|
|
|
10,932
|
|
|
|
1,326
|
|
|
|
$
|
85,773
|
|
|
$
|
12,447
|
|
4.
|
EARNINGS PER SHARE (“EPS”)
|
The Company’s basic EPS is calculated using net income available to common shareholders and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants and the assumed conversion of convertible notes and preferred stock.
The reconciliation of the numerator of the basic and diluted EPS calculations was as follows for the three month periods ended March 31, 2014 and 2013:
|
|
Three Months ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Basic Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(299,214
|
)
|
|
$
|
(315,579
|
)
|
|
|
|
|
|
|
|
|
|
Basic Denominator
|
|
|
115,876,461
|
|
|
|
81,465,289
|
|
|
|
|
|
|
|
|
|
|
Per Share Amount
|
|
$
|
*
|
|
|
$
|
*
|
|
* Represents less than ($0.01) per share
The following table sets forth the options and warrants which were excluded from the diluted per share calculation even though the exercise prices were less than the average market price of the common shares because the effect of including these potential shares was antidilutive due to the net losses for the three months ended March 31, 2014 and 2013:
|
|
Three Months Ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
1,203,624
|
|
|
|
647,660
|
|
Warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,203,624
|
|
|
|
647,660
|
|
The following table sets forth options and warrants which were excluded from the diluted per share calculation because the exercise price was greater than the average market price of the common shares:
|
|
Three Months Ended
March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
3,580,000
|
|
|
|
3,025,000
|
|
Warrants
|
|
|
30,369,129
|
|
|
|
8,250,000
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
33,949,129
|
|
|
|
11,275,000
|
|
The 2010 Exchange Agreement
Effective as of December 31, 2010, the Company entered into a Securities Exchange Agreement (the “2010 Exchange Agreement”) with Thomas Colatosti (“Colatosti”), the Company’s former Chairman of the Board. Pursuant to the 2010 Exchange Agreement, Mr. Colatosti agreed to exchange all of his outstanding shares of Series D Convertible Preferred Stock, including all accrued and unpaid dividends thereon, and the 7% Convertible Promissory Note dated as of December 28, 2009 issued by the Company to Mr. Colatosti in the original principal amount of $64,878 for a new non-convertible 7% Secured Promissory Note in the original principal amount of $350,804 (the “Colatosti Note”).
The principal and interest under the Colatosti Note was scheduled to be repaid by the Company in cash on December 31, 2012. Pursuant to a Note Amendment and Extension Agreement effective as of December 31, 2012, the maturity date of the Colatosti Note was extended to March 31, 2013. In February 2013, the principal balance and accrued interest owing under the Colatosti Note was repaid from the proceeds of the new financing described below.
2013 Note Purchase Agreement
Pursuant to a Note Purchase Agreement (the “InterDigital NPA”) dated February 26, 2013 by and between the Company and DRNC Holdings, Inc. (“DRNC”), the Company issued to DRNC a $497,307 principal amount promissory note (the “InterDigital Note”) which accrued interest at a rate of 7% per annum. The InterDigital Note was to mature on December 31, 2015, was secured by a security interest in all of the tangible and intangible assets of the Company and was subject to acceleration upon an event of default. A portion of the proceeds from the sale of the InterDigital Note was used to repay the Colatosti Note in full, with the remaining proceeds used for other general corporate purposes. On November 22, 2013, the Company repaid in full the $497,307 principal balance and accumulated interest payable under the InterDigital Note. In connection with the repayment, DRNC's security interest in all of the Company’s tangible and intangible assets was terminated.
Derivative Liabilities
In connection with the issuances of equity instruments or debt, the Company may issue options or warrants to purchase common stock. In certain circumstances, these options or warrants may be classified as liabilities, rather than as equity. In addition, the equity instrument or debt may contain embedded derivative instruments, such as conversion options or listing requirements, which in certain circumstances may be required to be bifurcated from the associated host instrument and accounted for separately as a derivative liability instrument. The Company accounts for derivative liability instruments under the provisions of FASB ASC 815, “Derivatives and Hedging.”
Securities Purchase Agreements dated October 25, 2013 and November 8, 2013
The Company issued common stock (the “Shares”) and warrants (the “Warrants”) pursuant to a series of Private Investors Securities Purchase Agreements (the “PI SPA”) on October 25, 2013 and November 8, 2013. Each unit had a purchase price of $0.15 and consisted of one Share and one Warrant. The Warrants are immediately exercisable at an exercise price of $0.25 per share, have a term of three years, and were exercisable on a cashless basis if at any time following the nine month anniversary of the issuance date, there was not an effective registration statement covering the public resale of the shares of Common Stock underlying the Warrants. The Shares and shares of common stock underlying the Warrants were subject to a registration rights agreement. The Company filed a registration statement on November 22, 2013 and such registration was declared effective on December 31, 2013.
Investors in the PI SPA have certain anti-dilution rights which require the Company to issue additional shares of common stock to the investors if within the nine months following November 8, 2013, the Company, sells or issues any common stock or common stock equivalents (other than sales or issuances to directors, officers, employees or independent contractors in the ordinary course of business for compensation purposes and stock splits and stock dividends payable in respect of the Company’s common stock) having a purchase, exercise or conversion price per share of less than $0.15.
Based on an evaluation as discussed in FASB ASC 815-15, “Embedded Derivatives” and FASB ASC 815-40-15, “Contracts in Entity’s Own Equity - Scope and Scope Exceptions,” the Company determined that the anti-dilution features in the common stock issued were not considered indexed to its own stock because neither the occurrence of a sale of equity securities by the issuer at market nor the issuance of another equity contract with a lower strike price is an input to the fair value of a fixed-for-fixed option or forward on equity shares. As such, the anti-dilution features should be bifurcated from the common stock and accounted for as a derivative liability.
The Company did not value the derivative liability. One of the key determinants of the Company’s decision to not value the derivative liability was the high likelihood that a future financing would not occur that would trigger the down round feature. Whether a future equity financing would occur would be determined by the cash needs of the Company and management’s willingness to trigger the down round feature. The Company’s reasons were as follows:
|
|
1.
|
The Company’s cash position.
|
|
|
2.
|
The stock price of the Company’s common stock.
|
|
|
3.
|
The unavailability of enough authorized shares to complete a large offering.
|
Under GAAP, the Company is required to mark-to-market the derivative liability at the end of each reporting period. The Company did not value the derivative liability at March 31, 2014. At such date, the Company determined that it was still highly unlikely that an equity financing would occur prior to July 8, 2014, the expiration date of the down round feature. Such conclusion was based upon the discussion noted above.
Pursuant to a placement agency letter agreement, the Company paid the placement agent cash commissions equal to 8% of the gross proceeds of the offering, reimbursed the placement agent for its reasonable out of pocket expenses, and issued to the placement agent warrants (the “Placement Agent Warrants”) to purchase an aggregate of 1,971,786 shares of common stock. The Placement Agent Warrants have substantially the same terms as the Warrants issued to the investors, except the Placement Agent Warrants are immediately exercisable on a cashless basis.
The cashless exercise features contained in the Placement Agent Warrants are considered to be derivatives and the Company recorded a warrant liability on the condensed consolidated balance sheet. The Company recorded the warrant liabilities equal to their estimated fair value in 2013. The Company is required to mark-to-market the warrant liability at the end of each reporting period. For the three months ended March 31, 2014, the Company recorded a loss on the change in fair value of the cashless exercise feature of $198,737. At March 31, 2014 and December 31, 2013, the fair value of the cashless exercise feature was $405,428 and $206,707, respectively.
Warrants
On August 15, 2013, the Company issued a warrant to purchase 300,000 shares of the Company’s common stock to an independent contractor for work associated with the InterDigital Note and InterDigital SPA as additional compensation (the “Compensatory Warrant”). On March 11, 2014, the warrant was exercised resulting in the issuance of 153,659 shares of common stock.
The cashless exercise feature contained in the warrant was considered to be a derivative and the Company recorded a warrant liability on the condensed consolidated balance sheet. The Company recorded the warrant liability equal to its estimated fair value. The Company was required to mark-to-market the warrant liabilities at the end of each reporting period. As the warrant was exercised, the Company marked-to-market the warrant on the day before the exercise and such value was then transferred to additional paid-in capital. For the three months ended March 31, 2014, the Company recorded a loss on the change in fair value of the cashless exercise feature of $6,211. $42,581, the value of the cashless exercise feature as of March 10, 2014, was transferred to additional paid-in capital. The fair value of the cashless exercise feature was $36,370 as of December 31, 2013.
On January 27, 2014, the Company repurchased a warrant for the purchase of 8,000,000 shares of common stock from the Shaar Fund Ltd. at a purchase price of $150,000. The warrant was exercisable at a strike price of $0.30 per share through December 31, 2015.
Issuances of Stock Options
During the three months ended March 31, 2014, the Company granted 3,420,000 stock options. The options are exercisable for a term of seven years and vest in equal installments over a three-year period commencing on the date of grant. 3,070,000 of the options are exercisable at $0.205 per share and 350,000 of the options are exercisable at $0.17 per share.
The Company has determined that it operates in one discrete segment consisting of biometric products. Geographically, North American sales accounted for approximately 98% of the Company’s total sales for the three-month periods ended March 31, 2014 and 2013.
8.
|
FAIR VALUES OF FINANCIAL INSTRUMENTS
|
Cash and cash equivalents, accounts receivable, due from factor, accounts payable and accrued liabilities are carried at, or approximate, fair value because of their short-term nature.
The fair value of the warrant liabilities were measured using the following assumptions:
Risk-free interest rate
|
|
|
0.42% - 0.67%
|
|
Expected term
|
|
|
2.4 - 2.61
|
|
Expected dividends
|
|
|
0
|
|
Volatility of stock price
|
|
|
132.9 %- 136.2%
|
|
The warrant liabilities are considered Level 3 liabilities on the fair value hierarchy as the determination of fair value includes various assumptions about of future activities and the Company’s stock prices and historical volatility as inputs.
Compensatory Warrant
|
|
|
|
|
Fair value at January 1, 2014
|
|
$
|
36,370
|
|
Loss on derivative
|
|
|
6,211
|
|
Transfer to additional paid-in capital
|
|
|
(42,581
|
)
|
|
|
|
|
|
Value at March 31, 2014
|
|
|
-
|
|
|
|
|
|
|
Warrant issued under PI SPA
|
|
|
|
|
Fair value at January 1, 2014
|
|
|
206,707
|
|
Loss on derivative
|
|
|
198,737
|
|
Other
|
|
|
(16
|
)
|
|
|
|
|
|
Value at March 31, 2014
|
|
|
405,428
|
|
|
|
|
|
|
Balance, March 31, 2014
|
|
$
|
405,428
|
|
9.
|
MAJOR CUSTOMERS AND ACCOUNTS RECEIVABLES
|
For the three months ended March 31, 2014 and 2013, two customers accounted for 79% and three customers accounted for 61% of revenue, respectively. At March 31, 2014, two customers accounted for 81% of accounts receivable. At December 31, 2013, one customer accounted for 50% of accounts receivable.
On or about March 13, 2014, LifeSouth Community Blood Centers, Inc. (“LifeSouth”) filed a lawsuit against the Company in the Superior Court of Monmouth County, New Jersey based on an alleged breach of a license agreement seeking return of all amounts paid under the license in the amount of $718,500. The Company has denied all claims and asserted a counterclaim against LifeSouth for non-payment of support and maintenance service fees. Discovery has commenced and is proceeding
.
The Company has reviewed subsequent events through the date of filing.