Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
———————
FORM 10-Q
———————
☑·QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the
quarterly period ended September 30, 2016
or
☐·TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the
transition period from: _____________ to _____________
Commission
File Number: 000-52719
———————
Brekford Corp.
(Exact name of registrant as specified in its charter)
———————
Delaware
|
|
20-4086662
|
(State
or Other Jurisdiction
|
|
(I.R.S.
Employer
|
of
Incorporation)
|
|
Identification
No.)
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7020 Dorsey Road, Hanover, Maryland 21076
(Address
of Principal Executive Office) (Zip Code)
(443) 557-0200
(Registrant’s
telephone number, including area code)
N/A
(Former
name, if changed since last report)
Indicate
by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for
the past 90
days. Yes ☒ No ☐
Indicate
by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required
to submit and post such
files) Yes ☒ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller
reporting company.
Large
accelerated
filer ☐ Accelerated
filer ☐ Non-accelerated
filer ☐ Smaller
reporting company ☒
Indicate
by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act).
Yes ☐ No ☒
Indicate
the number of shares outstanding of each of the issuer’s
classes of Common Stock, as of the latest practicable date. The
issuer had 49,311,264 shares of Common Stock, par value $0.0001 per
share (“Common Stock”) issued and outstanding as of
November 14, 2016.
1
Brekford Corp.
Form 10-Q
Index
PART I – FINANCIAL INFORMATION
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Page |
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Item
1
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Financial
Statements
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3
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|
Condensed Consolidated Balance Sheets at September 30, 2016 and
December 31, 2015 (unaudited)
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3
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|
Condensed Consolidated Statements of Operations and Comprehensive
loss for the Three and Nine Months Ended September 30, 2016 and
2015 (unaudited)
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4
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|
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2016 and 2015 (unaudited)
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5
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Notes to Unaudited Condensed Consolidated Financial
Statements
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6
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|
|
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Item
2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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16
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Item
4.
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Controls and
Procedures
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24
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PART II – OTHER INFORMATION
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|
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Item
1.
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Legal
Proceedings
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25
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Item
2.
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Unregistered Sales
of Equity Securities and Use of Proceeds
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25
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Item
5.
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Other
Information
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25
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Item
6.
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Exhibits
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25
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SIGNATURES
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26
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EXHIBIT
INDEX
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27
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2
PART I – FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
Brekford Corp.
Condensed Consolidated Balance Sheets (unaudited)
|
September
30,
2016
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December 31,
2015
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ASSETS
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|
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CURRENT
ASSETS
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|
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Cash
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$593,806
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$580,400
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Accounts
receivable, net of allowance of $0 at September 30, 2016 and
December 31, 2015
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1,677,923
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3,781,263
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Unbilled
receivables
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762,718
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304,470
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Prepaid
expenses
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38,133
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71,740
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Inventory
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472,000
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606,471
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Total current
assets
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3,544,580
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5,344,344
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Property and
equipment, net
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269,104
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223,347
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Other non-current
assets
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81,402
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179,208
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TOTAL
ASSETS
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$3,895,086
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$5,746,899
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LIABILITIES
AND STOCKHOLDERS’ EQUITY (DEFICIT)
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|
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CURRENT
LIABILITIES
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|
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Accounts payable
and accrued expenses
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$1,741,872
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$2,979,131
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Accrued payroll and
related expenses
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74,773
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98,000
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Line of credit, net
of fees
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836,813
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1,402,380
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Term loan –
current portion, net of fees
|
166,667
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166,667
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Deferred
revenue
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72,080
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95,233
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Customer
deposits
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31,863
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36,070
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Obligations under
other notes payable – current portion
|
24,392
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29,277
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Derivative
liability
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18,228
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99,036
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Other
liabilities
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46,179
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46,979
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Total current
liabilities
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3,012,867
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4,952,773
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LONG - TERM
LIABILITIES
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Notes payable
– stockholders
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500,000
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500,000
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Other notes payable
- net of current portion, net of fees
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4,409
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21,660
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Deferred rent, net
of current portion
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43,937
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44,923
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Term notes payable, net of current portion
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333,358
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Convertible
promissory notes, net of debt discounts and issuance costs of
$90,207 and $418,731 at September 30, 2016 and December 31, 2015 ,
respectively
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249,794
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221,269
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Total long-term
liabilities
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1,131,498
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787,852
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TOTAL
LIABILITIES
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4,144,365
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5,740,625
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STOCKHOLDERS’
(DEFICIT) EQUITY
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Preferred stock,
par value $0.0001 per share; 20,000,000 shares
authorized; none
issued and outstanding
|
—
|
—
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Common stock, par
value $0.0001 per share; 150,000,000 shares authorized; 49,177,264
and 45,151,254 issued and outstanding, at September 30, 2016 and
December 31, 2015, respectively
|
4,918
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4,515
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Additional
paid-in capital
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11,498,570
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10,951,491
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Treasury Stock, at
cost 10,600 shares at September 30, 2016 and December 31, 2015
respectively
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(5,890)
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(5,890)
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Accumulated
deficit
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(11,746,378)
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(10,942,380)
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Other
comprehensive loss
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(499)
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(1,462)
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TOTAL
STOCKHOLDERS’ (DEFICIT) EQUITY
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(249,279)
|
6,274
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TOTAL LIABILITIES
AND STOCKHOLDERS’ (DEFICIT) EQUITY
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$3,895,086
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$5,746,899
|
The
accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.
3
Brekford Corp.
Condensed Consolidated Statements
of Operations and Comprehensive loss
(unaudited)
|
Three Months Ended
September 30,
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Nine Months Ended
September 30,
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||
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2016
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2015
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2016
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2015
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NET
REVENUE
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$3,035,153
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5,776,862
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10,748,006
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14,586,453
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COST
OF REVENUE
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2,158,181
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4,887,299
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8,201,217
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11,711,852
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GROSS
PROFIT
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876,972
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889,563
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2,546,789
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2,874,601
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OPERATING
EXPENSES
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Salaries and related expenses
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484,783
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485,740
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1,489,311
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1,482,003
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Selling, general and administrative expenses
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335,666
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397,473
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1,122,333
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1,264,458
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TOTAL
OPERATING EXPENSES
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820,449
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883,213
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2,611,644
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2,746,461
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INCOME
(LOSS) FROM OPERATIONS
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56,523
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6,350
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(64,855)
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128,140
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OTHER
(EXPENSE) INCOME
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Interest
expense
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(207,062)
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(194,061)
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(528,039)
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(487,287)
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Change
in fair value of derivative liability
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10,500
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(54,936)
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80,808
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(39,228)
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Loss on
extinguishment of debt
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(130,517)
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—
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(291,912)
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—
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TOTAL
OTHER (EXPENSE) INCOME
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(327,079
)
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(248,997
)
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(739,143
)
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(526,515
)
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NET
LOSS
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$(270,556
)
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(242,647
)
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(803,998
)
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(398,375
)
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OTHER
COMPREHENSIVE LOSS – foreign currency
translation
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(499)
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(4,383)
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(499)
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(4,383)
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COMPREHENSIVE
LOSS
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(271,055
)
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(247,030
)
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(804,497
)
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(402,758
)
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LOSS
PER SHARE – BASIC AND DILUTED
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$(0.01)
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(0.01)
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(0.02)
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(0.01)
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WEIGHTED
AVERAGE NUMBER OF SHARES OUTSTANDING – BASIC
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48,360,299
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44,632,569
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46,710,189
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44,630,151
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WEIGHTED
AVERAGE NUMBER OF SHARES OUTSTANDING – DILUTED
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48,360,299
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44,632,569
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46,710,189
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44,630,151
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The
accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.
4
Brekford Corp.
Condensed Consolidated Statements
of Cash Flows (unaudited)
|
Nine Months
Ended September 30,
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2016
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2015
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CASH FLOWS FROM
OPERATING ACTIVITIES:
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Net
loss
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$ (803,998)
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(398,375)
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Adjustments to
reconcile net loss to net cash provided by (used in) operating
activities:
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|
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Depreciation and
amortization
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94,817
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150,627
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Share based
compensation
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50,590
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52,890
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Deferred
rent
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(986)
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44,131
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Amortization
of debt discount
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191,874
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257,505
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Amortization
of finance cost
|
39,106
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35,924
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Change
in fair value of warrant liability
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(80,808)
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39,228
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Loss
on extinguishment of debt
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291,912
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—
|
Changes in
operating assets and liabilities:
|
|
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Accounts
receivable
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2,103,340
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(2,133,049)
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Unbilled
receivables
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(458,248)
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(291,921)
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Prepaid expenses
and other non-current assets
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131,413
|
3,489
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Inventory
|
134,471
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(488,886)
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Customer
deposits
|
(4,207)
|
(511)
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Accounts payable
and accrued expenses
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(1,215,316)
|
874,399
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Accrued payroll and
related expenses
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(23,227)
|
57,962
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Deferred
revenue
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(23,153)
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(173,451)
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Other
liabilities
|
(800)
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(1,300)
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NET CASH PROVIDED
BY (USED IN) OPERATING ACTIVITIES
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426,780
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(1,971,248
)
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CASH FLOWS FROM
INVESTING ACTIVITIES:
|
|
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Purchase of fixed
assets
|
(140,574
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—
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NET CASH USED IN
INVESTING ACTIVITIES
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(140,574)
|
—
|
|
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CASH FLOWS FROM
FINANCING ACTIVITIES:
|
|
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Net change in line
of credit
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(584,960)
|
1,441,126
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Principal
payments on capital lease obligations
|
—
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(140,209)
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Payments on other
notes payable
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(22,136)
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(18,813)
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Borrowings
on term notes
|
500,000
|
650,000
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Payments on term
notes
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(166,667)
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(187,500)
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Deferred
financing cost
|
—
|
(85,444)
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NET
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
|
(273,763
)
|
1,659,160
|
Effect of foreign
currency translation
|
963
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(4,383)
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NET CHANGE IN
CASH
|
13,406
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(316,471)
|
CASH –
Beginning of period
|
580,400
|
1,112,881
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CASH –
End of period
|
$593,806
|
796,410
|
|
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SUPPLEMENTAL
DISCLOSURES OF CASH FLOW INFORMATION
|
|
|
Cash paid for
interest
|
$215,557
|
181,382
|
Cash paid for
income taxes
|
800
|
1,300
|
SUPPLEMENTAL
DISCLOSURES OF NON-CASH INFORMATION
|
|
|
Conversion
of notes payable in exchange for common stock
|
$300,000
|
—
|
Discount on
convertible debt
|
$7,104
|
41,590
|
The
accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.
5
Brekford
Corp.
Notes to Unaudited Condensed Consolidated Financial
Statements
For the Three and Nine Months Ended September 30, 2016 and
2015
NOTE 1 – DESCRIPTION OF THE BUSINESS
Brekford
Corp. (BFDI), headquartered in Hanover, Maryland, is a leading
public safety technology service provider of fully integrated
traffic safety solutions, parking enforcement citation management,
and mobile technology equipment for public safety vehicle services
to state and local municipalities, the U.S. Military and various
federal public safety agencies throughout the United States and
Mexico. Brekford’s combination of upfitting services,
cutting edge technology, and automated traffic safety enforcement
(“ATSE”) services offers a unique 360º solution
for law enforcement agencies and municipalities. Our core values of
integrity, accountability, respect, and teamwork drive our
employees to achieve excellence and deliver industry leading
technology and services, thereby enabling a superior level of
safety solutions to our clients. Brekford has one wholly
owned subsidiary, Municipal Recovery Agency, LLC, a Maryland
limited liability company, formed in 2012 for the purpose of
providing collection systems and services for unpaid citations and
parking fines.
As used
in these notes, the terms “Brekford”, “the
Company”, “we”, “our”, and
“us” refer to Brekford Corp. and, unless the context
clearly indicates otherwise, its consolidated
subsidiary.
NOTE 2 – LIQUIDITY
For the
nine months ended September 30, 2016, the Company incurred a net
loss of $803,998 and provided $426,780 of cash for operations.
Additionally, at September 30, 2016 the Company had cash available
of $593,806, a working capital surplus of $531,713
and availability under the established credit facility (see
Note 4) of $2,163,187.
On July
12, 2016 (the “Closing Date”), the Company entered into
a loan and security agreement (the “Loan Agreement”)
with Fundamental Funding LLC (the
“Lender”). The primary purpose of the new
Loan Agreement is to pay off the prior loan with the lender, and
provide additional working capital. The Loan Agreement provides for
a multi-draw loan to the Company for (i) the Company’s
accounts receivable, the lesser of (y) $2,500,000 or (z) 85%
of the Company’s eligible accounts and (ii) the
Company’s inventory advances, the lesser of (y) $500,000 or
(z) 50% of the eligible inventory (the “Revolving
Loans”). The maximum amount available to the Company under
the Loan Agreement for the Revolving Loans is $3,500,000 (the
“Credit Limit”). In addition, the Lender agreed to
provide the Company with an accommodation loan in an amount not to
exceed $500,000, which shall be repaid in thirty-six (36) equal
monthly installments of principal and interest (the
“Accommodation Loan” and together with the Revolving
Loans, the “Loans”). Management believes
that the Company’s current level of cash combined with cash
that it expects to generate in its operations during the next
twelve months including anticipated new customer contracts and
funds available from the credit facility (see Note 14) will be
sufficient to sustain the Company’s business initiatives
through at least September 30, 2017, but there can be no assurance
that these measures will be successful or adequate. In the
event that the Company’s cash reserves, cash flow from
operations and funds available under the Credit Facility (see Note
14) are not sufficient to fund the Company’s future
operations, it may need to obtain additional capital.
There
can be no assurance, however, that such financing will be available
or, if it is available, that we will be able to structure such
financing on terms acceptable to us and that it will be sufficient
to fund our cash requirements until we can reach a level of
sustained profitable operations and positive cash flows. If we are
unable to obtain the financing necessary to support our operations,
we may be unable to continue as a going concern. We currently have
no firm commitments for any additional capital. Further, if we
issue additional equity or debt securities, stockholders may
experience additional dilution or the new equity securities may
have rights, preferences or privileges senior to those of existing
holders of our shares of common stock.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING
POLICES
Principles of Consolidation and Basis of Presentation
The
Company’s consolidated financial statements include the
accounts of Brekford and its wholly owned subsidiary, Municipal
Recovery Agency, LLC. Intercompany transactions and balances are
eliminated in consolidation.
Use of Estimates
The
preparation of financial statements in conformity with U.S.
generally accepted accounting principles (“GAAP”)
requires us 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 financial
statements and the reported amount of revenues and expenses during
the reporting period. In the accompanying unaudited condensed
consolidated financial statements, estimates are used for, but not
limited to, stock-based compensation, allowance for doubtful
accounts, sales returns, allowance for inventory obsolescence, fair
value of long-lived assets, deferred taxes and valuation allowance,
and the depreciable lives of fixed assets. Actual results could
differ from those estimates.
Concentration of Credit Risk
The
Company maintains cash accounts with major financial
institutions. From time to time, amounts deposited may exceed
the FDIC insured limits.
Accounts Receivable
Accounts
receivable are carried at estimated net realizable value. The
Company has a policy of reserving for uncollectable accounts based
on its best estimate of the amount of probable credit losses in its
existing accounts receivable. The Company calculates the allowance
based on a specific analysis of past due balances. Past due status
for a particular customer is based on how recently payments have
been received from that customer. Historically, the Company’s
actual collection experience has not differed significantly from
its estimates, due primarily to credit and collections practices
and the financial strength of its customers.
6
Inventory
Inventory
principally consists of hardware and third party packaged software
that is modified to conform to customer specifications and held
temporarily until the completion of a contract. Inventory is valued
at the lower of cost or market value. The cost is determined by the
first-in, first-out (“FIFO”) method, while market value
is determined by replacement cost for raw materials and parts and
net realizable value for work-in- process.
Property and Equipment
Property
and equipment is stated at cost. Depreciation of furniture,
vehicles, computer equipment and software and phone equipment is
calculated using the straight-line method over the estimated useful
lives (two to ten years), and leasehold improvements are amortized
on a straight-line basis over the shorter of their estimated useful
lives or the lease term (which is three to five
years).
Management
reviews property and equipment for impairment whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of the long-lived
asset is measured by a comparison of the carrying amount of the
asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount
by which the carrying amount of the assets exceeds the estimated
fair value of the assets.
Revenue Recognition
The
Company recognizes revenue relating to its vehicle upfitting
solutions when all of the following criteria have been
satisfied: (i) persuasive evidence of an arrangement
exists; (ii) delivery or installation has been completed; (iii) the
customer accepts and verifies receipt; and (iv) collectability is
reasonably assured. The Company considers delivery to
its customers to have occurred at the time at which products are
delivered and/or installation work is completed and the customer
acknowledges its acceptance of the work.
The
Company provides its customers with a warranty against defects in
the installation of its vehicle upfitting solutions for one year
from the date of installation. Warranty claims
were insignificant for the three months and nine months
ended September 30, 2016 and September 30, 2015. The
Company also performs warranty repair services on behalf of the
manufacturers of the equipment it sells. The Company also offers
separately priced extended warranty and product maintenance
contracts to its customers on the equipment sold by the Company.
Revenues from extended warranty services are apportioned over the
period of the extended warranty service contracts and the warranty
costs are expensed as incurred. Revenue from extended warranties
amounted to $25,054 and $86,594 for the three and nine months ended
September 30, 2016, respectively, compared to $39,166 and $211,100
respectively, for the same periods in 2015.
For
automated traffic safety enforcement revenue, the Company
recognizes the revenue when the required collection efforts are
completed and the respective municipality is billed depending on
the terms of the respective contract. The Company records revenue
related to automated traffic violations for the Company’s
share of the violation amount.
Share-Based Compensation
The
Company complies with the provisions of Financial Accounting
Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 718, Compensation-Stock Compensation, in measuring and
disclosing stock based compensation cost. The measurement objective
in ASC Paragraph 718-10-30-6 requires public companies to measure
the cost of employee services received in exchange for an award of
equity instruments based on the grant date fair value of the award.
The cost is recognized in expense over the period in which an
employee is required to provide service in exchange for the award
(the vesting period). Performance-based awards are expensed ratably
from the date that the likelihood of meeting the performance
measures is probable through the end of the vesting
period.
Treasury Stock
The
Company accounts for treasury stock using the cost method. As of
September 30, 2016, 10,600 shares of our common stock were held in
treasury at an aggregate cost of $5,890.
Income Taxes
The
Company uses the liability method to account for income taxes.
Income tax expense includes income taxes currently payable and
deferred taxes arising from temporary differences between financial
reporting and income tax bases of assets and liabilities. Deferred
income taxes are measured using the enacted tax rates and laws that
are expected to be in effect when the differences are expected to
reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.
Income tax expense, if any, consists of the taxes payable for the
current period. Valuation allowances are established when
the realization of deferred tax assets are not considered more
likely than not. Due to the Company’s continued losses, 100%
valuation allowance has been established on all deferred tax
assets.
The
Company files income tax returns with the U.S. Internal Revenue
Service and with the revenue services of various states. The
Company’s policy is to recognize interest related to
unrecognized tax benefits as income tax expense. The Company
believes that it has appropriate support for the income tax
positions it takes and expects to take on its tax returns, and that
its accruals for tax liabilities are adequate for all open years
based on an assessment of many factors including past experience
and interpretations of tax law applied to the facts of each
matter.
7
Earnings (loss) per Share
Basic
earnings (loss) per share is calculated by dividing net income
(loss) available to common stockholders by the weighted-average
number of common shares outstanding and does not include the effect
of any potentially dilutive common stock
equivalents. Diluted earnings (loss) per share is
calculated by dividing net income (loss) by the weighted-average
number of shares outstanding, adjusted for the effect of any
potentially dilutive common stock equivalents. There is
no dilutive effect on the loss per share during loss
periods. See Note 13 for the calculation of basic and diluted
earnings (loss) per share.
Fair Value of Financial Instruments
The
carrying amounts reported in the balance sheets for cash, accounts
receivable, accounts payable and accrued expenses approximate their
fair values based on the short-term maturity of these instruments.
The carrying amount of the Company’s promissory note
obligations approximate fair value, as the terms of these notes are
consistent with terms available in the market for instruments with
similar risk.
We
account for our derivative financial instruments, consisting solely
of certain stock purchase warrants that contain non-standard
anti-dilutions provisions and/or cash settlement features, and
certain conversion options embedded in our convertible instruments,
at fair value using Level 3 inputs, which are discussed in Note 14
to these condensed consolidated financial statements. We determine
the fair value of these derivative liabilities using the
Black-Scholes option-pricing model when appropriate, and in certain
circumstances using binomial lattice models or other accepted
valuation practices.
When
determining the fair value of our financial assets and liabilities
using the Black-Scholes option-pricing model, we are required to
use various estimates and unobservable inputs, including, among
other things, contractual terms of the instruments, expected
volatility of our stock price, expected dividends, and the
risk-free interest rate. Changes in any of the assumptions related
to the unobservable inputs identified above may change the fair
value of the instrument. Increases in expected term, anticipated
volatility and expected dividends generally result in increases in
fair value, while decreases in the unobservable inputs generally
result in decreases in fair value.
Foreign Currency Transactions
The
Company has certain revenue and expense transactions with a
functional currency in Mexican pesos and the Company's reporting
currency is the U.S. dollar. Assets and liabilities are translated
from the functional currency to the reporting currency at the
exchange rate in effect at the balance sheet date and equity at the
historical exchange rates. Revenue and expenses are translated at
rates in effect at the time of the transactions. Resulting
translation gains and losses are accumulated in a separate
component of stockholders' equity - other comprehensive income
(loss). Realized foreign currency transaction gains and losses are
credited or charged directly to operations.
Segment Reporting
FASB
ASC Topic 280, Segment
Reporting, requires that an enterprise report selected
information about operating segments in its financial reports
issued to its stockholders. Based on its current analysis,
management has determined that the Company has only one operating
segment, which is Traffic Safety Solutions. The chief operating
decision-makers use combined results to make operating and
strategic decisions, and, therefore, the Company believes its
entire operation is covered under a single segment.
Recent Accounting Pronouncements
In May
2014 the FASB issued ASU 2014-09, Revenue from contracts with
Customers (Topic 606) (May 2014). The topic of Revenue Recognition
had become broad with several other regulatory agencies issuing
standards, which lacked cohesion. The new guidance established a
“comprehensive framework” and “reduces the number
of requirements to which an entity must consider in recognizing
revenue” and yet provides improved disclosures to assist
stakeholders reviewing financial statements. The amendments in this
Update are effective for annual reporting periods beginning after
December 15, 2017. Early adoption is permitted for annual reporting
periods beginning after December 31, 2016. The Company will adopt
the methodologies prescribed by this ASU by the date required.
Adoption of the ASU is not expected to have a significant effect on
the Company’s consolidated financial statements.
The
FASB has issued ASU No. 2014-15, Presentation of Financial
Statements-Going Concern (Subtopic 205-40): Disclosure of
Uncertainties about an Entity’s Ability to Continue as a
Going Concern. ASU 2014-15 is intended to define management’s
responsibility to evaluate whether there is substantial doubt about
an organization’s ability to continue as a going concern and
to provide related footnote disclosures. Under Generally Accepted
Accounting Principles (GAAP), financial statements are prepared
under the presumption that the reporting organization will continue
to operate as a going concern, except in limited circumstances.
Financial reporting under this presumption is commonly referred to
as the going concern basis of accounting. The going concern basis
of accounting is critical to financial reporting because it
established the fundamental basis for measuring and classifying
assets and liabilities. Currently, GAAP lacks guidance about
management’s responsibility to evaluate whether there is
substantial doubt the organization’s ability to continue as a
going concern or to provide footnote disclosures. The ASU provides
guidance to an organization’s management, with principles and
definition that are intended to reduce diversity in the timing and
content of disclosures that are commonly provided by organizations
today in the financial statement footnotes. The amendments in this
update are effective for the annual period ending after December
31, 2016, and for annual periods and interim periods thereafter.
Early application is permitted. The Company will adopt the
methodologies prescribed by this ASU by the date required. Adoption
of the ASU is not expected to have a significant effect on the
Company’s consolidated financial statements.
In
April 2015, the FASB issued ASU No. 2015-03,
“Interest-Imputation of Interest (Subtopic 835-30):
Simplifying the Presentation of the Debt Issuance Cost.” To
simplify the presentation of the debt issuance costs, the
amendments in this ASU require that debt issuance costs related to
a recognized debt liability be presented in the balance sheet as a
direct deduction from the carrying amount of that debt liability,
consistent with debt discounts. The recognition and measurement
guidance for debt issuance costs are not affected by the amendments
in this ASU. The amendments in this ASU are effective for financial
statements issued for fiscal years beginning after December 15,
2015 and interim periods within those years. By adopting this
standard, we have reclassified certain of our assets and
liabilities.
8
In
February 2016, FASB issued ASU-2016-02, "Leases (Topic 842)." The
guidance requires that a lessee recognize in the statement of
financial position a liability to make lease payments (the lease
liability) and a right of use asset representing its right to use
the underlying asset for the lease term. For finance leases: the
right-of-use asset and a lease liability will be initially measured
at the present value of the lease payments, in the statement of
financial position; interest on the lease liability will be
recognized separately from amortization of the right-of-use asset
in the statement of comprehensive income; and repayments of the
principal portion of the lease liability will be classified within
financing activities and payments of interest on the lease
liability and variable lease payments within operating activities
in the statement of cash flows. For operating leases: the
right-of-use asset and a lease liability will be initially measured
at the present value of the lease payments, in the statement of
financial position; a single lease cost will be recognized,
calculated so that the cost of the lease is allocated over the
lease term on a generally straight-line basis; and all cash
payments will be classified within operating activities in the
statement of cash flows. Under Topic 842 the accounting applied by
a lessor is largely unchanged from that applied under previous
GAAP. The amendments in Topic 842 are effective for the Company
beginning January 1, 2019, including interim periods within that
fiscal year. We are currently evaluating the impact of adopting the
new guidance of the consolidated financial statements.
In
January 2016, the Financial Accounting Standards Board ("FASB"),
issued Accounting Standards Update ("ASU") 2016-01, "Financial
Instruments-Overall (Subtopic 825-10): Recognition and Measurement
of Financial Assets and Financial Liabilities," which amends the
guidance in U.S. generally accepted accounting principles on the
classification and measurement of financial instruments. Changes to
the current guidance primarily affect the accounting for equity
investments, financial liabilities under the fair value option, and
the presentation and disclosure requirements for financial
instruments. In addition, the ASU clarifies guidance related to the
valuation allowance assessment when recognizing deferred tax assets
resulting from unrealized losses on available-for-sale debt
securities. The new standard is effective for fiscal years and
interim periods beginning after December 15, 2017, and is to be
adopted by means of a cumulative-effect adjustment to the balance
sheet at the beginning of the first reporting period in which the
guidance is effective. Early adoption is not permitted except for
the provision to record fair value changes for financial
liabilities under the fair value option resulting from
instrument-specific credit risk in other comprehensive income. The
Company is currently evaluating the impact of adopting this
standard.
In
November 2015, the FASB issued ASU 2015-17, "Income Taxes (Topic
740): Balance Sheet Classification of Deferred Taxes," which
simplifies the presentation of deferred income taxes by requiring
that deferred tax liabilities and assets be classified as
noncurrent in a classified statement of financial position. This
ASU is effective for financial statements issued for annual periods
beginning after December 16, 2016, and interim periods within those
annual periods. The adoption of this standard will not have any
impact on the Company's financial position, results of operations
and disclosures.
NOTE 4 – LINE OF CREDIT AND OTHER NOTES PAYABLE
On July
12, 2016 (the “Closing Date”), the Company entered into
a loan and security agreement (the “Loan Agreement”)
with Fundamental Funding LLC (the
“Lender”). The Loan Agreement provides for a
multi-draw loan to the Company for (i) the Company’s accounts
receivable, the lesser of (y) $2,500,000 or (z) 85% of the
Company’s eligible accounts and (ii) the Company’s
inventory advances, the lesser of (y) $500,000 or (z) 50% of the
eligible inventory (the “Revolving Loans”). The maximum
amount available to the Company under the Loan Agreement for the
Revolving Loans is $3,500,000 (the “Credit Limit”). In
addition, the Lender agreed to provide the Company with an
accommodation loan in an amount not to exceed $500,000, which shall
be repaid in thirty-six (36) equal monthly installments of
principal and interest (the “Accommodation Loan” and
together with the Revolving Loans, the
“Loans”).
On the
Closing Date, the Lender advanced the Company an amount equal to
$533,670. The amounts advanced under the Loan Agreement
are due and payable on the three (3) year anniversary of the
Closing Date (the “Maturity Date”), and thereafter, the
Maturity Date shall automatically be extended for successive
periods of one year unless the Company shall give lender written
notice of termination not less than ninety (90) days prior to the
end of such term or renewal term, as applicable. Lender may
terminate the Loan Agreement at any time in its sole discretion by
giving the Company ninety (90) days prior written notice, provided
that upon an Event of Default (as defined in the Loan Agreement),
Lender may terminate the Loan Agreement without notice to the
Company, effective immediately. Upon termination by the Lender, the
Company shall be required to pay certain termination fees based on
a percentage of the Credit Limit as set forth in the Loan
Agreement.
The
outstanding principal balance under the Note for the Revolving
Loans shall bear interest at a rate per annum equal to the
“prime rate” published from time to time in
the Wall Street
Journal (the “Prime Rate”), plus 1.75% per
annum, accruing daily and payable monthly. The outstanding
principal balance under the Accommodation Loan shall bear interest
at a rate per annum equal to the Prime Rate in effect from time to
time, plus 12.75% per annum, accruing daily and payable
monthly. Notwithstanding any other provision
in the Loan Agreement, interest on Loans shall be calculated on the
higher of: (i) the actual average monthly balance of all Loans from
the prior month, or (ii) $1,350,000. In addition the Company will
be subject to certain monthly or annual fees on the Loans as set
forth in the Loan Agreement.
The
remaining portion of Credit Limit may be advanced to the Company
upon written notice provided to the Lender during the period
beginning from the Closing Date through the Maturity Date provided
no default has occurred under the Loan Agreement. The Company may
prepay any portion of the Accommodation Loan, in whole or in part,
to Lender on or prior to the Maturity Date.
Initial
borrowings under the Loan Agreement were subject to, among other
things, the substantially concurrent repayment by the Company of
all amounts due and owing under the Company’s credit
facility, dated May 24, 2014, with Rosenthal & Rosenthal, Inc.
and the satisfaction and termination of such borrowing and all
liens thereunder (collectively, the “Rosenthal
Loan”). All amounts owed under the Rosenthal Loan,
which was approximately an aggregate of $2,253,617, was satisfied
and terminated by the Company on the Closing Date.
In
addition, on the Closing Date, the Company entered into a
subordination agreement with each of C.B. Brechin and Scott
Rutherford, the Company’s chief executive officer and chief
strategy officer, respectively, as well as with the Investor
described in Note 6 pursuant to which each of the parties agreed to
subordinate all present and future indebtedness held by each of
them to the obligations of the Lender.
9
On the
Closing Date, as part of the Loan Agreement and to secure the
payment and performance of all of the obligations owed to Lender
under the Loan Agreement when due, the Company granted to Lender a
security interest in all right, title and interest to all assets of
the Borrower, whether now owned or hereafter arising or acquired
and wherever located.
The
Loan Agreement contains customary affirmative and negative
covenants for loan agreements of its type, including but not
limited to, limiting the Company’s ability to pay dividends
or make any distributions, incur additional indebtedness, grant
additional liens, engage in any other lime of business, make
investments, merge, consolidate or sell all or substantially all of
its assets and enter into transactions with related
parties. The Loan Agreement also contains certain
financial covenants, including, but not limited to, a debt service
coverage ratio.
The
Loan Agreement includes customary events of default, including but
not limited to, failure to pay principal, interest or fees when
due, failure to comply with covenants, default under certain other
indebtedness, certain insolvency or bankruptcy events, the
occurrence of certain material judgments the institution of any
proceeding by a government agency or a change of control of the
Company.
All
borrowings under the Loan Agreement are due upon a default under
the terms of the Loan Agreement. The Company’s obligations
under the Loan Agreement are guaranteed by C.B. Brechin, the
Company’s chief executive officer pursuant to the terms of a
surety agreement.
At
September 30, 2016, the Company had $836,813 in outstanding
indebtedness under the Revolving Facility and $500,000 in
outstanding indebtedness under the Term Loan, and the Company could
have borrowed up to an additional $2,163,187 under the Revolving
Facility. As of September 30, 2016, we were out of compliance
with one of the financial covenants contained in the Credit
Facility as a result of the loss recorded for the nine months ended
September 30, 2016. We reported this non-compliance to
Fundamental, and requested a waiver for the nine months ended
September 30, 2016.
The
Company financed certain vehicles and equipment under finance
agreements. The agreements mature at various dates through December
2017. The agreements require various monthly payments of principal
and interest until maturity. At September 30, 2016 and December 31,
2015, financed assets of $26,539 and $47,732, respectively, net of
accumulated amortization of $115,377 and $98,184, respectively,
were included in property and equipment on the balance sheets. The
weighted average interest rate was 3.75% at September 30, 2016 and
December 31, 2015.
NOTE 5 – CONVERTIBLE NOTES PAYABLE –
STOCKHOLDERS
Brekford financed the repurchase of shares of its common stock and
warrants from the proceeds of convertible promissory notes that
were issued by Brekford on November 9, 2009 in favor of a
lender group that included two of its directors, Messrs. C.B.
Brechin and Scott Rutherford, in the principal amounts of $250,000
each (each, a “Promissory Note” and together, the
“Promissory Notes”). Each Promissory Note bears
interest at the rate of 12% per annum and at the time of issuance
was to be convertible into shares of Brekford common stock, at the
option of the holder, at an original conversion price of $.07 per
share. At the time of issuance, Brekford agreed to pay the unpaid
principal balance of the Promissory Notes and all accrued but
unpaid interest on the date that was the earlier of (i) two years
from the issuance date or (ii) 10 business days after the date on
which Brekford closes an equity financing that generates gross
proceeds in the aggregate amount of not less than
$5,000,000.
On
April 1, 2010, Brekford and each member of the lender group
executed a First Amendment to each Promissory Note, which amended
the respective Promissory Note as follows:
●
|
Revise
the conversion price in the provision that allows the holder of the
Promissory Note to elect to convert any outstanding and unpaid
principal portion of the Promissory Note and any accrued but unpaid
interest into shares of the common stock at a price of fourteen
cents ($0.14) per share, and
|
●
|
Each
Promissory Note’s maturity date was extended to the earlier
of (i) four years from the issuance date or (ii) 10 business days
after the date on which Brekford closes an equity financing that
generates gross proceeds in the aggregate amount of not less than
$5,000,000.
|
On
November 8, 2013, Brekford and each member of the lender group
agreed to extend the maturity dates of the Promissory Notes to the
earlier of (i) November 9, 2014 or (ii) 10 business days after the
date on which Brekford closes an equity financing that generates
gross proceeds in the aggregate amount of not less than
$5,000,000.
On November 9, 2015, the maturity dates of the Promissory Notes
were extended to the earlier of (i) November 9, 2016 or
(ii) 10 business days from the date on which Brekford closes
an equity financing that generates gross proceeds in the aggregate
amount of not less than $5,000,000.
On November 4, 2016, the maturity dates of the Promissory Notes
were extended to the earlier of (i) November 9, 2017 or
(ii) 10 business days from the date on which Brekford closes
an equity financing that generates gross proceeds in the aggregate
amount of not less than $5,000,000. Mr. Brechin and Mr. Rutherford
have indicated that they will not exercise their right of repayment
prior to September 30, 2017.
The Company anticipates the maturity date of the Promissory Notes
will continue to be extended for the foreseeable future; thus, they
are classified as long-term liabilities. As of September 30, 2016
and December 31, 2015, the amounts outstanding under the Promissory
Notes totaled $500,000.
10
NOTE 6 – CONVERTIBLE PROMISSORY NOTES PAYABLE -
INVESTOR
On March 17, 2015, the Company entered into a note and warrant
purchase agreement (the “Agreement”) with an accredited
investor (the “Investor”) pursuant to which the
Investor purchased an aggregate principal amount of $715,000 of a
6% convertible promissory note issued by the Company for an
aggregate purchase price of $650,000 (the “Investor
Note”). The Investor Note bears interest at a rate of 6% per
annum and the principal amount is due on March 17, 2017. Any
interest that accrues under the Investor Note is payable either
upon maturity or upon any principal being converted on any
voluntary conversion date (as to that principal amount then being
converted). The Investor Note is convertible at the option of the
Investor at any time into shares of Common Stock at a conversion
price equal to the lesser of (i) $0.25 per share and (ii) 70% of
the average of the lowest three volume weighted average prices for
the twelve (12) trading days prior to such conversion (the
“Conversion Price”). In no event can the Conversion
Price be less than $0.10; provided, however, that if on or after
the date of the Agreement the Company sells any Common Stock or
Common Stock Equivalents (as defined in the Agreement) at an
effective price per share that is less than $0.10 per share, then
the Conversion Price shall be equal to the par value of the Common
Stock then in effect. In connection with the Agreement, the
Investor received a warrant to purchase 780,000 shares of Common
Stock (the “Warrant”). The Warrant is exercisable for a
period of five years from the date of issuance at an exercise price
of $0.50 per share, subject to adjustment (the “Exercise
Price”).
On October 23, 2015, the Investor converted $25,000 of principal
and $904 of accrued interest due under the Investor Note into
169,530 shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $19,869.
On December 2, 2015, the Investor converted $50,000 of principal
and $2,129 of accrued interest due under the Investor Note into
349,155 shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $35,160.
On February 26, 2016 the Investor converted $50,000 of principal
and $2,844 of accrued interest due under the Investor Note into
476,500 shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $49,525.
On March 31, 2016 the Investor converted $50,000 of principal and
$3,123 of accrued interest due under the Investor Note into 510,310
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $72,947.
On May 31, 2016 the Investor converted $50,000 of principal and
$3,625 of accrued interest due under the Investor Note into 605,928
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $38,923.
On July 1, 2016 the Investor converted $50,000 of principal and
$3,880 of accrued interest due under the Investor Note into 699,733
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $40,875.
On July 27, 2016 the Investor converted $50,000 of principal and
$4,093 of accrued interest due under the Investor Note into 758,670
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $45,024.
On August 31, 2016 the Investor converted $50,000 of principal and
$4,381 of accrued interest due under the Investor Note into 776,869
shares of Common Stock and the Company recognized a loss on
extinguishment of debt of $44,618.
The
following table provides information relating to the Investor Note
at September 30, 2016:
|
September
30,
2016
|
December
31,
2015
|
Convertible
promissory note payable
|
$340,000
|
$640,000
|
Original issuance
discount, net of amortization of the $57,896 and $29,820 as of
September 30, 2016 and December 31, 2015
|
(7,104)
|
(35,180)
|
Beneficial
conversion feature, net of amortization of $496,948 and $255,960 as
of September 30, 2016 and December 31, 2015
|
(60,973)
|
(301,960)
|
Warrant feature,
net of amortization of the $82,015 and $42,243 as of September 30,
2016 and December 31, 2015
|
(10,063)
|
(49,835)
|
Original issuance
cost, net of amortization of $40,433 and $20,744 as of September
30, 2016 and December 31, 2015
|
(12,066)
|
(31,756)
|
Convertible
promissory note payable, net
|
$249,794
|
$221,269
|
We evaluated the financing transactions in accordance with ASC
Topic 470, Debt with Conversion and Other Options, and
determined that the conversion feature of the Investor Note was
afforded the exemption for conventional convertible instruments due
to its fixed conversion rate. The Investor Note has an explicit
limit on the number of shares issuable so it did meet the
conditions set forth in current accounting standards for equity
classification. The debt was issued with non-detachable conversion
options that are beneficial to the investors at inception, because
the conversion option has an effective strike price that is less
than the market price of the underlying stock at the commitment
date. The accounting for the beneficial conversion feature requires
that the beneficial conversion feature be recognized by allocating
the intrinsic value of the conversion option to additional
paid-in-capital, resulting in a discount on the convertible notes,
which will be amortized and recognized as interest
expense.
11
Accordingly, a portion of the proceeds was allocated to the Warrant
based on its relative fair value, which totaled $92,079 using the
Black Scholes option-pricing model. Further, the Company attributed
a beneficial conversion feature of $557,921 to the shares of
Common Stock issuable under the Investor Note based upon the
difference between the effective Conversion Price and the closing
price of the Common Stock on the date on which the Investor Note
was issued. The assumptions used in the Black-Scholes model are as
follows: (i) dividend yield of 0%;
(ii) expected volatility of 80.5%, (iii) weighted
average risk-free interest rate of 1.56%, (iv) expected
life of five years, and (v) estimated fair value of the Common
Stock of $0.26 per share. The expected term of the Warrant
represents the estimated period of time until exercise and is based
on historical experience of similar awards giving consideration to
the contractual terms. The Company recorded amortization of the
beneficial conversion feature and warrant feature of the Investor
Note in other expense in the amount of $240,988 and $39,773 during
the nine months ended September 30, 2016 and $255,960 and $42,243,
during the year ended December 31, 2015 which also includes the
unamortized beneficial conversion feature and warrant feature
attributable to the $375,000 principal converted to
equity.
The Company recorded an original issue discount of $65,000 to be
amortized over the term of the Agreement as interest expense. The
Company recognized $28,076 and $29,820 of interest expense as a
result of the amortization during the nine months ended September
30, 2016 and the year ended December 31, 2015 respectively, which
also includes the unamortized original issue discount attributable
to the $375,000 principal converted to equity.
NOTE 7 – WARRANT DERIVATIVE LIABILITY
On
March 17, 2015, in conjunction with the issuance of the Investor
Note (see Note 6), the Company issued the Warrant, which permits
the Investor to purchase 840,000 shares of Common Stock, including
60,000 related to the financing costs, with an exercise price of
$0.50 per share and a life of five years.
The
Exercise Price is subject to anti-dilution adjustments that allow
for its reduction in the event the Company subsequently issues
equity securities, including shares of Common Stock or any security
convertible or exchangeable for shares of Common Stock, for no
consideration or for consideration less than $0.50 a share. The
Company accounted for the conversion option of the Warrant in
accordance with ASC Topic 815. Accordingly, the conversion option
is not considered to be solely indexed to the Company’s own
stock and, as such, is recorded as a liability. The derivative
liability associated with the Warrant has been measured at fair
value at March 17, 2015 and September 30, 2016 using the Black
Scholes option-pricing model. The assumptions used in the
Black-Scholes model are as follows: (i) dividend yield of
0%; (ii) expected volatility of 81.67% -80.50%;
(iii) weighted average risk-free interest rate of 1.14% -
1.56% (iv) expected life of five years; and (v) estimated fair
value of the Common Stock of $0.10-$0.26 per share.
At
September 30, 2016, the outstanding fair value of the derivative
liability was $18,228.
NOTE 8 – LEASES
Capital Leases
At
September 30, 2016 and December 31, 2015, no capital lease was
included in property and equipment on the consolidated balance
sheets.
Operating Leases
The
Company rents office space under separate non-cancelable
operating leases. Rent expense under our main headquarters lease,
expiring on April 30, 2020 amounted to $128,432 and $126,486 for the nine
months ended September 30, 2016 and 2015,
respectively.
The
Company also leases approximately 2,500 square feet of office space
from a related party under a non-cancelable operating lease
expiring on June 30, 2017. Rent expense under this lease amounted
to $36,900 for the nine months ended September 30, 2016 and 2015,
respectively.
NOTE 9 – MAJOR CUSTOMERS AND VENDORS
Major Customers
The Company has several contracts with government agencies, of
which net revenue from one major customer during the nine months
ended September 30, 2016 represented 14% of the total net revenue
for the period. Accounts receivable due from three customers at
September 30, 2016 amounted to 43% of total accounts
receivable.
For the period ended September 30, 2015, the Company has several
contracts with government agencies, of which net revenue from one
major customer represented 23% of the total net revenue for the
period. Accounts receivable due from three customers at September
30, 2015 amounted to 60% of total accounts receivable.
Accounts
receivable due from these customers at December 31, 2015 amounted
to 53% of total accounts receivable at that date.
Major Vendors
The
Company purchased substantially all hardware products that it
resold during the periods presented from two major
distributors. Revenues from hardware products amounted to 51%
and 47% of total revenues for the nine months ended September 30,
2016 and 2015, respectively. As of September 30, 2016 and
2015, accounts payable due to these distributors amounted to 62%
and 43% of total accounts payable, respectively.
Accounts
payable due to these distributors at December 31, 2015, amounted to
72% of total accounts payable at that date.
12
NOTE 10 - STOCKHOLDERS’ EQUITY
Warrants
The
assumptions used to value warrant grants during the nine months
ended September 30, 2016, which consisted solely of the Warrant,
were as follows:
|
Nine months
ended September 30,
2016
|
Expected life (in
years)
|
5.00
|
Volatility
|
81.67%
|
Risk free interest
rate
|
1.14%
|
Expected Dividend
Rate
|
0
|
Summary
of the warrant activity for the nine
months ended September 30, 2016 is as follows:
|
Number of
Warrants
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Remaining
Contractual Life
(Years)
|
Aggregate
Intrinsic
Value
|
Outstanding at
January 1, 2016
|
840,000
|
$0.50
|
4.21
|
$0.00
|
Granted
|
—
|
—
|
—
|
0.00
|
Forfeited or
expired
|
—
|
—
|
—
|
0.00
|
Exercised
|
—
|
—
|
—
|
—
|
Outstanding at
September 30, 2016
|
840,000
|
0.50
|
3.46
|
0.00
|
Exercisable at
September 30, 2016
|
840,000
|
0.50
|
3.46
|
0.00
|
The
weighted average remaining contractual life of warrants outstanding
as of September 30, 2016 was as follows:
|
|
|
Weighted
|
|
|
|
Average
|
|
Stock
|
Stock
|
Remaining
|
Exercisable
|
Warrants
|
Warrants
|
Contractual
|
Prices
|
Outstanding
|
Exercisable
|
Life
(years)
|
$0.50
|
840,000
|
840,000
|
3.46
|
|
|
|
|
Total
|
840,000
|
840,000
|
3.46
|
NOTE 11 – SHARE-BASED COMPENSATION
The
Company has issued shares of restricted common stock and warrants
to purchase shares of common stock and has granted non-qualified
stock options to certain employees and non-employees. On April 25,
2008, the Company’s stockholders approved the 2008 Stock
Incentive Plan (the “2008 Incentive
Plan”).
Stock Options
Option grants during the nine months ended September 30, 2016 were
primarily made to non-employee directors who elected to receive
options for their Board service. The options had a grant date fair
value of $0.07 per share and will vest and become exercisable with
respect to option shares over a three year period commencing from
the date of grant at a rate of 33.33% per year. The
Company recorded $3,515 and $10,988 and $4,360 and $8,100 in stock
option compensation expense for the three and nine months ended
September 30, 2016 and 2015, respectively, related to the stock
option grants.
13
Summary
of the option activity for nine months ended September 30, 2016 is
as follows:
|
Number of
Options
|
Weighted
Average
Remaining
Contractual
Life (Years)
|
Weighted
Average
Remaining
Contractual Life
(Years)
|
Aggregate
Intrinsic
Value
|
Outstanding at
January 1, 2016
|
400,000
|
$0.20
|
3.25
|
$0.00
|
Granted
|
225,000
|
0.12
|
3.50
|
0.00
|
Forfeited or
expired
|
75,000
|
0.22
|
2.00
|
0.00
|
Exercised
|
—
|
—
|
—
|
—
|
Outstanding at
September 30, 2016
|
550,000
|
0.20
|
3.25
|
0.00
|
Exercisable at
September 30, 2016
|
225,000
|
—
|
—
|
0.00
|
Vested and expected
to vest
|
325,000
|
0.20
|
3.25
|
0.00
|
The
unrecognized compensation cost for unvested stock option awards
outstanding at September 30, 2016 was approximately $24,547 to be
recognized over approximately 3.25 years.
Restricted Stock Grants
During the nine months ended September 30, 2016, the
Company granted an aggregate of 198,000 shares of Common
Stock to key employees in consideration of services rendered and
part of employment agreement. The weighted average value of the
shares amounted to $0.20 per share based upon the closing price of
shares of Common Stock on the date of the grant. These
shares were fully vested on the date of the grant. The Company
recorded $0 and $39,600 in share-based compensation expense
for the three and nine months ended September 30, 2016 related to stock grants. For the three and nine
months ended September 30, 2015, the Company recorded $0 and
$44,880 in share-based compensation expense related to stock
grants.
NOTE 12 – INVENTORY
As of
September 30, 2016 and December 31, 2015, inventory consisted of
the following:
|
September
30,
2016
|
December
31,
2015
|
Raw
Materials
|
$472,000
|
$573,769
|
Work in
Process
|
—
|
32,702
|
Total
Inventory
|
$472,000
|
$606,471
|
14
NOTE 13 –LOSS PER SHARE
The
following table provides information relating to the calculation of
loss per common share.
|
Three Months
Ended
September
30,
|
Nine Months
Ended
September
30,
|
||
|
2016
|
2015
|
2016
|
2015
|
|
|
|
|
|
Basic net income
(loss) per share :
|
|
|
|
|
Net
income (loss)
|
$(270,556)
|
$(242,647)
|
$(803,998)
|
$(398,375)
|
Weighted
average common shares outstanding
|
48,360,299
|
44,632,569
|
46,710,189
|
44,630,151
|
Basic
net income (loss) per share
|
$(0.01)
|
$(0.01)
|
$(0.02)
|
$(0.01)
|
|
|
|
|
|
Diluted net income
(loss) per share :
|
|
|
|
|
Net
income (loss)
|
$(270,556)
|
$(242,647)
|
$(803,998)
|
$(398,375)
|
Weighted
average common shares outstanding
|
48,360,299
|
44,632,569
|
46,710,189
|
44,630,151
|
Potential
dilutive securities
|
—
|
—
|
—
|
—
|
Weighted
average common shares outstanding – diluted
|
48,360,299
|
44,632,569
|
46,710,189
|
44,630,151
|
Diluted
earnings per share
|
$(0.01)
|
$(0.01)
|
$(0.02)
|
$(0.01)
|
Common
stock equivalents excluded due to anti-dilutive effect
|
6,961,429
|
9,067,311
|
6,961,429
|
9,067,311
|
NOTE 14 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosures
about fair value of financial instruments require disclosure of the
fair value information, whether or not recognized in the balance
sheet, where it is practicable to estimate that value. As of
September 30, 2016, the amounts reported for cash, accrued interest
and other expenses, notes payables, and derivative liability
approximate their fair values because of their short
maturities.
Fair
value is defined as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. ASC Topic 820
established a three-tier fair value hierarchy, which prioritizes
the inputs used in measuring 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).
These tiers include:
●
|
Level
1, defined as observable inputs such as quoted prices for identical
instruments in active markets;
|
|
●
|
Level
2, defined as inputs other than quoted prices in active markets
that are either directly or indirectly observable such as quoted
prices for similar instruments in active markets or quoted prices
for identical or similar instruments in markets that are not
active; and
|
|
●
|
Level
3, defined as unobservable inputs in which little or no market data
exists, therefore requiring an entity to develop its own
assumptions, such as valuations derived from valuation techniques
in which one or more significant inputs or significant value
drivers are unobservable.
|
We
measure certain financial instruments at fair value on a recurring
basis. Assets and liabilities measured at fair value on a recurring
basis are as follows at September 30, 2016:
|
Total
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
Liabilities
|
|
|
|
|
Derivative
liability
|
18,228
|
—
|
—
|
18,228
|
Total liabilities
measured at fair value
|
$18,228
|
$—
|
$—
|
$18,228
|
The
following is a reconciliation of the derivative liability for which
Level 3 inputs were used in determining the approximate fair
value:
Beginning balance
as of December 31, 2015
|
$99,036
|
Fair value of
derivative liabilities issued
|
—
|
Gain on change in
derivative liability
|
(80,808)
|
Ending balance as
of September 30, 2016
|
$18,228
|
15
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The
following discussion and analysis presents a review of the
condensed operating results of Brekford for the three and nine
months ended September 30, 2016 and 2015 and the financial
condition of Brekford at September 30, 2016. The discussion and
analysis should be read in conjunction with the condensed
consolidated financial statements and accompanying notes included
herein, as well as the Company’s audited financial statements
for the year ended December 31, 2015 filed with its Annual Report
on Form 10-K on March 24, 2016.
Forward-Looking Statements
This
Quarterly Report on Form 10-Q (“Quarterly Report”)
may contain forward-looking statements within the meaning of The
Private Securities Litigation Reform Act of
1995. Readers of this report should be aware of the
speculative nature of “forward-looking
statements.” Statements that are not historical in
nature, including those that include the words
“anticipate”, “estimate”,
“should”, “will”, “expect”,
“believe”, “intend”, and similar
expressions, are based on current expectations, estimates and
projections about, among other things, the industry and the markets
in which we operate, and they are not guarantees of future
performance. Whether actual results will conform to
expectations and predictions is subject to known and unknown risks
and uncertainties, including risks and uncertainties discussed in
this Quarterly Report; general economic, market, or business
conditions and their effects; industry competition, conditions,
performance and consolidation; changes in applicable laws or
regulations; changes in the budgets and/or public safety priorities
of our customers; economic or operational repercussions from
terrorist activities, war or other armed conflicts; the
availability of debt and equity financing; and other circumstances
beyond our control. Consequently, all of the
forward-looking statements made in this report are qualified by
these cautionary statements, and there can be no assurance that the
actual results anticipated will be realized, or if substantially
realized, will have the expected consequences on our business or
operations.
Forward-looking
statements speak only as of the date the statements are made.
Except as required by applicable laws, we do not intend to publish
updates or revisions of any forward-looking statements we make to
reflect new information, future events or otherwise. If
we update one or more forward-looking statements, then no inference
should be drawn that we will make additional updates with respect
thereto or with respect to other forward-looking
statements.
As used
in this Quarterly Report, the terms “Brekford”,
“the Company”, “we”, “our”, and
“us” refer to Brekford Corp. and, unless the context
clearly indicates otherwise, its consolidated
subsidiary.
Overview
The
Company, headquartered in Hanover, Maryland, is a leading public
safety technology service provider of fully integrated traffic
safety solutions, parking enforcement citation management, and
mobile technology equipment for public safety vehicle services to
state and local municipalities, the U.S. Military and various
federal public safety agencies throughout the United States and
Mexico. Brekford’s combination of upfitting services,
cutting edge technology, and automated traffic safety enforcement
(“ATSE”) services offers a unique 360º solution
for law enforcement agencies and municipalities. The
Company’s core values of integrity, accountability, respect,
and teamwork drive our employees to achieve excellence and deliver
industry leading technology and services, thereby enabling a
superior level of safety solutions to our
clients. Brekford has one wholly owned subsidiary,
Municipal Recovery Agency, LLC, a Maryland limited liability
company, formed in 2012 for the purpose of providing collection
systems and services for unpaid citations and parking
fines.
Products and Services
Automated
Traffic Safety Enforcement (“ATSE”) – Red Light
and Speed Camera Systems
Public
safety is a major concern for most communities – especially
as populations grow, and yet there is continual pressure on public
safety budgets. One way to help make streets safer while reducing
workload is a well-run photo red light or speed enforcement
program. The objective of photo enforcement is to help curtail
aggressive driving through voluntary compliance. Revenue generated
from fines routinely goes directly back into supporting other
public safety initiatives.
Although
opponents of red light cameras cite the increase in rear end
collisions as cause for disapproval of cameras, a study conducted
in February 2011 by the Insurance Institute for Highway Safety (the
“IIHS”) reported that red-light cameras reduced fatal
red light running crashes by 24% in 14 large U.S. cities with
populations over 200,000. IIHS concluded that if red
light cameras had been operating in all 99 U.S. cities with
populations over 200,000 during this study period (five years), a
total of 815 deaths could have been avoided. Because the
types of crashes prevented by red light cameras tend to be far more
severe than rear-end crashes, research has shown there is a net
positive benefit. Photo enforcement solutions can reduce
collisions, injuries and deaths by providing a useful tool for
municipalities and law enforcement agencies, without unduly taxing
drivers who do not break the law. Today, nearly 600 communities
across the U.S. operate red light or speed camera enforcement
programs.
16
Despite
the increased safety effects and prevention of fatalities, there is
still a common misconception that automated traffic safety
enforcement systems are not supported by the general
public. An IIHS survey conducted in November 2012 found
that a large majority of people living in Washington, D.C., one of
the largest combined red light and speed enforcement programs in
the U.S., favor camera enforcement. Of those surveyed,
87% support red light cameras and 76% support speed
cameras. Even the majority of violators (59%) agreed
that they deserved their most recent citation. In 2012, IIHS
reported that 633 people were killed and an estimated 133,000 were
injured in crashes that involved red light
running. Speeding was a factor in 31% of motor vehicle
crash deaths in 2012.
Brekford’s ATSE
products offer intersection safety (red light), speed, and cell
phone enforcement options by way of a complete suite of
solution-based products. Our team of industry
professionals has extensive experience in this field, we have
developed equipment and a full turnkey solution that we
believe will ensure the success of any program. We have
created and implemented some of the most cutting-edge features into
our design while constructing end-to-end systems specifically with
our clients’ needs in mind.
ATSE
systems are one of a wide range of measures that are effective at
reducing vehicle speeds and crashes. The ATSE system is an
enforcement technique with one or more motor vehicle sensors
producing recorded images of motor vehicles traveling at speeds
above a defined threshold. Images captured by the ATSE system
are processed and reviewed in an office environment and violation
notices are mailed to the registered owner of the identified
vehicle. ATSE is a technology available to law enforcement as a
supplement and not a replacement for traditional enforcement
operations. Evaluations of ATSE, both internationally and in the
United States have identified some advantages over traditional
speed enforcement methods. These include:
●
High
rate of violation detection. ATSE units can detect and record
multiple violations per minute. This can provide a strong deterrent
effect by increasing drivers’ perceived likelihood of being
cited for speeding.
●
Physical safety of
ATSE operators and motorists. ATSE can operate at locations where
roadside traffic stops are dangerous or infeasible, and where
traffic conditions are unsafe for police vehicles to enter the
traffic stream and stop suspected violators. With ATSE there is
normally no vehicle pursuit or confrontation with motorists. ATSE
might also reduce the occurrence of traffic congestion due to
driver distraction caused by traffic stops on the
roadside.
●
Fairness of
operation. Violations are recorded for all vehicles traveling in
excess of the enforcement speed threshold. Efficient use of
resources. ATSE can act as a “force multiplier,”
enhancing the influence of limited traffic enforcement staff and
resources.
Beyond
traditional tax collection on income or property, state agencies
and local municipalities rely heavily on fine and fee revenue
generated from a multitude of violator-funded
sources. For example, jurisdictions generate sizable
revenues from court fees, traffic and parking violations, ordinance
infractions, and library and utility arrearages. Each of these
revenue sources funds public safety and community development
initiatives and without the income, the services are curtailed.
Brekford offers client-specific solutions to these agencies and
municipalities to assist them with collecting unpaid fines,
including:
●
Notification
continuance
●
Mail
house and printing
●
Data
purification and verification
●
Back
office support
●
Call
center response (inbound & out bound)
●
Lock-box &
treasury
●
Payment
processing
Rugged Information Technology Solutions – Mobile Data &
Digital Video
Law
enforcement agency, fire department and emergency medical services
(“EMS”) personnel have unique requirements for fleet
vehicle upfitting and IT equipment to include characteristics such
as ruggedness and reliability. The equipment must be able to work
in extreme environments that include high levels of vibration and
shock, wide temperature ranges, varying humidity, electromagnetic
interference as well as voltage and current transients. Our rugged
and non-rugged IT products and mobile data communication systems
provide public safety workers with the unique functionalities
necessary to enable effective response to emergency
situations.
For
more than a decade, Brekford has been a distributor and integrator
for most major brands in the mobile technology arena. We handle
everything from Panasonic Toughbooks® and Arbitrator®
digital video systems to emergency lighting systems and wireless
technology. We believe that we have all of the high-end
products our customers need to handle their day-to-day operations
and protect the public they serve. Every product we sell is tested
by highly trained technicians and guaranteed to work in even the
most extreme conditions. We specialize in seamlessly incorporating
custom-built solutions within existing networks. We deliver our
end-to-end solutions with service programs that work for agencies
large and small, from turnkey drop shipping to municipal
leases. Our commitment is to design and deliver solutions that meet
or exceed industry standards for safety, ergonomics, reliability,
serviceability and uniformity.
17
We
develop integrated, interoperable, feature-rich mobile systems that
enable first responders, such as police, fire and EMS, to obtain
and exchange information in real time. The rapid dissemination of
real time information is critical to determine and assure timely
and precise resource allocation by public sector decision makers.
As a premiere Panasonic Toughbook® partner, we augment these
rugged laptops by designing and manufacturing vehicle mounting
systems and docking stations for in-vehicle communications
equipment. With rugged laptop computers, tablets and hand-held
devices, GPS terminals, two-way radios, and full console systems,
we provide ergonomically sound mounting products with full port
replication.
Toughbook
Arbitrator is a rugged revolution in law enforcement video capture.
The fully integrated system offers unparalleled video capture (up
to 360 degrees), storage and transfer, and is designed to work with
back-end software for seamless video management, including
archiving and retrieving. Brekford augments this
solution with an Automatic License Plate Reader (ALPR / LPR), an
image-processing technology used to identify vehicles by their
license plates. License Plate Readers (LPRs) can record
plates at about one per second at speeds of up to 70 MPH and they
often utilize infrared cameras for clarity and to facilitate
reading at any time of day or night. The data collected can either
be processed in real-time, at the site of the read, or it can be
transmitted to remote centers and processed at a later
time. When combined with wearable body cameras, our
total client solution provides a video capture solution that
maintains the chain of evidence from the initial event through to
court proceedings.
Vehicle
Services - Upfitting
The Brekford
360-degree vehicle solution provides complete vehicle upfitting,
mobile data and video solutions for public safety agencies. The
360-degree vehicle solutions approach provides customers with a
one-stop upfitting, cutting edge technology and installation
service. The comprehensive approach enables Brekford to be the only
stop our customers need to make to purchase law enforcement
vehicles (GM, Ford, Dodge), have them upfitted with lights, sirens,
radio communication and rugged IT technology, and have them
“ready to roll”. Our mission is to provide and install
equipment that ensures safe and efficient mission critical vehicles
while incorporating the latest technological advances. We adhere to
strict quality control procedures and provide comprehensive
services. The Brekford certified installation team provides our
customers the highest level of expertise and service from inception
to completion, including maintenance and upgrades.
Results of Operations
Results of Operations for the Nine Months Ended September 30, 2016
and 2015
The
following tables summarize and compare selected items from the
statements of operations for the nine months ended September 30,
2016 and the nine months ended September 30, 2015.
|
Nine Months
Ended
September 30,
|
(Decrease) / Increase
|
||
|
2016
|
2015
|
$
|
%
|
Net
Revenues
|
$10,748,006
|
14,586,453
|
(3,838,447)
|
(26.3) %
|
|
|
|
|
|
Cost
of Revenues
|
8,201,217
|
11,711,852
|
(3,510,635
)
|
(30.0) %
|
|
|
|
|
|
Gross
Profit
|
$2,546,789
|
2,874,601
|
(327,812
)
|
(11.4) %
|
|
|
|
|
|
Gross
Profit Percentage of Revenue
|
23.7%
|
19.7%
|
|
|
18
Revenues
Revenues
for the nine months ended September 30, 2016 amounted to
$10,748,006 as compared to
revenues of $14,586,453
for the nine months ended September 30, 2015, representing a
decrease of $3,838,447 or
26.3%. ATSE services and vehicle services decreased by 12.9% and
28.7% respectively.
The
ATSE decrease was primarily driven by reduced collections on our
Saltillo, Mexico contract as well as reduced revenue for certain
legacy Maryland contracts due to the changeover to a fixed fee
invoicing model. Revenue for existing legacy Maryland contracts
should remain flat through expiration of the contracts, barring any
unforeseen changes in the number of cameras deployed. We have
started to see revenue contributions from our three new ATSE
contracts (Brice, OH, New Rochelle, NY, and Calvert County, MD), as
all have completed warning phases and are in full enforcement.
Projected camera deployments from these three contracts is
projected to more than double in the first quarter of 2017, with
commitments to add 16 more units to the existing 11.
We have
also continued to experience challenges that are outside the
Company’s control with respect to collection rates for our
Saltillo, Mexico program. Due to extended delays with
implementation of enforcement procedures and other concerns
regarding uncollected fine amounts, the Company elected to
terminate its exclusive distribution agreement with Grupo Canviso
Tech. We have subsequently initiated discussions directly with the
City of Saltillo in order to establish a direct contract to support
operations through the original term of the program, which is
expected to run through December 31, 2017. We chose to take this
approach for the purpose of ensuring future revenue and profit
streams that are beneficial to the Company. The Company anticipates
that a new agreement will be signed in the fourth quarter of 2016;
however, we are not able to predict when, or if, collection efforts
on prior unpaid fines will be successful until we are able to
implement new procedures within the new agreement
structure.
Newly
added contracts in New Rochelle, New York, Brice, Ohio, and Calvert
County, Maryland have begun to provide a material contribution to
paid citation rates as of this quarter. As stated previously, we
anticipate adding 16 additional cameras specific to these contracts
between now and the end of the first quarter of 2017. Additionally,
we are continuing to pursue contracts in the U.S. and Latin
America, via pilot projects and/or RFP processes, with a current
prospect pipeline in excess of 1,000 cameras. Some of these
potential programs are in advanced stages of discussion; however,
there is no assurance that these efforts will lead to contracts.
The Company observes a policy not to comment on the specifics of
any pre-contract discussions or pilot projects.
The
vehicle services decrease was primarily driven by decreased sales
and installations of rugged IT products, as certain large scale
orders from this period in 2015 were not repeated in 2016. Our open
sales order pipeline totaled approximately $1.5 million at
September 30, 2016 and we have initiated procedures to expedite
shipments and installations in the future. Additionally, we are
working to broaden our customer base regionally and nationally in
order to offset revenue reductions caused by the three-year upgrade
cycle.
Cost of Revenues
Cost of
revenues for the nine months ended September 30, 2016 amounted to
$8,201,217 as compared to $11,711,852 for the nine months ended
September 30, 2015, a decrease of $3,510,635 or 30.0%. The change was
primarily due to the lower sales volume and direct expenses for
ATSE programs and lower sales and installations of rugged IT
products.
Gross Profit
Gross
profit for the nine months ended September 30, 2016 amounted to
$2,546,789 as compared to
$2,874,601 for the nine months
ended September 30, 2015, a decrease of $327,812 or 11.4%. The change was primarily
due to the lower sales volume and direct expenses for ATSE programs
and lower sales and installations of rugged IT products. Overall
gross margin for the nine months ended September 30, 2016 was 23.7%
as compared to 19.7% for the nine months ended September 30, 2015.
ATSE gross margin for the nine months ended September 30, 2016 was
67.8% as compared to 68.7% for the nine months ended September 30,
2015. Vehicle services gross margin for the nine months ended
September 30, 2016 was 14.3% as compared to 11.1% for the nine
months ended September 30, 2015. The increase in gross margin was
due to a higher concentration of e-ticketing and installation
purchase orders for the nine months ended September 30,
2016.
Expenses
|
Nine Months
Ended
September 30,
|
Increase / (Decrease)
|
||
|
2016
|
2015
|
$
|
%
|
OPERATING
EXPENSES
|
|
|
|
|
Salaries
and related expenses
|
$1,489,311
|
1,482,003
|
7,308
|
0.5%
|
Selling,
general and administrative expenses
|
1,122,333
|
1,264,458
|
(142,125)
|
(11.2) %
|
Total
operating expenses
|
$2,611,644
|
2,746,461
|
(134,817
)
|
(4.9) %
|
19
Salaries and Related Expenses
Salaries
and related expenses for the nine months ended September 30, 2016
amounted to $1,489,311as
compared to $1,482,003 for the
nine months ended September 30, 2015, an increase of $7,308 or
0.5%, as there was no significant difference in personnel head
count or compensation expense.
Selling, General and Administrative Expenses
Selling,
general and administrative expenses for the nine months ended
September 30, 2016 amounted to $1,122,333 as compared to $1,264,458 for the nine months ended
September 30, 2015, a decrease of $142,125 or 11.2%. The decrease was
primarily driven by lower ATSE program management and depreciation
expenses.
Other Expenses, net
Total
other expenses increased for the nine months ended September 30,
2016 to $739,143 compared to $526,515 for the nine months ended
September 30, 2015. The increased expenses were due to
primarily to a net increase in financing cost of $528,039 that
includes non-cash interest expense related to the original issue
discount of $28,076 and the debt discount amortization of $280,761,
as well as the loss on extinguishment of debt of $291,912 resulting
from the $300,000 conversion of debt to Common Stock during the
period September 30, 2016 related to the Investor Note and
Warrant. The remainder of the increase was due to cash
interest expense associated with balances on the Company’s
revolving line of credit.
Net (Loss) Income
Net
loss for the nine months ended September 30, 2016 amounted to
$803,998 compared to a net loss of $398,375 for the nine months
ended September 30, 2015, an increase of $405,623. The increased
loss was primarily due to lower sales and gross profits from rugged
IT and ATSE services, as well as other expenses consisting of
non-cash financing costs associated with the Investor Note and
Warrant. Excluding other expenses consisting of both
cash and non-cash interest expense, operating loss amounted to
$64,855 for the nine months ended September 30, 2016 as compared to
income of $128,140 for the nine months ended September 30,
2015.
Results of Operations for the Three Months Ended September 30, 2016
and 2015
The
following tables summarize and compare selected items from the
statement of operations for the three months ended September 30,
2016 and the three months ended September 30, 2015.
|
Three Months
Ended
September 30,
|
(Decrease) / Increase
|
||
|
2016
|
2015
|
$
|
%
|
Net
Revenues
|
$3,035,153
|
5,776,862
|
(2,741,709)
|
(47.5) %
|
|
|
|
|
|
Cost
of Revenues
|
2,158,181
|
4,887,299
|
(2,729,118
)
|
(55.8) %
|
|
|
|
|
|
Gross
Profit
|
$876,972
|
889,563
|
(12,591)
|
(1.4) %
|
|
|
|
|
|
Gross
Profit Percentage of Revenue
|
28.9%
|
15.4%
|
|
|
20
Revenues
Revenues
for the three months ended September 30, 2016 amounted to
$3,035,153 as compared to
revenues of $5,776,862 for
the three months ended September 30, 2015, representing a decrease
of $2,741,709 or
47.5%. ATSE services decreased by 5.8% and vehicle services
decreased by 53.4%.
The
ATSE decrease was primarily driven by reduced collections on our
Saltillo, Mexico contract as well as reduced revenue for certain
legacy Maryland contracts due to the changeover to a fixed fee
invoicing model, offset by collections from the initial startup of
contracts in Brice Ohio, New Rochelle New York, and Calvert County
Maryland. Revenue for existing legacy Maryland contracts should
remain flat through expiration of the contracts, barring any
unforeseen changes in the number of cameras deployed. We have
started to see revenue contributions from our three new ATSE
contracts (Brice OH, New Rochelle NY, and Calvert County MD), as
all have completed warning phases and are in full enforcement.
Projected camera deployments from these three contracts is
projected to more than double in the first quarter of 2017, with
commitments to add 16 more units to the existing 11.
We have
also continued to experience challenges that are outside the
Company’s control with respect to collection rates for our
Saltillo, Mexico program. Due to extended delays with
implementation of enforcement procedures and other concerns
regarding uncollected fine amounts, the Company elected to
terminate its exclusive distribution agreement with Grupo Canviso
Tech. We have subsequently initiated discussions directly with the
City of Saltillo in order to establish a direct contract to support
operations through the original term of the program, which is
expected to run through December 31, 2017. We chose to take this
approach for the purpose of ensuring future revenue and profit
streams that are beneficial to the Company. The Company anticipates
that a new agreement will be signed in the fourth quarter of 2016;
however, we are not able to predict when, or if, collection efforts
on prior unpaid fines will be successful until we are able to
implement new procedures within the new agreement
structure.
Newly
added contracts in New Rochelle, New York, Brice, Ohio, and Calvert
County, Maryland have begun to provide a material contribution to
paid citation rates as of this quarter. As stated previously, we
anticipate adding 16 additional cameras specific to these contracts
between now and the end of the first quarter of 2017. Additionally,
we are continuing to pursue contracts in the U.S. and Latin
America, via pilot projects and/or RFP processes, with a current
prospect pipeline in excess of 1,000 cameras. Some of these
potential programs are in advanced stages of discussion; however,
there is no assurance that these efforts will lead to contracts.
The Company observes a policy not to comment on the specifics of
any pre-contract discussions or pilot projects.
The
vehicle services decrease was primarily driven by decreased sales
and installations of rugged IT products, as certain large scale
orders from this period in 2015 were not repeated in 2016 Our open
sales order pipeline totaled approximately $1.5 million at
September 30, 2016 and we have initiated procedures to expedite
shipments and installations in the future. Additionally, we are
working to broaden our customer base regionally and nationally in
order to offset revenue reductions caused by the three-year upgrade
cycle.
Cost of Revenues
Cost of
revenues for the three months ended September 30, 2016 amounted to
$2,158,181 as compared to $4,887,299 for the three months ended
September 30, 2015, a decrease of $2,729,118 or 55.8%. The change
was primarily due to the decrease in sales volume for rugged IT
products.
Gross Profit
Gross
profit for the three months ended September 30, 2016 amounted to
$876,972 as compared to
$889,563 for the three months
ended September 30, 2015, a decrease of $12,591 or 1.4%. Overall gross margin for
the three months ended September 30, 2016 was 22.9% as compared to
15.4% for the three months ended September 30, 2015. ATSE gross
margin for the three months ended September 30, 2016 was 72.7% as
compared to 64.5% for the three months ended September 30, 2015.
The increase was due to a reduction in fixed direct program
expenses. Vehicle services gross margin for the three months ended
September 30, 2016 was 16.4% as compared to 8.5% for the three
months ended September 30, 2015. The increase in gross margin was
due to a higher concentration of e-ticketing and installation
purchase orders for the three months ended September 30, 2016
compared to a higher concentration of lower margin rugged IT orders
for the three months ended September 30, 2015.
Expenses
|
Three Months
Ended
September 30,
|
Increase / (Decrease)
|
||
|
2016
|
2015
|
$
|
%
|
OPERATING
EXPENSES
|
|
|
|
|
Salaries
and related expenses
|
$484,783
|
485,740
|
(957)
|
(0.2) %
|
Selling,
general and administrative expenses
|
335,666
|
397,473
|
(61,887)
|
(15.5) %
|
Total
operating expenses
|
$820,449
|
883,213
|
(62,764)
|
(7.1) %
|
Salaries and Related Expenses
Salaries
and related expenses for the three months ended September 30, 2016
amounted to $484,783 as
compared to $485,740 for the
three months ended September 30, 2015, a decrease of $957 or 0.2%, as there was no significant
difference in personnel head count or compensation
expense.
21
Selling, General and Administrative Expenses
Selling,
general and administrative expenses for the three months ended
September 30, 2016 amounted to $335,666 as compared to $397,473 for the three months ended
September 30, 2015, a decrease of $61,887 or 15.5%. The decrease was primarily
driven by lower ATSE program management and depreciation
expenses.
Other Expenses, net
Total
other expenses decreased for the three months ended September 30,
2016 to $327,079 compared to $248,997 for the three months ended
September 30, 2015. The increase in expenses was primarily
due to conversion of debt to common stock during the three months
ended September 30, 2016 related to the Investor Note and Warrant.
The remainder of the expense included financing costs of $207,062
that includes non-cash interest expense related to the original
issue discount of $8,740 and the debt discount amortization of
$87,402, as well as the loss on extinguishment of debt of $130,517
resulting from the $150,000 conversion of debt to common stock
during the three months ended September 30, 2016 related to the
Investor Note and Warrant. The remainder of the increase was
due to an increase in cash interest expense associated with
balances on the Company’s revolving line of
credit.
Net (Loss) Income
Net
loss for the three months ended September 30, 2016 amounted to
$270,556 compared to a net loss of $242,647 for the three months
ended September 30, 2015, an increase of $27,909. The
increased loss was primarily due to other expenses consisting of
non-cash financing costs associated with the Investor Note and
Warrant. Excluding other expenses consisting of both
cash and non-cash interest expense, operating income amounted to
$56,523 for the three months ended September 30, 2016 as compared
to income of $6,350 for the three months ended September 30,
2015.
Financial Condition, Liquidity and Capital Resources
At
September 30, 2016, we had total current assets of $3,544,580 and
total current liabilities of $3,012,867 resulting in a working
capital surplus of $531,713. At September 30, 2016 inventory
totaled $472,800 consisting primarily of raw materials related to
our existing pipeline of committed customer sales
orders. In comparison, at December 31, 2015, we had
total current assets of $5,344,344 and total current liabilities of
$4,952,773, resulting in a working capital surplus of
$391,571.
The
Company’s accumulated deficit increased to $11,746,378 at
September 30, 2016 from $10,942,380 at December 31, 2015, as a
result of the net loss recorded for the period ended September 30,
2016. Cash flows provided by operations for the period ended
September 30, 2016 were $426,780, compared to cash flows used in
operations for the period ended September 30, 2015 of
$1,971,248.
As
discussed in Note 5 to the condensed consolidated financial
statements presented elsewhere in this Quarterly Report, the
Company is indebted to C.B. Brechin and Scott Rutherford under
unsecured promissory notes in the aggregate balance of $500,000 as
of December 31, 2015. On November 9, 2015, the maturity
dates of these unsecured promissory notes were extended to the
earlier of (i) November 9, 2016 or (ii) 10 business days from the
date on which Brekford closes an equity financing that generates
gross proceeds in the aggregate amount of not less than
$5,000,000.
The
Company intends to continue its efforts to expand sales of ATSE
services, and such expansion may significantly increase the
Company’s working capital needs. On March 17, 2015, the
Company entered into a note and warrant purchase agreement
providing for immediate funding of $650,000 through the issuance of
the Investor Note (see Note 6 to the condensed consolidated
financial statements presented elsewhere in this Quarterly Report
for additional detail). The primary use of proceeds was to fund
startup costs for the initial phase of a project in Mexico
providing turnkey ATSE services to the City of Saltillo, which
began operations in the second quarter of 2015. Additionally,
the Company entered contracts for three ATSE programs in Calvert
County, Maryland, Brice, Ohio and New Rochelle, New York, which
started generating revenue in the 3rd quarter of
2016.
On July
12, 2016 (the “Closing Date”), the Company entered into
a loan and security agreement (the “Loan Agreement”)
with Fundamental Funding LLC (the
“Lender”). The primary purpose of the new
Loan Agreement is to pay off the prior loan, and provide additional
working capital. The Loan Agreement provides for a multi-draw loan
to the Company for (i) the Company’s accounts receivable, the
lesser of (y) $2,500,000 or (z) 85% of the Company’s
eligible accounts and (ii) the Company’s inventory advances,
the lesser of (y) $500,000 or (z) 50% of the eligible inventory
(the “Revolving Loans”). The maximum amount available
to the Company under the Loan Agreement for the Revolving Loans is
$3,500,000 (the “Credit Limit”). In addition, the
Lender agreed to provide the Company with an accommodation loan in
an amount not to exceed $500,000, which shall be repaid in
thirty-six (36) equal monthly installments of principal and
interest (the “Accommodation Loan” and together with
the Revolving Loans, the “Loans”).
Management believes that the Company’s current level of cash
combined with cash that it expects to generate in its operations
during the next twelve months including anticipated new customer
contracts and funds available from the credit facility (see Note
14) will be sufficient to sustain the Company’s business
initiatives through at least September 30, 2017, but there can be
no assurance that these measures will be successful or
adequate.
22
In the
event that the Company’s cash reserves, cash flow from
operations and funds available under the Credit Facility (see Note
14) are not sufficient to fund the Company’s future
operations, it may need to obtain additional capital. We
currently have no firm commitments for any additional capital. No
assurance can be given that the Company will be able to obtain
additional capital in the future or that such capital will be
available to the Company on acceptable terms. The
Company’s ability to obtain additional capital will be
subject to a number of factors, including market conditions, the
Company’s operating performance and investor sentiment, which
may make it difficult for the Company to consummate a transaction
at the time, in the amount and/or upon the terms and conditions
that the Company desires. Even if we are able to raise
the funds required, it is possible that we could incur unexpected
costs and expenses, fail to collect significant amounts owed to us,
or experience unexpected cash requirements that would force us to
seek alternative financing. Further, if we issue additional equity
or debt securities, stockholders may experience additional dilution
or the new equity securities may have rights, preferences or
privileges senior to those of existing holders of our shares of
common stock or the debt securities may cause us to be subject to
restrictive covenants. If the Company is unable to raise
additional capital at the times, in the amounts, or upon the terms
and conditions that it desires, then it might have to delay, scale
back or abandon its expansion efforts. Even with such
changes, the Company’s operations could consume available
capital resources and liquidity.
Cash Flows Used in Operating Activities
Our
cash flows from operating activities are significantly affected by
our cash to support the growth of our business in areas such as
selling, general and administrative. Our operating cash flows are
also affected by our working capital needs to support growth and
fluctuations in inventory, personnel related expenditures, accounts
payable and other current assets and liabilities.
Net
cash provided by operating activities was $426,780 for the nine
months ended September 30, 2016 compared to $1,971,248 used in
operating activities for the nine months ended September 30, 2015,
respectively. Cash was used primarily to fund our operations and
working capital needs, net of non-cash expenditures such as
depreciation and amortization, share based compensation for
services and financing related costs. During the nine months ended
September 30, 2016, the net loss of $803,998, offset by adjustments
of customer payments and vendor payments, was the primary driver of the cash provided by
operating activities.
During
the nine months ended September 30, 2015, the net loss of $398,375
and increase in accounts receivable
amounting to a net cash decrease of $2,133,049 were the primary
drivers of the cash used, offset by an increase in other working
capital assets and liabilities.
Cash Flows Used in Investing Activities
Net
cash used in investing activities was $140,574 for the period ended
September 30, 2016 and there was no cash used for the period ended
September 30, 2015.
Cash Flows Provided by Financing Activities
Net cash used in financing activities was $273,763 for the nine
months ended September 30, 2016, compared to net cash provided by
financing activities $1,659,160 for the nine months ended September
30, 2015. In the nine months ended September 30, 2016, the Company
made payments to line of credit of $584,960 under the Credit
Facility related to outstanding customer invoices, compared to line
of credit advance of $1,441,126 for the nine months ended September
30, 2015.
Off-Balance Sheet Arrangements
We do
not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future material effect on
our financial condition, changes in financial condition, revenues
or expenses, results of operations, liquidity, capital expenditures
or capital resources.
Critical Accounting Policies and Estimates
Certain
of our accounting policies are considered critical, as these
policies require significant, difficult or complex judgments by
management, often requiring the use of estimates about the effects
of matters that are inherently uncertain. Our Annual Report on Form
10-K for the fiscal year ended December 31, 2015
discusses those critical accounting policies and
estimates that management uses to prepare our consolidated
financial statements, which include those relating to accounts
receivables allowances, revenue recognition and income taxes. We
have reviewed those polices and believe that they remain our most
critical accounting policies for the period ended September 30,
2016, and that no material changes therein have
occurred.
23
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to
ensure that material information required to be disclosed in our
periodic reports filed under the Exchange Act, as amended, or 1934
Act, is recorded, processed, summarized, and reported within the
time periods specified in the SEC’s rules and forms and to
ensure that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief
Financial Officer (Principal Financial Officer) as appropriate, to
allow timely decisions regarding required disclosure. During
the quarter ended September 30, 2016, we carried out an evaluation,
under the supervision and with the participation of our management,
including the Chief Executive Officer and Chief Financial Officer
(Principal Financial Officer), of the effectiveness of the design
and operation of our disclosure controls and procedures, as defined
in Rule 13(a)-15(e) under the Exchange Act. Based on this
evaluation, because of the Company’s limited resources and
limited number of employees as discussed below, management concluded that our disclosure
controls and procedures were ineffective as of September 30,
2016.
Management has identified the major control deficiencies as
the lack of segregation of duties and limited accounting knowledge
of Company debt and equity transactions. Our management
believes that these material weaknesses are due to the small size
of our accounting staff. The small size of our accounting
staff may prevent adequate controls in the future, such as
segregation of duties, due to the high cost of such remediation
relative to the benefit expected to be derived
thereby.
To mitigate the current limited resources and limited employees, we
rely heavily on direct management oversight of transactions, along
with the use of external legal and accounting professionals.
As we grow, we expect to increase our number of employees,
which will enable us to implement adequate segregation of duties
within the internal control framework. These control
deficiencies could result in a misstatement of account balances
that would result in a reasonable possibility that a material
misstatement to our consolidated financial statements may not be
prevented or detected on a timely basis. Accordingly, we have
determined that these control deficiencies as described above
together constitute a material weakness. In light of this
material weakness, we performed additional analyses and procedures
in order to conclude that our consolidated financial statements for
the quarter ended September 30, 2016 included in this Quarterly
Report were fairly stated in accordance with US GAAP.
Accordingly, management believes that despite our material
weaknesses, our financial statements for the quarter ended
September 30, 2016 are fairly stated, in all material respects, in
accordance with U.S. GAAP. This report does not include an
attestation report of our registered public accounting firm
regarding internal control over financial reporting.
Management’s report was not required to attestation by
our registered public accounting firm under section 404(a) of the
Sarbanes-Oxley Act.
Limitations on Effectiveness of Controls and
Procedures
Our management, including our Principal Executive Officer and
Principal Financial Officer, does not expect that our disclosure
controls and procedures or our internal controls will prevent all
errors and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact
that there are resource constraints and the benefits of controls
must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and
instances of fraud, if any, within the Company have been detected.
These inherent limitations include, but are not limited to,
the realities that judgments in decision-making can be faulty and
that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by
management override of the control. The design of any system
of controls also is based in part upon certain assumptions about
the likelihood of future events and there can be no assurance that
any design will succeed in achieving its stated goals under all
potential future conditions. Over time, controls may become
inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective
control system, misstatements due to error or fraud may occur and
not be detected.
Changes in Internal Controls
During the quarter ended September 30, 2016, there have been no
changes in our internal control over financial reporting that have
materially affected or are reasonably likely to materially affect
our internal controls over financial reporting.
24
PART II – OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS
The
Company was not a party to pending legal proceedings during the
period ended September 30, 2016 that are material to the Company or
its assets.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
Recent Sales of Unregistered Securities
None.
Issuer Repurchases of Equity Securities
Neither
Brekford nor any of its affiliated purchasers (as defined by Rule
10b-18 under the Exchange Act) purchased any shares of its common
stock during the quarter ended September 30, 2016.
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM
5. OTHER INFORMATION
None.
ITEM 6.
EXHIBITS
The
exhibits that are filed or furnished with this report are listed in
the Exhibit Index, which immediately follows the signatures hereto,
and that Exhibit Index is incorporated herein by
reference.
25
SIGNATURES
Pursuant
to the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
|
Brekford Corp.
|
|
|
|
|
|
|
|
Date:
November 14, 2016
|
By:
|
/s/
C.B. Brechin
|
|
|
C.B.
Brechin
|
|
|
Chief
Executive Officer, Chief Financial Officer, Treasurer and
Director
|
|
|
(Principal
Executive Officer and Principal Financial Officer)
|
26
EXHIBIT INDEX
Exhibit
Number
|
|
Description
|
|
|
|
|
|
31.1
|
|
Certification of
Principal Executive Officer and Principal Financial Officer
pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a)
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 (filed herewith).
|
|
32.1
|
|
Certification of
Principal Executive Officer and Principal Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
herewith).
|
|
101.INS
|
|
XBRL
Instance Document (filed herewith).
|
|
101.SCH
|
|
XBRL
Taxonomy Extension Schema (filed herewith).
|
|
101.CAL
|
|
XBRL
Taxonomy Extension Calculation Linkbase (filed
herewith).
|
|
101.DEF
|
|
XBRL
Taxonomy Extension Definition Linkbase (filed
herewith).
|
|
101.LAB
|
|
XBRL
Taxonomy Extension Label Linkbase (filed herewith).
|
|
101.PRE
|
|
XBRL
Taxonomy Extension Presentation Linkbase (filed
herewith).
|
27