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EX-32.1 - CERTIFICATE PURSUANT TO SECTION 18 U.S.C. PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - Brekford Traffic Safety, Inc.bfdi_ex321.htm
EX-31.1 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) CERTIFICATIONS SECTION 302 OF THE SARBANES-OXLY ACT OF 2002 - Brekford Traffic Safety, Inc.bfdi_ex311.htm
 

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.)
 
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  
Page
 
 
 
Item 1
Financial Statements    
3
 
Condensed Consolidated Balance Sheets at September 30, 2016 and December 31, 2015 (unaudited)    
3
 
Condensed Consolidated Statements of Operations and Comprehensive loss for the Three and Nine Months Ended September 30, 2016 and 2015 (unaudited)    
4
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015 (unaudited)    
5
 
Notes to Unaudited Condensed Consolidated Financial Statements    
6
 
 
 
Item 2. 
Management’s Discussion and Analysis of Financial Condition and Results of Operations    
16
Item 4. 
Controls and Procedures    
24
 
 
 
PART II – OTHER INFORMATION      
 
 
 
 
Item 1.
Legal Proceedings    
25
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds    
25
Item 5.
Other Information    
25
Item 6.
Exhibits    
25
SIGNATURES  
 26
EXHIBIT INDEX  
 27
 
 
 
 
 
 
 
2
 
 
PART I – FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 Brekford Corp.
Condensed Consolidated Balance Sheets (unaudited)
 
 
September 30,
2016
 
 
December 31,
2015
 
ASSETS
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
Cash
 $593,806 
 $580,400 
Accounts receivable, net of allowance of $0 at September 30, 2016 and December 31, 2015
  1,677,923 
  3,781,263 
Unbilled receivables
  762,718 
  304,470 
    Prepaid expenses
  38,133 
  71,740 
Inventory
  472,000 
  606,471 
Total current assets
  3,544,580 
  5,344,344 
Property and equipment, net
  269,104 
  223,347 
Other non-current assets
  81,402 
  179,208 
TOTAL ASSETS
 $3,895,086  
 $5,746,899  
 LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
    
    
CURRENT LIABILITIES
    
    
Accounts payable and accrued expenses
 $1,741,872 
 $2,979,131 
Accrued payroll and related expenses
  74,773 
  98,000 
Line of credit, net of fees
  836,813 
  1,402,380 
Term loan – current portion, net of fees
  166,667 
  166,667 
Deferred revenue
  72,080 
  95,233 
Customer deposits
  31,863 
  36,070 
Obligations under other notes payable – current portion
  24,392 
  29,277 
Derivative liability
  18,228 
  99,036 
Other liabilities
  46,179 
  46,979 
Total current liabilities
  3,012,867  
  4,952,773  
 
    
    
LONG - TERM LIABILITIES
    
    
Notes payable – stockholders
  500,000 
  500,000 
Other notes payable - net of current portion, net of fees
  4,409 
  21,660 
Deferred rent, net of current portion
  43,937 
  44,923 
Term notes payable, net of current portion
  333,358 
    
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
  249,794 
  221,269 
Total long-term liabilities
  1,131,498  
  787,852 
TOTAL LIABILITIES
  4,144,365  
  5,740,625  
 
    
    
STOCKHOLDERS’ (DEFICIT) EQUITY
    
    
Preferred stock, par value $0.0001 per share; 20,000,000 shares
authorized; none issued and outstanding
   
   
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 
  4,515 
   Additional paid-in capital
  11,498,570 
  10,951,491 
Treasury Stock, at cost 10,600 shares at September 30, 2016 and December 31, 2015 respectively
  (5,890)
  (5,890)
Accumulated deficit
  (11,746,378)
  (10,942,380)
   Other comprehensive loss
  (499)
  (1,462)
TOTAL STOCKHOLDERS’ (DEFICIT) EQUITY
  (249,279)
  6,274 
TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
 $3,895,086  
 $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,
 
 
Nine Months Ended
 September 30,
 
 
 
2016
 
 
2015
 
 
2016    
 
 
2015
 
 
 
 
 
 
 
 
 
         
 
 
 
 
NET REVENUE
 $3,035,153 
  5,776,862 
  10,748,006 
  14,586,453 
COST OF REVENUE 
  2,158,181 
  4,887,299 
  8,201,217 
  11,711,852 
GROSS PROFIT
  876,972 
  889,563 
  2,546,789  
  2,874,601  
 
    
    
    
    
OPERATING EXPENSES
    
    
    
    
Salaries and related expenses
  484,783 
  485,740 
  1,489,311 
  1,482,003 
Selling, general and administrative expenses
  335,666 
  397,473 
  1,122,333 
  1,264,458 
TOTAL OPERATING EXPENSES
  820,449 
  883,213 
  2,611,644  
  2,746,461  
INCOME (LOSS)  FROM OPERATIONS
  56,523 
  6,350 
  (64,855)
  128,140 
OTHER (EXPENSE) INCOME 
    
    
    
    
Interest expense
  (207,062)
  (194,061)
  (528,039)
  (487,287
Change in fair value of derivative liability
  10,500 
  (54,936)
  80,808 
  (39,228)
Loss on extinguishment of debt
  (130,517)
   
  (291,912)
   
TOTAL OTHER (EXPENSE) INCOME
  (327,079 )
  (248,997 )
  (739,143 )
  (526,515 )
NET LOSS
 $(270,556 )
  (242,647 )
  (803,998 )
  (398,375 )
OTHER COMPREHENSIVE LOSS – foreign currency translation
  (499)
  (4,383)
  (499)
  (4,383)
 COMPREHENSIVE LOSS
  (271,055 )
  (247,030 )
  (804,497 )
  (402,758 )
LOSS PER SHARE – BASIC AND DILUTED
 $(0.01)
  (0.01)
  (0.02)
  (0.01)
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING – BASIC
  48,360,299  
  44,632,569  
  46,710,189  
  44,630,151  
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING – DILUTED
  48,360,299  
  44,632,569  
  46,710,189  
  44,630,151  
 
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,           
 
 
 
    2016 
 
 
    2015 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
    
    
Net loss
 (803,998)
  (398,375)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
    
    
Depreciation and amortization
  94,817 
  150,627 
Share based compensation
  50,590 
  52,890 
    Deferred rent
  (986)
  44,131 
               Amortization of debt discount
  191,874 
  257,505 
    Amortization of finance cost
  39,106 
  35,924 
    Change in fair value of warrant liability
  (80,808)
  39,228 
    Loss on extinguishment of debt
  291,912 
   
Changes in operating assets and liabilities:
    
    
Accounts receivable
  2,103,340 
  (2,133,049)
    Unbilled receivables
  (458,248)
  (291,921)
Prepaid expenses and other non-current assets
  131,413 
  3,489 
Inventory
  134,471 
  (488,886)
Customer deposits
  (4,207)
  (511)
Accounts payable and accrued expenses
  (1,215,316)
  874,399 
Accrued payroll and related expenses
  (23,227)
  57,962 
Deferred revenue
  (23,153)
  (173,451)
Other liabilities
  (800)
  (1,300)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
  426,780 
  (1,971,248 )
 
    
    
CASH FLOWS FROM INVESTING ACTIVITIES:
    
    
Purchase of fixed assets
  (140,574 
   
NET CASH USED IN INVESTING ACTIVITIES
  (140,574)
   
 
    
    
CASH FLOWS FROM FINANCING ACTIVITIES:
    
    
Net change in line of credit
  (584,960)
  1,441,126 
    Principal payments on capital lease obligations
   
  (140,209)
Payments on other notes payable
  (22,136)
  (18,813)
    Borrowings on term notes
  500,000 
  650,000 
Payments on term notes
  (166,667)
  (187,500)
    Deferred financing cost
   
  (85,444)
   NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
  (273,763 )
  1,659,160  
Effect of foreign currency translation
  963 
  (4,383)
NET CHANGE IN CASH
  13,406 
  (316,471)
 CASH – Beginning of period
  580,400 
  1,112,881 
 CASH – End of period
 $593,806 
  796,410 
 
    
    
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.
 
 
 
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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.
 
 
 
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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.
 
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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)
 
 
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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).
 
 
 
 
 
 
 
 
 
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