UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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. See the definitions of “large accelerated filer,” “accelerated filer” and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ☒  No ☐

As of December 31, 2016, there were 79,875,620 shares of the registrant’s Common Stock outstanding.

SECURE POINT TECHNOLOGIES, INC.

TABLE OF CONTENTS

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The accompanying notes are an integral part of these condensed consolidated financial statements.

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The accompanying notes are an integral part of these condensed consolidated financial statements.

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The accompanying notes are an integral part of these condensed consolidated financial statements.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.

Description of Business, Liquidity and Going Concern

Secure Point Technologies, Inc. (the “Company”) formerly known as Implant Sciences Corporation, up until the time of the sale of its business to L-3 Communications Corporation in January 2017 (as described below) provided systems and sensors for the homeland security market and related industries.  We developed and acquired technologies using ion mobility spectrometry to develop a product line for use in trace explosives and narcotics detection.  Prior to the sale of the Company’s business to L-3 Communications Corporation in January 2017, the Company marketed and sold its existing trace explosives and narcotics detector products while continuing to make significant investments in developing the next generation of these products.  At the present time, We are a shell company with no operations.  We are actively considering various acquisition targets and other business opportunities.  We hope to acquire one or more operating businesses or consummate a business opportunity within the next twelve months. However, we cannot guarantee that we will successfully consummate an acquisition or other business opportunity within such timeframe, or at all.

Sale of Explosives Detector Assets and Bankruptcy Filing

On October 10, 2016, we and our subsidiaries entered into an asset purchase agreement (as amended, the “Asset Purchase Agreement”) with L-3 Communications Corporation (“L-3”)  to sell our explosives trace detection assets, constituting our entire business, to L-3 for $117.5 million in cash, plus the assumption of specified liabilities, subject to adjustment (the “Transaction”).  The Asset Purchase Agreement served as the “stalking horse bid” in a sale process that was conducted under Section 363 of the U.S. Bankruptcy Code (the “Bankruptcy Code”) and an order of the U.S. Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) establishing certain procedures and protections (the “Sales Procedures Order”).    In connection with the Asset Purchase Agreement, on October 10, 2016, the Company and its subsidiaries IMX Acquisition Corp., C Acquisition Corp. and Accurel Systems International Corp. (together with the Company, the “Debtors”) filed voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court.  After commencement of the Chapter 11 proceedings, we continued to operate our businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code.  On the Petition Date, we filed several “first day” motions with the Bankruptcy Court, including a motion to have the Chapter 11 cases jointly administered.  At a hearing held on October 11, 2016, the Bankruptcy Court entered orders approving the various first day motions.

On December 16, 2016, after completion of the auction process in accordance with the requirements of the Bankruptcy Code and the Sales Procedures Order, the Bankruptcy Court entered an order authorizing and approving the Transaction with L-3 under Section 363 of the Bankruptcy Code.

On January 5, 2017, the closing of the Transaction occurred and L-3 acquired substantially all the assets of the Debtors in exchange for $117.5 million in cash plus the assumption of certain liabilities. In connection with the closing of the Transaction, on January 5, 2017, each of Drs. William J. McGann and Darryl Jones, Messrs. Roger Deschenes and Todd Silvestri and Ms. Brenda L. Baron resigned from their positions as executive officers and employees of the Company, and Dr. William J. McGann resigned from his position as a member of the Company’s board of directors.  Also in connection with the closing of the Transaction, on January 5, 2017, the Company filed Articles of Amendment to the Company’s Articles of Organization in the State of Massachusetts to change the Company’s name to Secure Point Technologies, Inc.

On the closing date of the Transaction, Mr. Robert Liscouski, our President, assumed the senior executive role for the Company and continues to serve as a Director of the Company along with the other two remaining board members, Mr. Michael Turmelle (Chairman) and Mr. James Simon, Jr.  Effective January 9, 2017, the Company entered into a service agreement with Mr. Christopher Roberts, pursuant to which Mr. Roberts agreed to assist in the preparation of the Company’s financial statements and provide related services. In connection therewith, on January 9, 2017, the board of directors of the Company appointed Mr. Roberts as the chief financial officer of the Company.

Effective February 1, 2017, the Company changed its address to 215 Depot Ct. SE, Leesburg, VA 20175.

In connection with the commencement of the Chapter 11 cases, we filed a motion seeking the approval of the Bankruptcy Court for a super-priority senior secured loan of $5.7 million (the “Original DIP Loan”) between the Debtors and DIP SPV I, L.P., as the debtor-in-possession lender ( the “Original DIP Lender”) pursuant to a Senior Secured Super-Priority Debtor-in-Possession Loan and Security Agreement entered into by the Debtors and the Original DIP Lender on October 10, 2016 (as amended on November 3, 2016, the “Original DIP Agreement”).  The Original DIP Loan would bear interest at 12% and included a one-time closing fee of $199,500 on the closing date of the Original DIP Loan and an exit fee equal to $427,500, less any interest, other that default interest (which was at a rate of 24%), paid to the Original DIP Lender as of the termination date of the Original DIP Loan. The Original

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DIP Loan was payable in full upon the consummation of the sale under the Asset Purchase Agreement with L-3 or a sale to any other winning bidder in the Bankruptcy Court auction.  On October 13, 2016, we borrowed $1,500,000 under the Original DIP Loan.

The use of proceeds from the Original DIP Loan were limited to working capital and other general corporate purposes consistent with the budget that the Company presented to the Original DIP Lender, including payment of costs and expenses related to the administration of the bankruptcy proceedings and payment of other expenses as approved by the Bankruptcy Court.  

On November 7, 2016, as a result of an auction process run in accordance with the requirements of the Bankruptcy Code, the Debtors terminated the Original DIP Agreement and entered into a replacement Senior Secured, Super-Priority Debtor-in-Possession Loan and Security Agreement (the “New DIP Agreement”) with Tannor Partners Credit Fund, LP, (the “New DIP Lender”), which New DIP Agreement was approved by the Bankruptcy Court on an interim basis pursuant to an order dated as of November 7, 2016 for the initial loan amount of $5,700,000.  Under the New DIP Agreement, subject to the terms and conditions thereof, the New DIP Lender lent up to a total of $8.0 million to the Debtors, with the initial installment of $5,700,000 paid upon the Bankruptcy Court entering the interim order for the New DIP Agreement and the remaining $2,300,000 paid upon the Bankruptcy Court entering the final order for the New DIP Agreement, which final order was entered by the Bankruptcy Court on November 30, 2016.  The New DIP Agreement was substantially identical to the Original DIP Agreement, except for the amounts of the closing fee and the exit fee, which was $35,000 and $425,000 (minus any interest other than default interest), respectively.  On November 8, 2016, we borrowed $5,700,000 under the New DIP Agreement and borrowed an additional $2,300,000 on November 30, 2016.  In connection with the termination of the Original DIP Agreement, the Company paid $1,610,769 to the Original DIP Lender and its advisors to satisfy outstanding obligations under the Original DIP Agreement, including $74,354 for expense reimbursement for the Original DIP Lender’s advisors.

On or about December 8, 2016, New DIP Lender asserted that we were not in compliance with Section 7.1(a) of the New DIP Agreement, wherein the net cash receipts for the cumulative period commencing on November 7, 2016 and ending on November 30, 2016 were required be equal to or exceed 85% of the budgeted cash receipts amount (the “DIP Budget”), which event constituted an event of default under the New DIP Agreement.  Effective as of December 1, 2016 the interest rate under the New DIP Agreement increased 12.0% to 24.0%. Subject to the terms of a Stipulation and Order entered in the Bankruptcy Case, we agreed with the New DIP Lender to waive such asserted default in exchange for an agreement by us to pay an additional $96,000 of interest, which interest was not credited against the exit fee.

The total amount borrowed under the New DIP Agreement together with accrued interest was paid in full effective January 5, 2017 in connection with the closing of the Transaction with L-3.

We believe that the proceeds from the Transaction with L-3 and the assumption by L-3 of certain liabilities, after taking into account the payment of the New DIP Loan, related expenses and exit fee, will be sufficient to pay all secured and unsecured creditor claims, financial advisor and legal expenses associated with the Transaction, payments due under our Change of Control Plan which were not assumed by L-3, and, legal fees and other expenses associated with the bankruptcy filing. $2.5 million of the cash proceeds from the Transaction are being held in an escrow account to secure the Debtors’ obligations for the purchase price adjustments under the Asset Purchase Agreement for the Debtors’ net working capital, which adjustments are expected to be completed in the first half of calendar 2017.  The Company’s Board of Directors is exploring opportunities to provide optionality to our shareholders with the remaining proceeds after the closing of the Transaction with L-3. We intend to provide alternatives as part of the plan to emerge from voluntary Chapter 11 bankruptcy that would recognize the value of a publicly listed shell. These alternatives may include the merger of an operating entity into the shell or a liquidation of the company, which determination is subject to approval by our shareholders.  A plan of reorganization was required to be filed with the Bankruptcy Court on February 7, 2017, but on January 26, 2017 we filed a motion with the Bankruptcy Court requesting a 60 day extension of the date by which the Debtors have an exclusive right  to file a plan of reorganization.

Termination of Zapata Industries SAS Letter of Intent

On July 18, 2016, the Company and Zapata Industries SAS (“Zapata”) entered into a Letter of Intent (the “LOI”) regarding a potential business combination between us and Zapata.  On November 21, 2016, the LOI was terminated.  On December 2, 2016 Zapata filed a claim seeking a breakup fee related to the cancellation of the acquisition.  The Company disputes any payment obligations it may have to Zapata in connection with the LOI or the termination thereof.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Liquidity, Going Concern and Management’s Plans

On December 10, 2008, we entered into a note and warrant purchase agreement with DMRJ Group LLC (“DMRJ”) pursuant to which we issued a senior secured convertible promissory note in the principal amount of $5,600,000 and a warrant to purchase 1,000,000 shares of our common stock.  We have entered into a series of amendments, waivers and modifications with DMRJ.  On July 20, 2016, we amended our credit agreements with DMRJ pursuant to which, amongst other matters, we extended the maturity date of all of our indebtedness to DMRJ to October 31, 2016.

On May 4, 2015, we entered into an assignment agreement with DMRJ and Montsant Partners, LLC (“Montsant”), wherein DMRJ assigned its rights, title and interest in the senior secured promissory note dated December 10, 2008 and appointed DMRJ as its collateral agent under the promissory note agreement. On July 20, 2016, we amended our credit agreement with Montsant, extending the maturity date of our indebtedness to October 31, 2016.

DMRJ and Montsant are funds managed by Platinum Partners Value Arbitrage Fund LP.

On March 19, 2014, we entered into a note purchase agreement with a group of institutional investors and BAM Administrative Services LLC (“BAM”), an administrative agent for the investors, pursuant to which we issued senior secured promissory notes in the aggregate principal amount of $20,000,000. We used all of the proceeds from the sale of the notes to repay (i) $17,624,000 of our outstanding indebtedness to DMRJ under revolving promissory note (ii) $1,809,000 of interest outstanding under that facility and (iii) $567,000 of interest outstanding under our senior secured convertible promissory note (see Note 12 to the condensed consolidated financial statements). We have entered into several amendments, waivers and modifications with BAM. The notes bore interest at 16% per annum.  Due to the filing of the voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court, we were deemed to be in default under our note purchase agreement with BAM and our interest rate was increased to 18.5% effective as of October 10, 2016.

The maturity of our indebtedness to BAM was automatically extended to October 30, 2016 as a result of the extension of the maturity date of our indebtedness to DMRJ and Montsant.

The payment of our indebtedness to DMRJ and Montsant are stayed pending the conclusion of the bankruptcy proceedings.

The full amount of the BAM Promissory Note and all accrued interest, along with the New DIP Loans and all accrued interest were paid in full on January 5, 2017 upon the closing of the Transaction with L-3.

We are incurring and expect to continue to incur increased legal and financial adviser costs associated with the bankruptcy proceedings following the closing of the Transaction with L-3. These ongoing costs raise doubt as to our ability to successfully emerge from Chapter 11 and provide a recovery to equity holders.

Our common stock was delisted by the NYSE Amex LLC in June 2009 as result of our failure to comply with certain continued listing requirements.  Our common stock has been quoted on the OTC Bulletin Board since May 2009 and is also quoted on the OTC Markets Group’s OTCQB tier under the symbol “IMSC”. We believe that trading ‘over the counter’ has limited our stock’s liquidity and has impaired our ability to raise capital.  We have submitted paperwork for a symbol change based on the corporate name change.  We anticipate that FINRA will issue a new ticker symbol in the near future.

For the six months ended December 31, 2016, we reported a net loss of $25,594,000 and used $5,916,000 in cash from operations.  As of December 31, 2016, the Company had an accumulated deficit of approximately $226,075,000 and a working capital deficit of $95,585,000.  

As of December 31, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of December 31, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $9,129,000 and is included in current liabilities in the condensed consolidated financial statements.

As of December 31, 2016, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of December 31, 2016, our obligation to Montsant for accrued interest under this instrument approximated was $405,000.

As of December 31, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2016, our obligation under such notes for accrued interest amounted to approximately $4,113,000 and is included in current liabilities in the condensed consolidated financial

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

statements.  The total amounts borrowed under the BAM senior secured promissory notes together with accrued interest were paid in full effective January 5, 2017 upon the closing of the Transaction with L-3.

As of February 13, 2017, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of February 13, 2017, our obligation to DMRJ for accrued interest under these instruments approximated $10,012,000. Please refer to Note 14 to the condensed consolidated financial statements for a discussion of the August 2016 conversions of principal indebtedness by DMRJ.

As of February 13, 2017, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of February 13, 2017, our obligation to Montsant for accrued interest under this instrument approximated $502,000.

On December 11, 2015, we entered into an Accounts Receivable Purchase Agreement (the “ RCA Purchase Agreement”) with Republic Capital Access, LLC (“RCA”), pursuant to which we may sell eligible accounts receivables relating to U.S. government prime contracts or subcontracts (as defined in the RCA Purchase Agreement, “Eligible Receivables”) to RCA.  The total amount of Eligible Receivables that we may sell to RCA is subject to a maximum limit of $2,000,000 of outstanding receivables at any given time.  On April 11, 2016, we amended the RCA Purchase Agreement (the “Amended RCA Purchase Agreement”). As amended, the total amount of Eligible Receivables that we may sell to RCA is subject to a maximum limit of $3,500,000 of outstanding receivables at any given time.

Pursuant to the terms of the RCA Purchase Agreement, we will receive from RCA, within two business days of the submission of the applicable invoice, an initial payment equal to 90% of the face value of an Eligible Receivable purchased by RCA.  Following payment of such Eligible Receivable to RCA by the relevant customer, RCA shall pay the Company the residual 10% of such receivable, less transaction fees payable to RCA by the Company pursuant to the RCA Purchase Agreement. 

We have paid, the following fees, as applicable, to RCA pursuant to the RCA Purchase Agreement: (i) an initial enrollment fee equal to $5,000.00; (ii) a discount factor equal to 0.35%, for U.S. government contracts (or 0.53% for U.S. government subcontracts), of the amounts of purchased receivables; (iii) a program access fee equal to 0.017% of the daily ending account balance for each day that receivables are outstanding; (iv) a commitment fee equal to 1% of Maximum Amount minus the amount of purchased receivables; and (v) expenses relating to the negotiation of the RCA Purchase Agreement, which amount is not expected to exceed $1,000.  As of December 31, 2016, RCA has purchased $16,913,000 of our receivables pursuant to the RCA Purchase Agreement.

The RCA Purchase Agreement terminated on October 10, 2016, as a consequence of our filing of voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court. As of that date, we were no longer able to sell eligible accounts receivable to RCA and we have collected all amounts owed under the RCA Purchase Agreement from RCA.  As of December 31, 2016 the outstanding amount borrowed under the RCA Purchase Agreement was $0.

$2.5 million of the cash proceeds from the Transaction with L-3 are being held in an escrow account to secure the Debtors’ obligations for the purchase price adjustments under the Asset Purchase Agreement for the Debtors’ net working capital, which adjustments are expected to be completed in the first half of calendar 2017.

The payment of our secured obligations with DMRJ and Montsant will be stayed until such time that the Official Committee of Equity Holders has concluded their activities to assert certain estate claims and causes of action and challenge the validity, enforceability, and perfection of certain prepetition secured claims. Subject to the terms of a settlement that will be filed with the Bankruptcy Court, and which is subject to Bankruptcy Court approval, interest on our debt obligations with DMRJ and Montsant will not accrue until such time that the obligations are paid by us, or until August 10, 2017.    Further, upon the occurrence of an event of default under certain provisions of our credit agreements with DMRJ, Montsant and BAM, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance. The failure to cure an event of default or negotiate further extensions of our obligations to our secured lenders would have a material adverse impact on our liquidity and financial condition and could raise doubt as to our ability to successfully emerge from Chapter 11 and provide a recovery to equity holders.

On August 24, 2016, a Cayman Islands court appointed an insolvency specialist, RHSW Caribbean, to liquidate the assets of Platinum Partners Value Arbitrage Fund LP (“Platinum”).  On October 18, 2016, RHSW Caribbean filed a Chapter 15 bankruptcy petition with the United States Bankruptcy Court for the District of Southern New

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

York, which seeks to protect Platinum's U.S. assets from its creditors while an insolvency proceeding is underway in the Cayman Islands.

We have suffered recurring losses from operations.  Our condensed consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

There can be no assurances that our forecasted results will be achieved or that we will be able to raise additional capital necessary to operate our business.  These conditions raise substantial doubt about our ability to continue as a going concern.  The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

2.

Interim Financial Statements and Basis of Presentation

Principles of Consolidation

The accompanying condensed consolidated financial statements include our operations in Massachusetts, California and Shanghai, China, and those of our wholly-owned subsidiaries. On March 25, 2015, our Board of Directors approved restructuring actions to better align costs with current and future geographic revenue sources and to improve efficiencies.  Our San Diego, CA advanced technology office was relocated to our Wilmington, MA facility and our Shanghai office was closed. All intercompany transactions and accounts have been eliminated in consolidation.

Accounting Principles

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). In the opinion of management, the accompanying condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments), which we consider necessary for a fair presentation of the financial position at such date and of the operating results and cash flows for the periods presented. The results of operations and cash flows for the three months ended may not necessarily be indicative of results that may be expected for any succeeding quarter or for the entire fiscal year. The balance sheet at June 30, 2016 has been derived from our audited consolidated financial statements at that date, but does not include all of the information and notes required by U.S. GAAP for complete financial statements.

The information contained in this Form 10-Q should be read in conjunction with our audited financial statements, included in our Form 10-K, as of and for the year ended June 30, 2016.

Use of Accounting Estimates

The preparation of these financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Some of the more significant estimates include allowance for doubtful accounts, allowance for sales returns, inventory valuation, warranty reserves, and long-lived assets. Management's estimates are based on the facts and circumstances available at the time estimates are made, past historical experience, risk of loss, general economic conditions and trends and management's assessments of the probable future outcome of these matters. Consequently, actual results could differ from such estimates.

Significant accounting policies are described in Note 2 to the condensed consolidated financial statements included in Item 7 of our Form 10-K for the fiscal year ended June 30, 2016.

Foreign Currency Translation

The assets and liabilities of our Shanghai representative office were translated into U.S. dollars at current exchange rates as of the balance sheet date, expenses were translated at average monthly exchange rates. Net unrealized translation gains or losses associated with the Shanghai office were recorded directly to other comprehensive income. Realized gains and losses from foreign currency transactions were not material for any of the periods presented. We had short-term inter-company receivables from our Shanghai office which were adjusted each period for changes in foreign currency exchange rates with a corresponding entry recorded as a component of the consolidated statement of operations and comprehensive loss.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Reclassification

Certain prior year amounts have been reclassified for consistency with the current period presentation. On October 10, 2016, we and our subsidiaries entered into an asset purchase agreement to sell our explosives trace detection assets, constituting substantially all of our assets, to L-3 Communications Corporation for $117.5 million in cash, plus the assumption of specified liabilities, subject to adjustment. We concluded that it was appropriate to classify the assets used in our explosives detection business as held for sale,  as all of the criteria established under ASC 205 were met.  Corresponding reclassifications have also been made to the balance sheet at June 30, 2016. These changes in classification had no effect on the previously reported condensed consolidated statement of operations for any period and did not materially affect previously reported cash flows in the condensed consolidated statement of cash flows.

Discontinued Operations and Assets Classified as Held for Sale

Accounting Standards Codification (Topic 205) Presentation of Financial Statements – Reporting Discontinued Operations (“ASC 205”), establishes the criteria for a component of an entity classification as held for sale and reporting an entities financial statements as a discontinued operation. Under ASC 205, a component or group of components, or a business should be classified as held for sale in period in which all of the criteria are met.

·

Management, having the authority to approve the action, commits to a plan to sell the entity to be sold.

·

The entity to be sold is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such entities to be sold.

·

An active program to locate a buyer or buyers and other actions required to complete the plan to sell the entity to be sold have been initiated.

·

The sale of the entity to be sold is probable (the future event or events are likely to occur), and transfer of the entity to be sold is expected to qualify for recognition as a completed sale, within one year, unless events or circumstances beyond an entity’s control extend the period required to complete the sale as discussed below.

·

The entity to be sold is being actively marketed for sale at a price that is reasonable in relation to its current fair value.

·

Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

The Financial Accounting Standards Board issued Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). Under ASU 2014-08, a disposal of a component of an entity, a component or group of components shall be reported in discontinued operation if the if the disposal represents a strategic shift that has or will have a major effect on an entity’s operations and financial results, as determined when the component or group of components; meets the criteria to be classified as held for sale; is disposed of by sale; or, is disposed of other than by sale.

The sale of our explosive detection assets will have a significant effect on our operations and financial results, given that we are disposing of essentially all of the assets used in our sole business and product line.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following balance sheet provides the major classes of our explosives detection business’ held for sale assets and liabilities and is reconciled to our condensed consolidated balance sheet as of December 31, 2016 and June 30, 2016.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Warrant Derivative Liability

Accounting Standards Codification (“ASC”) 815-40-15 “Derivatives and Hedging”, requires freestanding contracts that are settled in common stock, including common stock warrants to be designated as an equity instrument, asset or liability. On July 20, 2016, we issued a warrant to purchase 50,657,894 shares of our common stock to DMRJ LLC, which warrant has since expired since the Zapata acquisition was not consummated. Under the provisions of ASC 815-40-15, a contract designated as an asset or a liability must be carried at fair value until exercised or expired, with any changes in fair value recorded in the results of operations. The warrant derivative liability should initially and subsequently be measured at fair value with changes in fair value recorded in earnings in each reporting period.

The fair value is estimated using a binomial option pricing model, which includes variables such as the expected volatility of our share price, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense / income recognized for changes in the valuation of the warrant liability.

Beneficial Note Conversion Feature - DMRJ

Accounting Standards Codification (“ASC”) 470-20 “Debt,” addresses the accounting for financial instruments which have a beneficial conversion feature. In accordance with ASC 470-20, a conversion feature is beneficial, or “in the money,” when the conversion rate of the convertible security is below the market price of the underlying common stock.  A beneficial conversion feature, calculated as of the commitment date, is the difference between the convertible instruments conversion price and the fair value of the company’s common stock on that date multiplied by the number of common shares the debt converts into.  

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition”. The FASB issued ASU 2014-09 to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein, which is effective for our fiscal year beginning July 1, 2018, the first day of our 2019 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In June 2014, the FASB issued Accounting Standards Update 2014-12, Compensation-Stock Compensation (“ASU 2014-12”). The FASB issued ASU 2014-12 to provide specific guidance on share-based payment awards that provide for achievement of a specific performance target that could be achieved after the requisite service period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. Earlier adoption is permitted. ASU 2014-12 may be applied prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this guidance should be recognized in the financial statements as an adjustment to the opening retained earnings balance at that date. The adoption of ASU 2014-12 did not have a material impact on our consolidated financial statements.

In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40) (“ASU 2014-15”). ASU 2014-15 provides guidance to U.S. GAAP about management’s responsibility to evaluate whether there is a substantial doubt about an entity’s ability to continue as a

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

going concern and to provide related footnote disclosures. This new rule requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles currently in U.S. auditing standards. Specifically, ASU 2014-15 (1) defines the term substantial doubt, (2) requires an evaluation of every reporting period including interim periods, (3) provides principles for considering the mitigating effect of management’s plan, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) requires an express statement and other disclosures when substantial doubt is not alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued. This guidance is effective for annual periods ending after December 15, 2016, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. The adoption of ASU 2014-15 did not have a material impact on our consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update 2015-11, Inventory (Topic 330) (“ASU 2015-11”). ASU 2015-11 was issued to more closely align the measurement of inventory in U.S. GAAP with the measurement of inventory in International Financial Reporting Standards. The core principle of this updated   guidance is that an entity should measure inventory at the lower of cost or net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in ASU 2015-11 apply to inventory that is measured using the first-in, first-out or average cost methods. ASU 2015-11 amends some of the guidance in Topic 330 to more clearly articulate the requirements for the measurement and disclosure of inventory, but the clarifications are not intended to result in any changes in practice other than the change in the subsequent measurement guidance from the lower of cost or market to the lower of cost or net realizable value for inventory.  There are no other substantive changes to the guidance on the measurement of inventory. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, which is effective for our fiscal year beginning July 1, 2017, the first day of our 2018 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In August 2015, the FASB issued Accounting Standards Update 2015-15, Interest – Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (“ASU 2015-15”). ASU 2015-15 states that Staff at the Securities and Exchange Commission would not object to an entity deferring or presenting debt issuance costs as an asset and subsequently amortizing deferred debt issuance cost ratably over the term of the line-of-credit arrangement, regardless of whether there were outstanding borrowings under the arrangement.

3.

Fair Value Measurement

Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” establishes a three-level fair value hierarchy to classify the inputs used in measuring fair value, which are as follows:

Level 1 inputs to the valuation methodology are based on quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2 inputs to the valuation methodology are based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

Level 3 inputs to the valuation methodology are based on unobservable inputs that reflect the company’s own assumptions about the assumptions market participants would use in pricing the asset or liability.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Our financial instruments at December 31, 2016 and June 30, 2016 include cash equivalents, restricted cash, accounts receivable accounts payable, derivative instruments, borrowings under our senior secured convertible promissory note, senior secured promissory note, debtor-in-possession financing, and a revolving line of credit. The carrying amounts of cash and cash equivalents, restricted cash, receivable and accounts payable are representative of their respective fair values because of the short-term maturities or expected settlement dates of these instruments. The fair value of debt, included in Note 12 to the condensed consolidated financial statements, is based on the fair value of similar instruments.  These instruments are short-term in nature and there is no known trading market for our debt.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table provides the non-recurring fair value measurements of assets and liabilities as of December 31, 2016:

The following table provides the non-recurring fair value measurements of assets and liabilities as of June 30, 2016:

The following table summarizes the changes in the fair value of our Level 3 financial liabilities that are measured at fair value for each reporting period:

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

4.

Restricted Cash and Investments

As of December 31, 2016 and June 30, 2016, we had restricted cash and investments, with maturities of less than one year, of $367,000 and $367,000, respectively. Restricted cash and investments consisted of the following:

The restricted investments of $312,000 held in certificates of deposit collateralize our performance under an irrevocable letter of credit issued in April 2010, aggregating to $297,000, in connection with our contract with the India Ministry of Defence, plus the bank required collateralization deposit of $15,000. The letter of credit provides warranty performance security equal to 5% of the contract amount under the terms of the contract with the India Ministry of Defence. We have amended the letter of credit, extending the expiration date to April 15, 2017.

In May 2015, we entered into a corporate credit card agreement with our primary bank, pursuant to which the bank reserves $55,000 of our available cash held in our operating account maintained with the bank to collateralize 105% of the credit limit that is available under the credit card agreement.

5.

Stock Based Compensation

For the three months ended December 31, 2016 and 2015, our consolidated statements of operations and comprehensive loss include $180,000 and $326,000, respectively, of compensation costs and no income tax benefit related to our stock-based compensation arrangements for employee and non-employee director awards.  For the six month ended December 31, 2016 and 2015, our condensed consolidated statements of operations and comprehensive loss include $470,000 and $668,000, respectively, of compensation costs and no income tax benefit related to our stock-based compensation arrangements for employee and non-employee director awards, as follows:

As of December 31, 2016, the total amount of unrecognized stock-based compensation expense was approximately $614,000, which will be recognized over a weighted average period of 1.47 years.

As of December 31, 2016, there were options outstanding to purchase 20,241,500 shares of our common stock at exercise prices ranging from $0.08 to $1.50.

6.

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

7.

Inventories, net

We value our inventories at lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method, including material, labor and factory overhead. The components of inventories, net of reserves, consist of the following:

As of December 31, 2016 and June 30, 2016, our reserves for excess and slow-moving inventories were $106,000 and $171,000, respectively.

8.

Property and Equipment, net

Property and equipment consist of the following:

For the three months ended December 31, 2016 and 2015, depreciation expense was approximately $34,000 and $50,000, respectively.

For the six months ended December 31, 2016 and 2015, depreciation expense was approximately $77,000 and $104,000, respectively.  

9.

Accrued Expenses

Accrued expenses consist of the following:

On January 16, 2015, Glenn D. Bolduc, resigned his positions as Chief Executive Officer and President of the Company), as well as his seat on the Company’s Board of Directors and his position as Chairman of the Board. In connection with and prior to Mr. Bolduc’s resignations, Mr. Bolduc entered into a Separation Agreement and Release (the “Separation Agreement”) with the Company.  The Separation Agreement provides that Mr. Bolduc’s resignation will be deemed an involuntary termination without cause pursuant to his Amended and Restated

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Employment Agreement dated as of June 25, 2013.  In this regard, and subject to the terms contained in the Employment Agreement, Mr. Bolduc is entitled to receive: (i) annual base salary for 18 months on a regular payroll basis; (ii) a pro rata portion of any bonus earned in 2015; (iii) continuation of coverage under and contributions to health care, dental and life insurance benefits for a 12 month period; and (iv) transfer of any key man life insurance.  In connection with Mr. Bolduc’s resignation, we recorded a non-recurring charge of $725,000 in our consolidated statements of operations and comprehensive loss for the year ended June 30, 2015.  As of December 31, 2016 and June 30, 2016, $0 and $55,000, respectively, of separation benefits are included in accrued expenses in our condensed consolidated financial statements.

10.

Deferred Revenues – Current and Long-Term

Deferred revenues are recorded when we receive payments for product or services for which we have not yet completed our obligation to deliver product or have not completed services required by the contractual agreements.

As of December 31, 2016 and June 30, 2016, we had customer advance payment and extended warranty service agreements with maturities of less than one year, of $779,000 and $406,000, respectively, and extended warranty service agreements, with maturities of more than one year, of $451,000 and $479,000, respectively. Deferred revenues consisted of the following:

11.

Earnings Per Share

Basic earnings per share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted earnings per share are based upon the weighted average number of common shares outstanding during the period plus additional weighted average common equivalent shares outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options and warrants, the proceeds of which are then assumed to have been used to repurchase outstanding common stock using the treasury stock method and assumed conversion of certain convertible promissory notes and convertible preferred stock. In addition, the numerator is adjusted for any changes in income or loss that would result from the assumed conversion of potential shares. As of December 31, 2016 and 2015, potentially dilutive shares are excluded from the earnings per share calculation, because their effect would be antidilutive. Shares deemed to be antidilutive include stock options, warrants, convertible debt and convertible preferred stock.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Common stock equivalents excluded from the diluted earnings per share calculation for the three and six months ended December 31, 2016 and 2015, were as follows:

12.

Long-Term Debt and Credit Arrangements

Term Debt and Revolving Credit Facility with DMRJ Group, LLC and Term Debt with Montsant Partners, LLC

We are a party to several loan and credit agreements with DMRJ Group LLC (“DMRJ”), an accredited institutional investor. In December 2008, we entered into a note and warrant purchase agreement with DMRJ pursuant to which we issued a senior secured convertible promissory note in the principal amount of $5,600,000 and a warrant to purchase 1,000,000 shares of our common stock.  Thereafter, we entered into a series of amendments, waivers and modifications of this facility. The note, which is collateralized by all of our assets, originally bore interest at 11.0% per annum.

The note contains restrictions and financial covenants including: (i) restrictions against declaring or paying dividends or making any distributions; against creating, assuming or incurring  any liens; against creating, assuming or incurring any indebtedness; against merging or consolidating with any other company, provided, however, that a merger or consolidation is permitted if we are the surviving entity; against the sale, assignment, transfer or lease of our assets, other than in the ordinary course of business and excluding inventory and certain asset sales expressly permitted by the note purchase agreement; against making investments in any company, extending credit or loans, or purchasing stock or other ownership interest of any company; and (ii) covenants that we have authorized or reserved for the purpose of issuance, 150% of the aggregate number of shares of our common stock issuable upon exercise of  the warrant; that we maintain a minimum cash balance of at least $500,000; that the aggregate dollar amount of all accounts payable be no more than 100 days past due; and that we maintain a current ratio, defined as current assets divided by current liabilities, of no less than 0.60 to 1.00.

On March 19 2015, we amended each of our credit instruments with DMRJ, pursuant to which the maturity of all of our indebtedness to DMRJ was extended from March 31, 2015 to March 31, 2016 and DMRJ waived our compliance with certain financial covenants contained in each of our promissory notes and all related credit agreements through the new maturity date.

On May 4, 2015, we entered into an assignment agreement with DMRJ and Montsant Partners LLC (“Montsant”), wherein DMRJ assigned its rights, title and interest in the senior secured promissory note dated December 10, 2008 and appointed DMRJ as its collateral agent under the promissory note agreement.

DMRJ and Montsant Partners, LLC are funds managed by Platinum Partners Value Arbitrage Fund LP.

The note purchase agreement with Montsant contains restrictions and financial covenants including: (i) restrictions against declaring or paying dividends or making any distributions; against creating, assuming or incurring any liens; against creating, assuming or incurring any indebtedness; against merging or consolidating with any other company, against the sale, assignment, transfer or lease of our assets, other than in the ordinary course of business; against making investments in any company, extending credit or loans, or purchasing stock or other ownership interest of any company; and (ii) covenants that  we maintain a minimum cash balance of at least $500,000; that the weighted average age of all accounts payable be no more than 100 days past due; and that we maintain a current ratio, defined as current assets divided by current liabilities, of no less than 0.60 to 1.00. Montsant waived our compliance with certain financial covenants in our promissory notes through the maturity date, consistent with the financial covenants which have been waived in each of our promissory notes and all related credit agreements with DMRJ.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On March 31, 2016, we further amended each of our credit instruments with DMRJ and Montsant, which were entered into on April 6, 2016 and effective March 31, 2016, pursuant to which:

·

the maturity of all of our  indebtedness to DMRJ under (i) a senior secured promissory note dated July 1, 2009 and (ii) a credit agreement dated September 4, 2009, was extended from March 31, 2016 to June 30, 2016;

·

the maturity of all of our indebtedness to (i) Montsant under an amended and restated senior secured convertible promissory note dated March 12, 2009 (the “March 2009 Note”), (ii) DMRJ under a senior secured convertible promissory note dated September 5, 2012 (the “September 2012 Note”) and (iii) to DMRJ under a senior secured convertible promissory note dated February 28, 2013 (the “February 2013 Note” and together with the March 2009 Note, the July 2009 Note, the September 2012 Note, the “Notes”), was extended from March 31, 2016 to December 30, 2016;

·

the provisions regarding the prepayment of the March 2009 Note were deleted;

·

the “blocker” provisions of the March 2009 Note limiting the number of shares of our common stock, par value $0.001 per share (“Common Stock”) to be issued upon the conversion of the March 2009 Note, when aggregated with the all other shares of Common Stock beneficially owned by the holder of the March 2009 Note at that time, to 4.99% of the then issued and outstanding shares of the Common Stock outstanding at such time were deleted;  

·

the conversion provisions of the March 2009 Note were fixed to remove the limitations on the conversion to only upon prepayment of the note or during the 30-day period ending March 31, 2014;

·

we agreed to make the amendments to our Series H Convertible Preferred Stock (the “Series H Preferred Stock”),  Series I Convertible Preferred Stock (the “Series I Preferred Stock”) and Series J Convertible Preferred Stock (the “Series J Preferred Stock” and together with the Series H Preferred Stock and the Series I Preferred Stock, the “Amended Preferred Stock Series”;

·

we agreed to prepay the interest due on each of the March 2009 Note, the September 2012 Note and the February 2013 Notes from the date of the amendment through June 30, 2016 by increasing the outstanding aggregate principal amount under each such Note;

·

all outstanding amounts due to DMRJ and Montsant shall be immediately due and payable if (a) we receive an offer from another person or entity with respect to a Major Transaction, (b) DMRJ notifies us that such offer is satisfactory to DMRJ (in its sole discretion), and (c) either (i) our Board of Directors does not approve such transaction within ten (10) days of our receipt of such notice from DMRJ, (ii) if such transaction is subject to stockholder approval, we do not file a preliminary proxy statement with the SEC within fifteen (15) days of the receipt of such notice from DMRJ or (iii) if such transaction is subject to stockholder approval, our stockholders do not approve such transaction within ninety (90) days of the  receipt of such notice from DMRJ, that we shall be obligated to immediately forward to DMRJ any offer that we receive with respect to any Major Transaction;

·

we shall provide not less than thirty (30) business days’ written notice to DMRJ and Montsant, as applicable, of the our intent to repay all or any portion of the principal, interest and other amounts outstanding under our indebtedness and following receipt of any such notice, DMRJ and Montsant shall have the option to convert all or any portion of their Notes in accordance with the applicable conversion terms of the applicable Note;

·

each Note, plus all accrued and unpaid interest thereon at the time of any conversion, may be converted at the option of DMRJ or Montsant, as applicable, at any time and from time to time into such number of shares of the applicable preferred stock of the Company, upon one (1) business days’ notice to us, and upon Montsant’s conversion of the March 2009 Note, the shares of preferred stock shall be issued to Montsant or any designee(s) of Montsant;

·

we agreed that if there is any breach of the Comfort Letter , the interest rate under each term note and advances under the Credit Agreement will be increased by an additional fourteen percent (14%) per annum (pro-rated for partial years), not to exceed the maximum amount of such interest permitted by applicable New York law;

·

agreed that we will not, and will not permit any Subsidiary to, enter into, create, incur, assume, suffer, become or be liable for in any manner, or permit to exist, any indebtedness, or guarantee, assume,

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

endorse or otherwise become responsible for (directly or indirectly), any indebtedness, performance or obligations of any other person, and failure by us to comply with this clause shall be an immediate event of default;

·

we shall be obligated to provide DMRJ and Montsant with written notice of the anticipated record date with respect to any Major Transaction at least five (5) business days prior to such record date, and failure by us to comply with this clause shall be an immediate event of default;

·

we agreed not to amend the terms of any Amended Preferred Stock Series without the prior written consent of the DMRJ and Montsant, and any breach is an immediate event of default; and

·

we agreed not to issue any shares of any Amended Preferred Stock Series other than upon the conversion of the March 2009 Note, the September 2012 Note and the February 2013 Note or with the prior written consent of the Investor, and any breach of this provision is an immediate event of default.

The prepayment by us of all interest to be accrued from the March 31, 2016 through June 30, 2016, amounted to $119,400 on account of the March 2009 Note, $450,000 on account of the September 2012 Note and $450,000 on account of the February 2013 Note. Such prepayments were effected by increasing the outstanding aggregate principal amount under each of the March 2009 Note, the September 2012 Note and the February 2013 Note, respectively.  Further, the accrued interest amount due under each of the March 2009 Note, the September 2012 Note and the February 2013 Note, as of March 31, 2016, of $1,980,000, $6,520,000 and $5,073,000, respectively, were added to the outstanding principal amount under each of the notes, as of March 31, 2016.  Consequently, the new outstanding principal balance under (i) the March 2009 Note was $5,284,000, (ii) the September 2012 Note was $18,970,000 and (iii) the February 2013 Note was $17,523,000, as of March 31, 2016.

However, despite the best efforts of the Company, DMRJ and the Assignee, certain post-closing effectiveness conditions to the April 6, 2016 amendment with respect to the delivery of an opinion of counsel and payment of the fees and expenses of DMRJ and the Assignee were not satisfied, and the April 6, 2016 amendment was, therefore, never deemed effective, resulting in our being in default of our obligations to DMRJ and the Montsant since March 31, 2016.

On July 20, 2016, we further amended each of our credit instruments with DMRJ and Montsant, effective as of June 30, 2016, pursuant to which:

·

the maturity of all of our indebtedness to DMRJ under (i) the amended and restated senior secured convertible promissory note, dated March 12, 2009 (as amended, the “March 2009 Note”), (ii) the senior secured promissory note dated July 1, 2009 (as amended, the “July 2009 Note”), (iii) the credit agreement dated September 4, 2009 (as amended, the “September 2009 Credit Agreement”), (iv) the senior secured convertible promissory note, dated September 5, 2012 (as amended, the “September 2012 Note”), and (v) the senior secured convertible promissory note, dated February 28, 2013 (as amended, the “February 2013 Note”) were each extended to October 31, 2016;

·

the “blocker” provisions of the March 2009 Note held by the Assignee, limiting the number of shares of Common Stock, to be issued upon the conversion of such notes, when aggregated with the all other shares of Common Stock beneficially owned by the holders of such notes at that time, to 4.99% of the then issued and outstanding shares of the Common Stock outstanding at such time, were confirmed as never having been deleted by the April 6, 2016 Amendment and an identical “blocker” provision was added to the September 2012 Note held by DMRJ;

·

the conversion and anti-dilution provisions of the February 2013 Note held by DMRJ were deleted in their entirety, and the conversion provisions of the September 2012 Note were limited to an aggregate total of $7,000,000 in obligations thereunder;

·

the conversion price for the September 2012 Note was reduced from $1.09 to $0.19 per share for up to $7,000,000 of the obligations thereunder, DMRJ agreed to convert $7,000,000 of the principal under the September 2012 Note prior to the consummation of the Zapata acquisition, and the remaining conversion rights under the September 2012 Note and the February 2013 Note were waived;

·

we agreed to amend our  Series H Convertible Preferred Stock (the “Series H Preferred Stock”), Series I Convertible Preferred Stock (the “Series I Preferred Stock”) and Series J Convertible Preferred Stock (the “Series J Preferred Stock” and together with the Series H Preferred Stock and the Series I Preferred Stock, the “Amended Preferred Stock Series”) to correct and amend and reinsert the 4.99%

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

“blocker” provisions in lieu and in replacement of the similar provision that was added in the Articles of Amendment to the Restated Articles of Organization that was filed on July 18, 2016;

·

we agreed to issue to DMRJ a warrant to purchase 50,657,894 shares of our common stock (see Note 16 to the condensed consolidated financial statements), which warrant has expired since the Zapata acquisition was not consummated; and

·

DMRJ and Montsant waived any defaults from the failure of the effectiveness of the March 31, 2016 amendment.

As of December 31, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of December 31, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $9,129,000 and is included in current liabilities in the condensed consolidated financial statements.

As of December 31, 2016, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of December 31, 2016, our obligation to Montsant for accrued interest under this instrument approximated was $405,000.

As of February 13, 2017, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of February 13, 2017, our obligation to DMRJ for accrued interest under these instruments approximated $10,012,000. Please refer to Note 14 to the condensed consolidated financial statements for a discussion of the August 2016 conversions of principal indebtedness by DMRJ.

As of February 13, 2017, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of February 13, 2017, our obligation to Montsant for accrued interest under this instrument approximated $502,000.

The payment of our indebtedness to DMRJ and Montsant are stayed pending the conclusion of the bankruptcy proceedings.

Term Debt with BAM

On March 19, 2014, we entered into a note purchase agreement with a group of institutional investors and BAM Administrative Services LLC (“BAM”), an administrative agent for the investors, pursuant to which we issued senior secured promissory notes in the aggregate principal amount of $20,000,000. The notes bear interest at 15% per annum and mature on March 31, 2015.  The proceeds from the sale of the notes were used to repay (i) $17,624,000 of our outstanding indebtedness to DMRJ under the amended and restated revolving promissory note dated September 29, 2011 (ii) $1,809,000 of interest outstanding under the amended and restated promissory note and (iii) $567,000 of interest outstanding under our senior secured convertible promissory note dated September 5, 2012.

On March 19, 2015, we extended our credit agreement with BAM pursuant to which, amongst other matters, the interest rate increased to 16% per annum, commencing on April 1, 2015 and we extended the maturity date of our indebtedness from March 31, 2015 to March 31, 2016. The maturity of our indebtedness to BAM was automatically extended to October 30, 2016 as a result of the extension of the maturity date of our indebtedness to DMRJ and Montsant.  Due to the filing of the voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court we were deemed to be in default under our note purchase agreement with BAM and our interest rate was increased to 18.5% effective as of October 10, 2016.

The notes purchase agreement contains restrictions and financial covenants including: (i) restrictions against declaring or paying dividends or making any distributions; against creating, assuming or incurring any liens; against creating, assuming or incurring any indebtedness; against merging or consolidating with any other company, against the sale, assignment, transfer or lease of our assets, other than in the inventory ordinary course of business ; against making investments in any company, extending credit or loans, or purchasing stock or other ownership interest of any company; and (ii) covenants that  we maintain a minimum cash balance of at least $500,000; that the weighted average age of all accounts payable be no more than 100 days past due; and that we maintain a current ratio, defined as current assets divided by current liabilities, of no less than 0.60 to 1.00. BAM waived our compliance with certain financial covenants in our promissory notes through the maturity date, consistent with the financial covenants which have been waived in each of our promissory notes and all related credit agreements with DMRJ.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Further, upon the occurrence of an event of default under certain provisions of our agreements with BAM, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance outstanding.

On April 6, 2016, we extended our credit agreement with BAM, effective March 31, 2016 pursuant to which;

·

the maturity of our indebtedness to the investors extended from March 30, 2016 to June 29, 2016; provided that in the event we extend the maturity date on all obligations owed to DMRJ,  to a date past June 30, 2016, the maturity date of the Secured Term Notes shall automatically extend to such business day as is immediately prior to such extended maturity date of the DMRJ obligations;

·

all outstanding amounts due to the under the notes shall be immediately due and payable if (a) we receive an offer from another person or entity with respect to a Major Transaction  (as defined below under the heading “Amendments to Preferred Stock”), (b) BAM, on behalf of the investors, notifies us that such offer is satisfactory to the investors (in their sole discretion), and (c) either (i) our Board of Directors  does not approve such transaction within ten (10) days of receipt of such notice from BAM, (ii) if such transaction is subject to stockholder approval, we do not file a preliminary proxy statement with the SEC within fifteen (15) days of receipt of such notice from BAM or (iii) if such transaction is subject to stockholder approval, our stockholders do not approve such transaction within ninety (90) days of  receipt of such notice from BAM; provided, that we shall be obligated to immediately forward to BAM, on behalf of the investors, any offer that we receive with respect to any Major Transaction;

·

we shall provide not less than thirty (30) business days’ written notice to BAM, of our intent to repay all or any portion of the principal, interest and other amounts outstanding under our obligations to the investors;

·

agreed that we will not, and will not permit any subsidiary to, enter into, create, incur, assume, suffer, become or be liable for in any manner, or permit to exist, any indebtedness, or guarantee, assume, endorse or otherwise become responsible for (directly or indirectly), any indebtedness, performance or obligations of any other person, and failure by us to comply with this clause shall be an immediate event of default;

·

we agreed to make the amendments to our Series H Convertible Preferred Stock (the “Series H Preferred Stock”),  Series I Convertible Preferred Stock (the “Series I Preferred Stock”) and Series J Convertible Preferred Stock (the “Series J Preferred Stock” and together with the Series H Preferred Stock and the Series I Preferred Stock, the “Amended Preferred Stock Series”.

As of December 31, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2016, our obligation under such notes for accrued interest amounted to approximately $4,113,000 and is included in current liabilities in the consolidated financial statements.

The total amount borrowed under the BAM senior secured promissory notes together with accrued interest were paid in full effective January 5, 2017 upon the closing of the Transaction with L-3.

Debtor-in-Possession Financing

In connection with the Chapter 11 filings, we filed a motion seeking the approval of the Bankruptcy Court for a super-priority senior secured loan of $5.7 million (the “Original DIP Loan”) between the Debtors and DIP SPV I, L.P., as the debtor-in-possession lender ( the “Original DIP Lender”) pursuant to a Senior Secured Super-priority debtor-in-possession Loan and Security Agreement entered into by the Debtors and the Original DIP Lender on October 10, 2016.  The Original DIP Loan would bear interest at 12% and shall pay a one-time closing fee of $199,500 on the closing date of the Original DIP Loan and an exit fee equal to $427,500, less any interest, other that default interest (which is at a rate of 24%), paid to the Original DIP Lender as of the termination date of the Original DIP Loan. The Original DIP Loan is payable in full upon the consummation of the sale under the Asset Purchase Agreement with L-3 or a sale to any other winning bidder in the Bankruptcy Court auction.  On October 13, 2016, we borrowed $1,500,000 under the Original DIP Loan.

The use of proceeds from the Original DIP Loan would be limited to working capital and other general corporate purposes consistent with the budget that the Company presented to the Original DIP Lender, including payment of costs and expenses related to the administration of the bankruptcy proceedings and payment of other expenses as approved by the Bankruptcy Court.  

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On November 7, 2016, we terminated the Senior Secured, Super-Priority Debtor-in-Possession Loan and Security Agreement, dated as of October 10, 2016 (as amended on November 3, 2016, the “Original DIP Agreement”), with the original lender, DIP SPV I, L.P. (the “Original DIP Lender”).  In connection with such termination, we paid $1,610,769 to the Original DIP Lender and its advisors to satisfy outstanding obligations under the Original DIP Agreement, including $74,354 for expense reimbursement for the Original DIP Lender’s advisors.

On November 7, 2016 (the “Effective Date”), we entered into a replacement Senior Secured, Super-Priority Debtor-in-Possession Loan and Security Agreement (the “New DIP Agreement”) with Tannor Partners Credit Fund, LP, the New DIP Lender, which DIP Agreement was approved by the Bankruptcy Court on an interim basis pursuant to an order dated as of the Effective Date for the initial loan amount of $5.7 million.  Under the New DIP Agreement, subject to the terms and conditions thereof, the New DIP Lender agreed to lend up to a total of $8.0 million to us, with the initial installment of $5.7 million payable upon the Bankruptcy Court entering the interim order for the New DIP Agreement and the remaining $2.3 million payable upon the Bankruptcy Court entering the final order for the New DIP Agreement.  On November 8, 2016, we borrowed $5,700,000 under the New DIP Agreement and borrowed an additional $2,300,000 on November 30, 2016. As of December 31, 2016 the total amount borrowed under the New DIP Agreement was $8,000,000, plus accrued interest of $0. Interest for the month ended December 31, 2016 was paid on December 30, 2016.

On or about December 8, 2016, New DIP Lender asserted that we were not in compliance with Section 7.1(a) of the New DIP Agreement, wherein the net cash receipts for the cumulative period commencing on November 7, 2016 and ending on November 30, 2016 were required be equal to or exceed 85% of the budgeted cash receipts amount (the “DIP Budget”), which event constituted an event of default under the New DIP Agreement.  Effective as of December 1, 2016 the interest rate under the New DIP Agreement increased 12.0% to 24.0%. Subject to the terms of a Stipulation and Order entered in the Bankruptcy Case, we agreed with the New DIP Lender to waive such asserted default in exchange for an agreement by us to pay an additional $96,000 of interest, which interest was not credited against the exit fee.

The total amount borrowed under the New DIP Agreement together with accrued interest was paid in full effective January 5, 2017 upon the closing of the Transaction with L-3.

13.

Convertible Preferred Stock

Series H Convertible Preferred Stock

In connection with the September 7, 2012 amendment to our credit instruments with DMRJ we issued to DMRJ a second senior secured convertible promissory note in the principal amount of $12,000,000 (the “September 2012 Note”).  The September 2012 convertible promissory note is convertible in whole or in part, at DMRJ’s option, into shares of Series H Convertible Preferred Stock at an initial conversion rate of $1,000 per share (as adjusted in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the Series H Preferred Stock, the “Series H Original Issue Price”).  The number of shares of our Preferred Stock, par value $0.10 per share (the “Preferred Stock”), designated as Series H Preferred Stock was 15,000.

The holders of the Series H Preferred Stock will be entitled to receive, prior to the payment of any dividends with respect to our Common Stock and/or Series G Convertible Preferred Stock, cumulative dividends on each share of Series H Preferred Stock at a rate equal to 15% of the Series H Original Issue Price per annum, (i) when, as and if declared by our Board of Directors, (ii) upon a liquidation, dissolution or winding up of the Company (a “Liquidation Event”), or (iii) upon the repurchase or conversion of the Series H Preferred Stock. All dividends accruing on the Series H Preferred Stock are payable by the issuance of additional shares of Series H Preferred Stock.

Each share of Series H Preferred Stock will be convertible, at the option of the holder, into that number of shares of Common Stock as is determined by (i) dividing the Series H Original Issue Price by the Series H Conversion Price (as defined below) in effect at the time of conversion and (ii) multiply the result by 1,000. The “Series H Conversion Price” will initially be equal to $1,090, and is subject to adjustment in the event that (a) we issue additional shares of Common Stock as a dividend or other distribution on outstanding shares of Common Stock, (b) there is a split or subdivision of outstanding shares of Common Stock, or (c) there is a combination or reverse stock split of outstanding shares of Common Stock into a smaller number of shares of Common Stock. Assuming no adjustments to the Series H Original Issue Price or the Series H Conversion Price, the New Note will be convertible indirectly, at DMRJ’s option, into shares of Common Stock at an effective conversion price of $1.09 per share, which represents a discount of approximately 20% from the daily volume weighted average price of the Common Stock over the 20 trading days preceding the date of the amendment.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Upon a Liquidation Event, the holders of shares of Series H Preferred Stock then outstanding will be entitled to be paid out of the assets of the company available for distribution to its stockholders, before any payment is made to the holders of Common Stock and/or Series G Preferred Stock in respect of such stock, an amount per share equal to the Series H Original Issue Price, plus any accrued but unpaid dividends thereon, whether or not declared. At the option of holders of a majority of the outstanding Series H Preferred Stock, (i) a consolidation or merger of us with or into another entity or person, or any other corporate reorganization, in which our stockholders immediately prior to such consolidation, merger or reorganization do not hold at least a majority of the resulting or surviving entities’ voting power immediately following such consolidation, merger or reorganization, or (ii) a sale or transfer of all or substantially all of our assets for cash, securities or other property, will be deemed to be a Liquidation Event.

The holders of the Series H Preferred Stock will have no voting rights except as required by applicable law. However, without the consent of the holders of a majority of the outstanding Series H Preferred Stock, we may not (i) amend, alter or repeal any provision of its Articles of Organization or By-laws in a manner that adversely affects the powers, preferences or rights of the Series H Preferred Stock; (ii) authorize or issue any equity securities (or any equity or debt securities convertible into equity securities) ranking prior and superior to the Series H Preferred Stock with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up; or (iii) consummate any capital reorganization or reclassification of any of its equity securities (or debt securities convertible into equity securities) into equity securities ranking prior and superior to the Series H Preferred Stock with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up.

On July 18, 2016, the Company adopted and filed Articles of Amendment to the Restated Articles of Organization of the Company (the “July 18 Preferred Stock Articles of Amendment”), pursuant to which the initial conversion price of the Series H Preferred Stock was reduced from $1,090 per share to $190 per share; and the “blocker” provisions of the Amended Series H Preferred Stock Series limiting the number of shares of the Common Stock to be issued upon the conversion of the applicable Amended Preferred Stock Series, when aggregated with the all other shares of Common Stock beneficially owned by the holder of such Amended Preferred Stock Series at that time, to 4.99% of the then issued and outstanding shares of the Common Stock outstanding at such time, which the Company purported to delete in the Articles of Amendment filed in connection with the Fourteenth Amendment, were reinserted.  In connection with such amendment, on July 20, 2016, DMRJ agreed to waive its rights under the September 2012 Note so that only $7,000,000 of the principal under the September 2012 Note would be convertible into shares of Series H Preferred Stock and the remaining balance would not be convertible.

Between August 11, 2016 and August 23, 2016, DMRJ converted $7,000,000 of principal into 7,000 Series H Preferred Stock shares, of which DMRJ assigned 4,401.54 shares of Series H Preferred Stock to Platinum Partners Value Arbitrage Fund LP and distributed 1,467.18 shares to ED&F Man Capital Markets Limited and 1,131.28 shares to Prime Capital (Bermuda) Limited.

As of December 31, 2016, 7,000 shares of Series H Convertible Preferred Stock were issued and outstanding.

Series I Convertible Preferred Stock and Series J Convertible Preferred Stock

In connection with the February 28, 2013  amendment to our credit instruments with DMRJ we issued to DMRJ a third senior secured convertible promissory note in the principal amount of $12,000,000 (the “February 2013 Note”).  The February 2013 Note is convertible in whole or in part, at DMRJ’s option, into shares of Series I Convertible Preferred Stock at an initial conversion rate of $1,000 per share (as adjusted in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the Series I Preferred Stock, the “Series I Original Issue Price”). The number of shares of our Preferred Stock, par value $0.10 per share (the “Preferred Stock”), designated as Series I Preferred Stock was 15,000.

As amended, the March 2009 Note is convertible in whole or in part, at DMRJ’s option, into shares of Series J Convertible Preferred Stock at an initial conversion rate of $1,000 per share (as adjusted in the event of any stock dividend, stock split, combination or other similar recapitalization with respect to the Series J Preferred Stock, the “Series J Original Issue Price”). The number of shares of our Preferred Stock, par value $0.10 per share (the “Preferred Stock”), designated as Series J Preferred Stock was 6,000.

Each share of Series I Preferred Stock will be convertible, at the option of the holder, into that number of shares of Common Stock as is determined by (i) dividing the Series I Original Issue Price by the Series I Conversion Price (as defined below) in effect at the time of conversion and (ii) multiplying the result by 1,000. The “Series I Conversion Price” will initially be equal to $1,180.00, and is subject to adjustment in the event that (a) we issue additional shares of Common Stock as a dividend or other distribution on outstanding shares of Common Stock, (b) there is a split or subdivision of outstanding shares of Common Stock, or (c) there is a combination or reverse stock

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

split of outstanding shares of Common Stock into a smaller number of shares of Common Stock. Assuming no adjustments to the Series I Original Issue Price or the Series I Conversion Price, the February 2013 Note will be convertible indirectly, at DMRJ’s option, into shares of Common Stock at an effective conversion price of $1.18 per share, which represents premium of approximately 3% over the closing price of the Common Stock on the trading day preceding the date of the February 28, 2013 amendments.

The holders of the Series I Preferred Stock will be entitled to receive, prior to the payment of any dividends with respect to our Common Stock and/or Series G Preferred Stock, cumulative dividends on each share of Series I Preferred Stock at a rate equal to 15% of the Series I Original Issue Price per annum, (i) when, as and if declared by our Board of Directors, (ii) upon a “Liquidation Event”, or (iii) upon the conversion of the Series I Preferred Stock All dividends accruing on the Series I Preferred Stock are payable by the issuance of additional shares of Series I Preferred Stock.

The holders of Series J Preferred Stock will be entitled to participate on an “as converted” basis in all dividends or distributions declared or paid on our Common Stock.

Upon a Liquidation Event, the holders of shares of Series I Preferred Stock and Series J Preferred Stock then outstanding will be entitled to be paid out of the assets of the company available for distribution to its stockholders, pari passu with distributions made with respect to the Series H Preferred Stock but before any payment is made to the holders of Common Stock and /or Series G Preferred Stock in respect of such stock, (i) an amount per share of Series I Preferred Stock equal to the Series I Original Issue Price, plus any accrued but unpaid dividends thereon, whether or not declared, and (ii) an amount per share of Series J Preferred Stock equal to the Series J Original Issue Price, plus any dividends declared but unpaid thereon. At the option of holders of a majority of the outstanding Series I Preferred Stock, (i) a consolidation or merger of the company with or into another entity or person, or any other corporate reorganization, in which the stockholders of the company immediately prior to such consolidation, merger or reorganization do not hold at least a majority of the resulting or surviving entities’ voting power immediately following such consolidation, merger or reorganization, or (ii) a sale or transfer of all or substantially all of our assets for cash, securities or other property, will be deemed to be a Liquidation Event.

Upon any such Liquidation Event, and after all payments described in the preceding paragraph are made in full in respect of the Series H Preferred Stock, the Series I Preferred Stock and the Series J Preferred Stock, the holders of the Series G Preferred Stock will be entitled to be paid out of the assets of the company available for distribution to its stockholders an amount equal to $8.00 per share of Series G Preferred Stock, plus any declared but unpaid dividends, prior to the payment of any amounts to the holders of our Common Stock by reason of their ownership of such stock.

Each share of Series J Preferred Stock will be convertible, at the option of the holder, into that number of shares of Common Stock as is determined by dividing the Series J Original Issue Price by the Series J Conversion Price (as defined below) in effect at the time of conversion. The “Series J Conversion Price” will initially be equal to $0.08, and is subject to adjustment in the event that (a) the Company issues additional shares of Common Stock as a dividend or other distribution on outstanding shares of Common Stock, (b) there is a split or subdivision of outstanding shares of Common Stock, or (c) there is a combination or reverse stock split of outstanding shares of Common Stock into a smaller number of shares of Common Stock. Assuming no adjustments to the Series J Original Issue Price or the Series J Conversion Price, the March 2009 Note will be convertible indirectly, at DMRJ’s option, into shares of Common Stock at an effective conversion price of $.08 per share. Prior to the execution of the amendment, the March 2009 Note was convertible directly into shares of Common Stock at a conversion price of $0.08 per share. Accordingly, we do not believe this change to be material.

The holders of the Series I Preferred Stock and the Series J Preferred Stock will have no voting rights except as required by applicable law. However, without the consent of the holders of a majority of the outstanding Series I Preferred Stock or Series J Preferred Stock, as the case may be, with each such series voting as a separate class, we may not (i) amend, alter or repeal any provision of our Articles of Organization or By-laws in a manner that adversely affects the powers, preferences or rights of the Series I Preferred Stock or Series J Preferred Stock, as the case may be; (ii) authorize or issue any equity securities (or any equity or debt securities convertible into equity securities) ranking prior and superior to the Series I Preferred Stock or Series J Preferred Stock, as the case may be, with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up; or (iii) consummate any capital reorganization or reclassification of any of its equity securities (or debt securities convertible into equity securities) into equity securities ranking prior and superior to the Series I Preferred Stock or Series J Preferred Stock, as the case may be, with respect to dividends, distributions, redemption rights or rights upon liquidation, dissolution or winding up.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In connection with the March 31, 2016  amendment to our credit agreements with DMRJ and Montsant, we agreed to amend certain terms of each of the Amended Preferred Stock Series as follows, which amendments were set forth in Articles of Amendment adopted on April 6, 2016:

·

the number of shares of our Preferred Stock, par value $0.10 per share (the “Preferred Stock”),  designated as Series H Preferred Stock was increased from 15,000 shares to 22,500 shares, Series I Preferred Stock was increased from 15,000 shares to 21,000 shares and Series J Preferred Stock was increased from 6,000 shares to 6,500 shares;

·

the Series J Preferred Stock was amended so that its holders are entitled to receive preferred dividends equal to fifteen percent (15%) of the original issue price (subject to certain adjustments) of such shares of Preferred Stock, which is paid by the issuance of additional shares of Series J Preferred Stock;

·

the Series J Preferred Stock was amended so that it has the same dividend rights as the Series H Preferred Stock and the Series I Preferred Stock wherein we cannot declare, pay or set aside any dividends on any shares of Common Stock unless the holders of the Series J Preferred Stock then outstanding shall simultaneously receive a dividend on each outstanding share of Series J Preferred Stock in an amount at least equal to that dividend per share of Series J Preferred Stock as would equal the product of (i) the dividend payable on each share of Common Stock and (ii) the number of shares of Common Stock issuable upon conversion of a share of Series J Preferred Stock, in each case calculated on the record date for determination of holders entitled to receive such dividend;

·

we agreed that if there is any breach of the Comfort Letter, the preferred dividend rate under each Amended Preferred Stock Series will be increased by an additional fourteen percent (14%) per annum (pro-rated for partial years), not to exceed the maximum amount (if any) permitted by law;

·

each Amended Preferred Stock Series was amended so that in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company (a “Liquidation Event”), instead of receiving just the original issue price (subject to certain adjustments) of such shares of Preferred Stock, the holders of such Preferred Stock receive the greater of the original issue price (subject to certain adjustments) of such shares of Preferred Stock and the amount that they would have received if all such shares of such Amended Preferred Stock Series were converted into Common Stock in accordance with the terms of such Amended Preferred Stock Series immediately prior to such Liquidation Event;

·

the Series J Preferred Stock was amended so that its holders have the same rights as the holders of Series H Preferred Stock and Series I Preferred Stock to, at the option of the holders of a majority of the outstanding applicable Amended Preferred Stock Series, have a Liquidation Event also include (i) a consolidation or merger of the Company with or into another entity or person, or any other corporate reorganization, in which the stockholders of the Company immediately prior to such consolidation, merger or reorganization do not hold at least a majority of the resulting or surviving entities voting power immediately following such consolidation, merger or reorganization (solely in respect of their equity interests), or (ii) a sale or transfer of all or substantially all of the Company’s assets for cash, securities or other property;

·

each Amended Preferred Stock Series was amended to give their respective holders voting rights on any Major Transaction that is approved by our board of directors and presented to the our stockholders  for their action or consideration at any meeting of our stockholders (or, if applicable, by written consent of stockholders in lieu of meeting) (a “Major Transaction Stockholder Vote”), entitling them to cast the number of votes equal to the number of whole shares of Common Stock into which the shares of the applicable Amended Preferred Stock Series held by such holder are convertible as of the record date for determining stockholders entitled to vote on such matter (irrespective of whether any such conversion would result in economic gain or loss to the holder) and shall be entitled to notice of any such meeting of stockholders in accordance with our by-laws, which holders of the applicable

Amended Preferred Stock Series, except as provided by law or as otherwise provided therein, vote on any Major Transaction Stockholder Vote together with the holders of Common Stock as a single class;

·

the “blocker” provisions of each Amended Preferred Stock Series limiting the number of shares of the Common Stock to be issued upon the conversion of the applicable Amended Preferred Stock Series, when aggregated with the all other shares of Common Stock beneficially owned by the holder of such

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Amended Preferred Stock Series at that time, to 4.99% of the then issued and outstanding shares of the Common Stock outstanding at such time were deleted; and,

·

we shall be obligated to provide each holder of an Amended Preferred Stock Series with written notice of the anticipated record date with respect to any Major Transaction at least five (5) business days prior to such record date, where “Major Transaction” means (i) the consolidation, merger or other business combination by us with or into another entity or person (other than (x) pursuant to a migratory merger effected solely for the purpose of changing the our jurisdiction of incorporation or (y) a consolidation, merger or other business combination in which holders of the Company’s voting power immediately prior to the transaction continue after the transaction to hold, directly or indirectly, the voting power of the surviving entity or entities necessary to elect a majority of the members of the board of directors (or their equivalent if other than a corporation) of such entity or entities); (ii) the sale or transfer of more than fifty percent (50%) of our assets (based on the fair market value as determined in good faith by the Board of Directors) other than inventory in the ordinary course of business in one or a related series of transactions; or (iii) the closing of a purchase, tender or exchange offer made to the holders of more than fifty percent (50%) of the outstanding shares of Common Stock in which more than fifty percent (50%) of the outstanding shares of Common Stock were tendered and accepted.

Further, we adopted on July 20, 2016, and filed on July 21, 2016, Articles of Amendment to the Restated Articles of Organization of the Company (the “July 21 Preferred Stock Articles of Amendment”), pursuant to which each of the Amended Preferred Stock Series was corrected and amended to reinsert the “blocker” provisions of each Amended Preferred Stock Series limiting the number of shares of the Common Stock to be issued upon the conversion of the applicable Amended Preferred Stock Series, when aggregated with the all other shares of Common Stock beneficially owned by the holder of such Amended Preferred Stock Series at that time, to 4.99% of the then issued and outstanding shares of the Common Stock outstanding at such time, in lieu and in replacement of the similar provisions in the July 18 Preferred Stock Articles of Amendment.  In connection with such amendment, on July 20, 2016, DMRJ agreed to waive its rights under the February 2013 Note so that it would no longer be convertible into shares of Series I Preferred Stock.

As of December 31, 2016, there were no shares of Series I Preferred Stock or Series J Preferred Stock outstanding.

14.

Derivative Liabilities

Beneficial Note Conversion Feature - DMRJ

Accounting Standards Codification (“ASC”) 470-20 “Debt,” addresses the accounting for financial instruments which have a beneficial conversion feature.  On July 20, 2016, we extended the maturity date of our obligations with DMRJ LLC.  As amended, the conversion and anti-dilution provisions of the February 2013 Note held by DMRJ were deleted in their entirety, and the conversion provisions of the September 2012 Note were limited to an aggregate total of $7,000,000 in obligations thereunder. The conversion price for the September 2012 Note was reduced from $1.09 to $0.19 per share for up to $7,000,000 of the obligations thereunder. The market price of our common stock on the date of the note extension was $0.44 per share; therefore a beneficial conversion feature existed.

In accordance with ASC 470-20, a conversion feature is beneficial, or “in the money,” when the conversion rate of the convertible security is below the market price of the underlying common stock.  A beneficial conversion feature, calculated as of the commitment date, is the difference between the convertible instruments conversion price and the fair value of the company’s common stock on that date multiplied by the number of common shares the debt converts into. For the six months ended December 31, 2016 we recorded a non-cash interest charge of $9,217,000 in our condensed consolidated statements of operations.

Between August 11, 2016 and August 23, 2016, DMRJ converted $7,000,000 of principal into 7,000 Series H Convertible Preferred Stock shares, of which DMRJ assigned 4,401.54 shares of Series H Convertible Preferred Stock to Platinum Partners Value Arbitrage Fund LP and assigned 1,467.18 shares to ED&F Man Capital Markets Limited and 1,131.28 shares to Prime Capital (Bermuda) Limited.

Warrant Derivative Liability

Accounting Standards Codification (“ASC”) 815-40-15 “Derivatives and Hedging”, requires freestanding contracts that are settled in common stock, including common stock warrants to be designated as an equity instrument, asset or liability. Under the provisions of ASC 815-40-15, a contract designated as an asset or a liability

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

must be carried at fair value until exercised or expired, with any changes in fair value recorded in the results of operations. On July 20, 2016, we issued a warrant to purchase 50,657,894 shares of our common stock to DMRJ LLC at an exercise price of no lower than $0.19 per share with a five-year term, first exercisable on October 31, 2016. The specific exercise price shall be the higher of: (i) $0.19 per share; and (ii) in the event that we sell our existing business (which would not include any assets acquired by us) on or prior to October 31, 2016, the price in such sale.  This warrant has since expired since the Zapata acquisition was not consummated.

The warrant derivative liability was valued using a binomial option pricing model, with the following assumptions on the following dates:

The warrant derivative liability was initially and is subsequently measured at fair value with changes in fair value recorded in earnings in each reporting period.

As of the date of grant, we recorded a warrant derivative liability of $15,703,000 and will accrete the fair value of the warrant derivative liability to non-cash interest expense in our condensed consolidated statements of operations over the least of the warrant vesting period or duration of the new note conversion feature. For the six months ended December 31, 2016, we accreted $15,703,000 to non-cash interest expense in our condensed consolidated statement of operations, given the new note conversion amount was converted to shares of our Series H Convertible Preferred Stock in August 2016 (see Note 13 to our condensed consolidated financial statements).  For the three and six months ended December 31, 2016, we recorded a non-cash benefits of $10,497,000 and $13,536,000, respectively, in our consolidated statements of operations and comprehensive loss  to recognize the change in the fair value of the warrant as of that date. The fair value is estimated using a binomial option pricing model, which includes variables such as the expected volatility of our share price, interest rates, and dividend yields. These variables are projected based on our historical data, experience, and other factors. Changes in any of these variables could result in material adjustments to the expense / income recognized for changes in the valuation of the warrants liability.

15.

Stockholders’ Deficit

Common Shares Authorized

On July 1, 2015, at an Annual Meeting of Stockholders, our stockholders approved an amendment to the Company’s Restated Articles of Organization to increase the number of authorized shares of common stock by 50,000,000 shares to 250,000,000 shares. Articles of Amendment to our Restated Articles of Organization with the Commonwealth of Massachusetts were filed on July 20, 2016 to affect that increase. As a result of the stockholder approval, we are authorized to issue 250,000,000 shares of our common stock.

Common Stock Options and Stock Purchase Warrants

In connection with various financing agreements and services provided by consultants, we have issued warrants to purchase shares of our common stock.  The fair value of warrants issued is determined using a binomial or Black-Scholes option pricing model.

Common Stock Options

In December 2004, we adopted the 2004 Stock Option Plan (the “2004 Plan”). The 2004 Plan provides for the grant of incentive stock options and non-qualified stock options to employees and affiliates. The exercise price of the options equa1 100% of the fair market value on the date of the grant or 110% of the fair market value for beneficial owners of more than 10% of our stock. Options expire between five and ten years from the date of the option grant and have various vesting periods. Options may be exercised by delivering to the company cash in an amount equal to such aggregate exercise price of the options exercised, or with the consent of the Committee, shares

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

of our common stock having a fair market value equal to such aggregate exercise price, a personal recourse note issued to the company in a principal amount equal to such aggregate exercise price, other acceptable consideration including a cashless exercise/resale procedure, or any combination of the foregoing. A total of 500,000 shares were originally reserved for issuance under the 2004 Plan. In December 2005, our stockholders approved an increase in the 2004 Plan from 500,000 shares to 1,000,000 shares.  In December 2007, our stockholders approved an increase in the 2004 Plan from 1,000,000 shares to 2,000,000 shares. In March 2012, our stockholders approved an increase in the 2004 Plan from 2,000,000 shares to 4,000,000. The 2004 Plan expired in May 2014, as such no further options grants may be issued under this plan. In September 2012, our Board of Directors adopted an amendment to our 2004 Stock Option increasing the total number of shares of our common stock issuable thereunder from 4,000,000 shares to 20,000,000 shares. On July 1, 2015, at the 2015 Annual Meeting of Stockholders, the September 2012 amendment was approved by our stockholders.

On July 2, 2014, our Board of Directors adopted the 2014 Stock Option Plan (the “2014 Plan”). The 2014 Plan provides for the grant of incentive stock options and non-qualified stock options to employees and affiliates. The exercise price of the options equa1 100% of the fair market value on the date of the grant or 110% of the fair market value for beneficial owners of more than 10% of our stock. Options expire between five and ten years from the date of the option grant and have various vesting periods. Options may be exercised by delivering to the company cash in an amount equal to such aggregate exercise price of the options exercised, or with the consent of the Committee, shares of our common stock having a fair market value equal to such aggregate exercise price, a personal recourse note issued to the company in a principal amount equal to such aggregate exercise price, other acceptable consideration including a cashless exercise/resale procedure, or any combination of the foregoing. A total of 15,000,000 shares were originally reserved for issuance under the 2014 Plan. The 2014 Plan was approved by our stockholders on July 1, 2015 at the 2015 Annual Meeting of Stockholders.

As of December 31, 2016, there were options outstanding to purchase 20,241,500 shares of our common stock at exercise prices ranging from $0.08 to $1.50.

We issued no shares and 20,000 shares of common stock during the three months ended December 31, 2016 and 2015, respectively, as a result of the exercise of options by employees and consultants. We issued no shares and 83,000  shares of common stock during the six months ended December 31, 2016 and 2015, respectively, as a result of the exercise of options by employees and consultants.

Stock Purchase Warrants and Stock Issuances

In connection with various financing agreements and services provided by consultants, we have issued warrants to purchase shares of our common stock.  The fair value of warrants issued is determined using the Black-Scholes option pricing model.

In May 2015 we entered into two advisory and consulting services agreements, which provided for the issuance of an aggregate of 2,200,000 shares of our common stock as payment. In June 2015, we issued 550,000 shares of common and the advisory and services agreements provide for the issuance of the remaining 1,650,000 shares in equal monthly installments of 110,000 shares commencing in September 2015. During the six months ended December 31, 2016, we issued 440,000 shares of common stock having a value of $183,000 to these two advisors for services rendered under the advisory and consulting services agreement and issued 50,000 shares of our common stock to a third advisor having a value of $20,000.

As of December 31, 2016, there were warrants outstanding to purchase 52,832,894, shares of our common stock at exercise prices ranging from $0.19 to $1.22 expiring at various dates between May 1, 2017 and October 20, 2021.

16.

Income Taxes

We are required to file federal and state income tax returns in the United States.  The preparation of these tax returns requires us to interpret the applicable tax laws and regulations in effect in such jurisdictions, which could affect the amount of tax paid by us. In consultation with our tax advisors, we base our tax returns on interpretations that are believed to be reasonable under the circumstances. The tax returns, however, are subject to routine reviews by the various federal and state taxing authorities in the jurisdictions in which we file tax returns. As part of these reviews, a taxing authority may disagree with respect to the income tax positions taken by us (“uncertain tax positions”) and, therefore, may require us to pay additional taxes. As required under applicable accounting rules, we accrue an amount for our estimate of additional income tax liability, including interest and penalties, which we could incur as a result of the ultimate or effective resolution of the uncertain tax positions. We account for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized.

We account for uncertain income tax positions by accruing for the estimated additional amount of taxes for the uncertain tax positions when the uncertain tax position does not meet the more likely than not standard for sustaining the position. We review and update our accrual as more definitive information becomes available from taxing authorities, upon completion of tax audits, upon expiration of statutes of limitation, or upon occurrence of other events.  This requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits of uncertain tax positions are recorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge, if any, from tax authorities. When facts and circumstances change, we reassess these probabilities and record any changes in the consolidated financial statements as appropriate.

Deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and the tax basis of the assets and liabilities using the enacted tax rate in effect in the years in which the differences are expected to reverse.  A valuation allowance has been recorded against the deferred tax asset as it is more likely than not, based upon our analysis of all available evidence, that the tax benefit of the deferred tax asset will not be realized.

A valuation allowance has been established for our tax assets as their use is dependent on the generation of sufficient future taxable income, which cannot be predicted at this time.  Included in the valuation allowance is approximately $800,000 related to certain operating loss carryforwards resulting from the exercise of employee stock options, the tax benefit of which, when recognized, will be accounted for as a credit to additional paid-in capital rather than a reduction in income tax.

As of December 31, 2016, the Company has the following unused net operating loss and tax credit carryforwards available to offset future federal and state taxable income, both of which expire at various times as noted below:

We have recorded a full valuation allowance against our net deferred tax assets of $52,892,000 as of December 31, 2016, due to uncertainties related to our ability to utilize these assets. The valuation allowance is based on our estimates of taxable income and the period over which our deferred tax assets will be recoverable.

Potential 382 Limitation

Our net operating loss and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service.  Our ability to utilize our net operating loss (“NOL”) and alternative minimum tax (“AMT”) and research and development credit (“R&D”) carryforwards may be substantially limited due to ownership changes that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), as well as similar state provisions.  These ownership changes may limit the amount of NOL, AMT and R&D credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively.  In general, an ownership change, as defined in Section 382 of the Code, results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50% of the outstanding stock of a company by certain stockholders or public groups.

The sale of our explosives trace detection assets, constituting our entire business, to L-3 for $117.5 million in cash, plus the assumption of specified liabilities, subject to adjustment (the “Transaction”) will result in the recognition of a taxable gain of approximately $100 million. We have engaged a consulting firm to perform a study to assess whether one or more ownership changes have occurred since we became a loss corporation as defined in Section 382 of the Code, but we believe that it is likely that an ownership change has occurred.  If we have experienced an ownership change, utilization of the NOL, AMT and R&D credit carryforwards would be subject to an annual limitation, which is determined by first multiplying the value of our common stock at the time of the

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ownership change by the applicable long-term, tax-exempt rate, and then could be subject to additional adjustments, as required.  Any such limitation may result in the expiration of a portion of the NOL, AMT or R&D credit carryforwards before utilization.  Until a study is completed and any limitation known, no amounts are being considered as an uncertain tax position or disclosed as an unrecognized tax benefit under ASC 740.  Any carryforwards that expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding adjustment to the valuation allowance.  Due to the existence of the valuation allowance, it is not expected that any potential limitation will have a material impact on our operating results.

From time to time we may be assessed interest or penalties by major tax jurisdictions, namely the states of Massachusetts and California.  As of June 30, 2016, we had no material unrecognized tax benefits and no adjustments to liabilities or operations were required. No interest and penalties have been recognized by the Company to date.

Tax years 2013 through 2016 are subject to examination by the federal and state taxing authorities.  There are no income tax examinations currently in process.

For the six months ended December 31, 2016 and 2015, we provided for no taxes in our consolidated statement of operations as we have significant net loss carryforwards.

Our net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service and are subject to certain limitations in the event of cumulative changes in the ownership interest of significant stockholders over a three-year period in excess of 50%.

17.

Commitments and Contingencies

On April 1, 2013, we entered into a lease for manufacturing, research and office space in Wilmington, Massachusetts, the lease of which expires on June 30, 2020.  Under the terms of the lease, we are responsible for our proportionate share of real estate taxes and operating expenses relating to this facility.  We leased research and office space in San Diego, California and leased 300 square feet of office space in Shanghai, China.   On March 25, 2015, our Board of Directors approved restructuring actions to better align costs with current and future geographic revenue sources and to improve efficiencies.  We have exited from our leases in San Diego, CA and Shanghai, China in November 2015. Total rent expense, including assessments for maintenance and real estate taxes for the six months ended December 31, 2016 and 2015, was $367,000 and $363,000, respectively.   On January 5, 2017, in connection with the closing of the Transaction with L-3, L-3 assumed our obligations under the Wilmington, Massachusetts lease.

License Agreements

We are obligated under one license agreement, assumed in connection with the acquisition of Ion Metrics, whereby we were granted rights to use certain intellectual property for safety, security and narcotic applications. The license agreement expired on September 30, 2016 and as of December 31, 2016 we have no obligation under this license agreement for future minimum guaranteed payments.

18.

Financial Information By Segment

Operating segments are defined as components of an enterprise about which separate financial information is available that is regularly evaluated by the chief operating decision maker or decision making group, in determining how to allocate resources and in accessing performance. Our chief operating decision making group is composed of the chief executive officer and members of senior management. Based on qualitative and quantitative criteria, we have determined that we operate within one reportable segment, which is the Security Products Segment.

19.

Legal

On March 23, 2015, Bernard Miller (“Mr. Miller”), individually and on behalf of all others similarly situated shareholders of the company, filed a complaint against Dr. William J. McGann, Messrs. Glenn D. Bolduc, John H. Hassett, John A. Keating, Robert P. Liscouski, Howard Safir and Michael C. Turmelle and the Company in the Suffolk Superior Court of the Commonwealth of Massachusetts, seeking derivative action as a result of director breaches of fiduciary duty and unjust enrichment.  Amongst other things, the plaintiff requested that the court compel the Company to hold an annual stockholders’ meeting; subject the September 2012 Amendment to the 2004 Plan to a vote at the next annual stockholders’ meeting; rescind the stock option awards granted under the September 2012 Amendment to 2004 Plan in the event that the amendment is not approved by a majority of our stockholders’; impose a trust, in favor of the Company, for any benefits improperly received; and award costs and expenses, including reasonable attorney fees.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On July 1, 2015 we held our 2015 Annual Meeting of Stockholders. Stockholders approved an amendment to the Company’s 2004 Stock Option Plan to increase the aggregate number of shares of the Company’s common stock, par value $0.001 per share available for issuance under the Plan by 16,000,000 shares to 20,000,000 shares and approved the Company’s Amended and Restated 2014 Stock Option Plan.

On May 22, 2015, a motion to dismiss the Complaint with prejudice was served on the plaintiff and subsequently filed with the Court. On July 21, 2015, the Court endorsed an Order of Stipulation the parties entered into. The Stipulation provides, among other things, that the Complaint is dismissed with prejudice and the Motion to Dismiss is moot. On December 17, 2015, the Court ruled that the Plaintiff’s counsel was entitled to a fee of $70,000 together with costs of approximately $6,000. During the fiscal year ended June 30, 2016, we recorded a charge of $76,000 in our condensed consolidated statement of operations and comprehensive loss.

On October 10, 2016, in connection with entering into the Asset Purchase Agreement with L-3, the Company and its subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court.

On November 21, 2016, the LOI with Zapata was terminated and Zapata filed a claim  seeking a breakup fee related to the cancellation of the acquisition.  The Company disputes any payment obligations it may have to Zapata in connection with the LOI or the termination thereof.

We are not currently a party to any other legal proceedings, other than routine litigation incidental to our business that which we believe will not have a material effect on our business, assets or results of operations.  From time to time, we are subject to various claims, legal proceedings and investigations covering a wide range of matters that arise in the ordinary course of our business activities and in connection with the Chapter 11 cases.  Each of these matters may be subject to various uncertainties.

20.

Subsequent Events

Sale of Explosives Detector Assets, Bankruptcy Filing and Court Order Authorizing Sale

On October 10, 2016, we and our subsidiaries entered into an asset purchase agreement (as amended, the “Asset Purchase Agreement”) with L-3 Communications Corporation (“L-3”) to sell our explosives trace detection assets, constituting our entire business, to L-3 for $117.5 million in cash, plus the assumption of specified liabilities, subject to adjustment (the “Transaction”).  The Asset Purchase Agreement constituted a “stalking horse bid” in a sale process that was conducted under Section 363 of the U.S. Bankruptcy Code (the “Bankruptcy Code”).    In connection with the Asset Purchase Agreement, on October 10, 2016, the Company and its subsidiaries IMX Acquisition Corp., C Acquisition Corp. and Accurel Systems International Corp. (together with the Company, the “Debtors”) filed voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”).  After the filings, we continued to operate our businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code.  On the petition date, we filed several motions with the Bankruptcy Court, including a motion to have the Chapter 11 cases jointly administered.

On December 16, 2016, after the completion of the auction process in accordance with the requirements of the Bankruptcy Code, the Bankruptcy Court issued an order authorizing the Transaction with L-3 under Section 363 of the Bankruptcy Code.

On January 5, 2017, the closing of the Transaction occurred and L-3 acquired substantially all the assets of the Debtors.  In connection with the closing of the Transaction, on January 5, 2017, each of Drs. William J. McGann and Darryl Jones, Messrs. Roger Deschenes and Todd Silvestri and Ms. Brenda L. Baron resigned from their positions as executive officers and employees of the Company, and Dr. William J. McGann resigned from his position as a member of the Company’s board of directors.  Also in connection with the closing of the Transaction, on January 5, 2017, the Company filed Articles of Amendment to the Company’s Articles of Organization in the State of Massachusetts to change the Company’s name to Secure Point Technologies, Inc.

On the closing date of the Transaction, Robert Liscouski took over as President and the senior executive of the company and remains serving as a Director of the Company along with the other two remaining board members, Michael Turmelle (Chairman) and James Simon.  Effective January 9, 2017, the Company entered into a service agreement with Christopher Roberts, pursuant to which Mr. Roberts agreed to assist in the preparation of the Company’s financial statements and provide related services. In connection therewith, on January 9, 2017, the board of directors of the Company appointed Mr. Roberts as the chief financial officer of the Company.

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SECURE POINT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Debtor-in-Possession Financing

In connection with the Chapter 11 filings, we filed a motion seeking the approval of the Bankruptcy Court for a super-priority senior secured loan of $5.7 million (the “Original DIP Loan”) between the Debtors and DIP SPV I, L.P., as the debtor-in–possession lender ( the “Original DIP Lender”) pursuant to a Senior Secured Super-Priority Debtor-in-Possession Loan and Security Agreement entered into by the Debtors and the Original DIP Lender on October 10, 2016 (as amended on November 3, 2016, the “Original DIP Agreement”).  The Original DIP Loan would bear interest at 12% and included a one-time closing fee of $199,500 on the closing date of the Original DIP Loan and an exit fee equal to $427,500, less any interest, other that default interest (which is at a rate of 24%), paid to the Original DIP Lender as of the termination date of the Original DIP Loan. The Original DIP Loan was payable in full upon the consummation of the sale under the Asset Purchase Agreement with L-3 or a sale to any other winning bidder in the Bankruptcy Court auction.  On October 13, 2016, we borrowed $1,500,000 under the Original DIP Loan.

The use of proceeds from the Original DIP Loan were limited to working capital and other general corporate purposes consistent with the budget that the Company presented to the Original DIP Lender, including payment of costs and expenses related to the administration of the bankruptcy proceedings and payment of other expenses as approved by the Bankruptcy Court.  

On November 7, 2016, as a result of an auction process run in accordance with the requirements of the Bankruptcy Code, the Debtors terminated the Original DIP Agreement and entered into a replacement Senior Secured, Super-Priority Debtor-in-Possession Loan and Security Agreement (the “New DIP Agreement”) with Tannor Partners Credit Fund, LP (the “New DIP Lender”), which New DIP Agreement was approved by the Bankruptcy Court on an interim basis pursuant to an order dated as of November 7, 2016 for the initial loan amount of $5,700,000.  Under the New DIP Agreement, subject to the terms and conditions thereof, the New DIP Lender lent up to a total of $8.0 million to the Borrowers, with the initial installment of $5,700,000 paid upon the Bankruptcy Court entering the interim order for the New DIP Agreement and the remaining $2.3 million paid upon the Bankruptcy Court entering the final order for the New DIP Agreement.  The New DIP Agreement was substantially identical to the Original DIP Agreement, except for the amounts of the closing fee and the exit fee, which was $35,000 and $425,000 (minus any interest other than default interest), respectively.  On November 8, 2016, we borrowed $5,700,000 under the New DIP Agreement and borrowed an additional $2,300,000 on November 30, 2016.  In connection with the termination of the Original DIP Agreement, the Company paid $1,610,769 to the Original DIP Lender and its advisors to satisfy outstanding obligations under the Original DIP Agreement, including $74,354 for expense reimbursement for the Original DIP Lender’s advisors. 

On or about December 8, 2016, New DIP Lender asserted that we were not in compliance with Section 7.1(a) of the New DIP Agreement, wherein the net cash receipts for the cumulative period commencing on November 7, 2016 and ending on November 30, 2016 were required be equal to or exceed 85% of the budgeted cash receipts amount (the “DIP Budget”), which event constituted an event of default under the New DIP Agreement.  Effective as of December 1, 2016 the interest rate under the New DIP Agreement increased 12.0% to 24.0%. Subject to the terms of a Stipulation and Order entered in the Bankruptcy Case, we agreed with the New DIP Lender to waive such asserted default in exchange for an agreement by us to pay an additional $96,000 of interest, which interest was not credited against the exit fee.

The total amounts borrowed under the New DIP Agreement together with accrued interest were paid in full effective January 5, 2017 upon the closing of the Transaction with L-3.  

Christopher Roberts Service Agreement and Appointment as Chief Financial Officer

Effective January 9, 2017, the Company entered into a service agreement with Christopher Roberts, pursuant to which Mr. Roberts agreed to assist in the preparation of the Company’s financial statements and provide related services. In connection therewith, on January 9, 2017, the board of directors of the Company appointed Mr. Roberts as the chief financial officer of the Company.

Change of Address

Effective February 1, 2017, the Company changed its address to 215 Depot Ct. SE, Leesburg, VA 20175.

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is a supplement to the accompanying condensed consolidated financial statements and provides additional information on Secure Point Technologies, Inc.’s (“Secure Point” or the “Company’) business, current developments, financial condition, cash flows and results of operations.

When we say “we,” “us,” “our,” “Company,” or “Secure Point,” we mean Secure Point Technologies, Inc. and its subsidiaries.

Please see our Annual Report on Form 10-K for the fiscal year ended June 30, 2016 for a complete description of our business.

Overview

Secure Point Technologies, Inc. (formerly known as Implant Sciences Corporation), up until the time of the sale of its business to L-3 pursuant to the Transaction in January 2017, provided systems and sensors for the homeland security market and related industries. A variety of technologies are currently used worldwide in security and inspection applications. In broad terms, the technologies focus on detection in two major categories: (i) the detection of “bulk” contraband, which includes materials that would be visible to the eye, such as weapons, explosives, narcotics and chemical agents; and (ii) the detection of “trace” amounts of contraband, which includes trace particles or vapors of explosives, narcotics and chemical agents. Technologies used in the detection of “bulk” materials include computed tomography, transmission and backscatter x-ray, metal detection, trace detection and x-ray, gamma-ray, passive millimeter wave, and neutron analysis. Trace detection techniques used include mass spectrometry, gas chromatography, chemical luminescence, and ion mobility spectrometry.

Prior to the closing of the Transaction, we developed proprietary technologies used in explosives and narcotics trace detection (“ETD” and “NTD”, respectively) applications and market and sold handheld ETD and desktop ETD and NTD systems that used our proprietary technologies. Our products were marketed and sold to a growing number of locations domestically and internationally. These systems are used by private companies and government agencies to screen baggage, cargo, other objects and people for the detection of trace amounts of explosives and narcotics.

A significant component of our ability to compete in the markets that we served was the attainment of regulatory approvals.  We have undertaken considerable efforts in the past twelve to eighteen months in this regard and achieved the following regulatory approvals and customer orders:

·

Our QS-B220 desktop ETD system successfully completed and passed testing requirements for the TSA’s qualification test for aviation checkpoint and checked baggage and has been placed on the TSA’s Qualified Product List (“QPL”) on August 28, 2014. The QS-B220 is the first ETD with a non-radioactive source to be approved by the TSA for use in U.S. airports for passenger and baggage screening. We are now able to participate in TSA tenders for ETD procurements for aviation checkpoint and checked baggage screening.

·

On October 6, 2014, the QS-B220 successfully passed the European Civil Aviation Conference's (“ECAC”) Common Evaluation Process of Security Equipment (“CEP”) for airport checkpoint screening of passengers and baggage. The CEP was established to provide standards for security equipment performance across ECAC's 44 member nations.

·

On November 10, 2014, we entered into an Indefinite Delivery / Indefinite Quantity (“IDIQ”) contract with the United States Transportation Security Administration (“TSA”) for our QS-B220 desktop explosives trace detectors. The IDIQ, a necessary prerequisite for competing for TSA’s annual trace detection procurements and establishes contract terms under which the TSA could purchase up to $162 million of equipment and services.   This contract  was transferred to L-3 as part of the Transaction.

·

On November 10, 2014, we received an initial delivery order from the TSA for 1,170 QS-B220 desktop explosives trace detectors.

We have taken significant strategic actions in the past eighteen months as well:

·

On December 3, 2015, we announced that our Board of Directors authorized management to retain financial advisors to explore strategic alternatives to maximize shareholder value.

·

On April 6, 2016, we amended our credit agreements with DMRJ and Montsant, effective as of March 31, 2016, pursuant to which, amongst other matters, we extended the maturity date of our indebtedness

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to June 30, 2016 and December 30, 2016, respectively. Further on that date, we amended our credit agreements with BAM, effective as of March 31, 2016, pursuant to which, amongst other matters, we extended the maturity date of all of our indebtedness from March 31, 2016 to June 29, 2016.

·

On July 20, 2016 we amended our credit agreements with DMRJ and Montsant, effective as of June 30, 2016, pursuant to which, amongst other matters, we extended the maturity date of our indebtedness to October 31, 2016.  Further, on that date, our credit agreements with BAM were automatically extended to October 30, 2016 as a result of the extension of the maturity date of our credit agreements with DMRJ and Montsant.

·

On July 18, 2016, we entered into a non-binding Letter of Intent (the “LOI”) with Zapata Industries SAS (“Zapata”), pursuant to which the we intended to acquire all the issued and outstanding shares of Zapata, or all of Zapata’s business, excluding inventory (with the our having the right to purchase all or a portion of the inventory of Zapata at cost), in exchange for (i) a number of shares of our common stock, par value $0.001 per share, (the “Common Stock”) equal to 60% of the total issued and outstanding shares of Common Stock on a fully-diluted basis (treating any preferred stock on an as converted basis and any warrants on an as exercised basis), (ii) $15,000,000 in cash and (iii) warrants to purchase 50,657,984 shares of Common Stock at an exercise price of $1.50 per share with a four-year term. We terminated the Zapata LOI on November 21, 2016.   On November 21, 2016, after performing due diligence on Zapata Industries, the Board of Directors voted against pursuing the acquisition due to Zapata Industries inability to comply with the elements of the LOI. .  Zapata has filed a claim in the Chapter 11 Bankruptcy for a breakup fee related to the cancelation of the acquisition.  The Company disputes any payment obligations it may have to Zapata in connection with the LOI or the termination thereof.

·

On September 13, 2016, we received a delivery order from the TSA for 1,353 QS-B220 desktop explosives trace detectors, with options to increase the delivery order quantity to 3,426 QS-B220 systems. The contract value, including options, aggregates to $71.3 million.

·

On October 10, 2016, we and our subsidiaries entered into an asset purchase agreement to sell our explosives trace detection assets to L-3 Communications Corporation for $117.5 million in cash, plus the assumption of specified liabilities, subject to adjustment. In connection with the Transaction, on October 10, 2016, Secure Point Technologies, Inc. and its subsidiaries IMX Acquisition Corp., C Acquisition Corp. and Accurel Systems International Corp. (together with the Company, the “Debtors”) filed voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware.

·

·

On January 5, 2017, the closing of the Transaction occurred and L-3 acquired substantially all the assets of the Debtors.  In connection with the closing of the Transaction, on January 5, 2017, each of Dr. William J. McGann, Darryl Jones, Roger Deschenes, Todd Silvestri and Brenda L. Baron resigned from their positions as executive officers and employees of the Company, and Dr. William J. McGann resigned from his position as a member of the Company’s board of directors.  Also in connection with the closing of the Transaction, on January 5, 2017, the Company filed Articles of Amendment to the Company’s Articles of Organization in the State of Massachusetts to change the Company’s name to Secure Point Technologies, Inc.

·

Effective January 5, 2017, Robert Liscouski, assumed the position of President of Secure Point Technologies and remains serving as a Director of the Company along with the other two remaining board members, Michael Turmelle (Chairman) and James Simon.  Effective January 9, 2017, the Company entered into a service agreement with Christopher Roberts, pursuant to which Mr. Roberts agreed to assist in the preparation of the Company’s financial statements and provide related services. In connection therewith, on January 9, 2017, the board of directors of the Company appointed Mr. Roberts as the chief financial officer of the Company.

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·

Effective as of February 1, 2017, the Company changed its address to 215 Depot Ct. SE, Leesburg, VA 20175.

At the present time, we are a shell company with no operations.  The Board of Directors is committed to satisfying all legitimate claims in accordance with the bankruptcy process and are committed to providing optionality to the shareholders to maximize shareholder value.  We are actively considering various acquisition targets and other business opportunities that will be presented to the shareholders for a vote in accordance with the legal procedures provided by the bankruptcy court.  Optionality includes the potential acquisition one or more operating businesses or consummate a business opportunity within the next twelve months. However, we cannot guarantee that we will successfully consummate an acquisition or other business opportunity within such timeframe, or at all.

Critical Accounting Policies

Our significant accounting policies are summarized in Note 2 to our consolidated financial statements included in Item 7 of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2016. However, certain of our accounting policies require the application of significant judgment by our management, and such judgments are reflected in the amounts reported in our condensed consolidated financial statements. In applying these policies, our management uses judgment to determine the appropriate assumptions to be used in the determination of estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of market trends, information provided by our strategic partners and information available from other outside sources, as appropriate. Actual results may differ significantly from the estimates contained in our condensed consolidated financial statements.

Results of Operations

Three Months Ended December 31, 2016 vs. December 31, 2015

Revenues

Revenues for the three months ended December 31, 2016 were $8,625,000 as compared with $10,292,000 for the comparable prior year period, a decrease of $1,667,000, or 16.2%. The decrease in revenue is due primarily to a 7.5% decrease in the number of QS-B220 desktop units sold and a 59.1% decrease in the number of QS-H150 handheld units sold in the three months ended December 31, 2016, due to decreased shipments to European airports, decreased shipments to Asia and lower non-US government shipments in the current three month period. The decrease in sales of our QS-B220 desktop systems were further impacted by a 10.2% decrease in the average unit sales prices, which resulted in a 17.0% decrease in QS-B220 revenues. Sales of our QS-B220 were favorably impacted in the comparable prior period due the European Civil Aviation Conference (“ECAC”) Common Evaluation Process of Security Equipment for airport checkpoint screening of passengers and baggage, which mandated the installation of ETD equipment in larger international airports by no later than September 1, 2015. Factors impacting our average unit sales prices are mainly due to the competitive market conditions in Europe and Asia, increased sales to agencies of the U.S. Government and foreign government agencies, offset partially by a decrease in early payment discounts to certain distributors to hasten collection of our accounts receivable, which discounts amounted to $97,000 in the three months ended December 31, 2015.

Sales of our QS-H150 handheld systems decreased 59.6% in the three months ended December 31, 2016, due to a 59.1% decrease in the number of QS-H150 handheld units sold in the three months ended December 31, 2016, compared to the prior period, due to increased shipments to Asia and Africa, and to a lesser extent by a 1.1% decrease in the average unit sales prices.  

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Sales of parts and supplies increased 59.2% in the three months ended December 31, 2016, due primarily to increased sales of consumables and other supplies due to the increased QS-B220 install base, in the current three month period.

Service revenues increased 96.2% in the three months ended December 31, 2016, due to commencement of service revenues under our initial delivery order with the TSA. Included in the prior comparable period were service revenues related to system improvements and training related documentation required under the TSA delivery order. During the three months ended December 31, 2016, we commenced activities under a cost-plus fixed-fee contract with the U.S. Department of Homeland Security (“DHS”), effective on August 24, 2016, to develop next generation explosives trace detection screening systems.

Competitive market conditions are expected to continue to have a negative impact on our average unit sales prices for the foreseeable future.

Cost of Revenues

Cost of revenues for the three months ended December 31, 2016 was $5,720,000 as compared with $6,439,000 for the comparable prior year period, a decrease of $719,000 or 11.2%. The decrease in cost of revenues recorded in the three months ended December 31, 2016 is primarily due to decreased unit sales of our QS-B220 desktop units, and our QS-H150 handheld units.

Gross Margin

Gross margin for the three months ended December 31, 2016 was $2,905,000 or 33.7% of revenues as compared with $3,853,000 or 37.4% of revenues for the comparable prior year period. The decrease in gross margin as a percent of revenues is primarily due to a 10.2% decrease in the average unit sales price on sales of our QS-B220 in the current three month period, due to competitive market conditions in Europe and Asia, increased sales to agencies of the U.S. Government and foreign government agencies at lower average unit sales prices, a 1.1% decrease in the average unit sales price on sales of our QS-H150 units, decreased manufacturing overhead absorption due to decreased QS-B220 unit volume and QS-H150 unit volume,  and lower margins under a cost-plus fixed-fee contract with the U.S. Department of Homeland Security.

Research and Development Expense

Research and development expense for the three months ended December 31, 2016 was $876,000 as compared with $901,000 for the comparable prior year period, a decrease of $25,000 or 2.8%. The decrease in research and development expense is primarily due to the reclassification of $139,000 of research and development expense incurred under a cost-plus fixed-fee contract with the DHS to cost of revenues, a $62,000 decrease in stock-based compensation and a $35,000 decrease in travel costs, partially offset by a $107,000 increase in payroll and related fringe benefits expenses and a $26,000 increase in the cost of regulatory filing expenses.  

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended December 31, 2016 were $7,510,000 as compared with $3,718,000 for the comparable prior year period, an increase of $3,792,000, or 102.0%. The increase in selling, general and administrative expenses is due primarily to a $4,401,000 increase in legal fees and expenses attributable to the negotiation and execution of the asset purchase agreement with L-3, and legal fees incurred with respect to the voluntary relief petitions filed under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware, a $73,000 increase in travel expenses incurred to support QS-B220 system installations with the TSA, a $59,000 increase in bank fees due to increased credit card processing fees on increased consumable product revenues, offset partially by a $178,000 decreased in variable selling expenses, due to decreased revenues, a $106,000 decrease in stock-based compensation on employee stock options, and a $337,000 decrease in payroll and benefit costs, due to the provision of $485,000 for incentive compensation recorded in the comparable prior period.

Other Expense and Other  Income

For the three months ended December 31, 2016, other income was $7,071,000 as compared with other expense of $2,547,000 for the comparable prior year period, an increase of $9,618,000.  For the three months ended December 31, 2016 interest expense increased $879,000 to $3,426,000.  For the three months ended December 31, 2016, we recorded a non-cash benefit of $10,497,000 to adjust the fair value of the warrant derivative liability as of that date.

Interest expense on our debt obligations increased $879,000 to $3,426,000 in the three months ended December 31, 2016 from $2,547,000 in the prior year, due to higher borrowings under our credit facility with DMRJ, due to the

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March 31, 2016, amendment to our credit facility with DMRJ and Montsant whereby we further amended each of our credit instruments with DMRJ and Montsant, which were entered into on April 6, 2016 and effective March 31, 2016, pursuant to which we agreed to prepay the interest due on each of the March 2009 Note, the September 2012 Note and the February 2013 Notes from the date of the amendment through June 30, 2016 by increasing the outstanding aggregate principal amount under each such Note, which increased the aggregate principal balance owed to DMRJ by $14,593,000 and, borrowings under the debtor-in-possession financing, which was inclusive of $83,000 of default interest.

Net Income (Loss)

Our net income for the three months ended December 31, 2016 was $1,590,000 as compared with a net loss of $3,313,000 for the comparable prior year period, an increase of $4,903,000. The increase in net income is primarily due to the non-cash benefit of $10,497,000 recorded to adjust the fair value of the warrant derivative liability, offset partially by decreased revenues and gross margin, increase in SG&A expense recorded in the current period, and an increase in interest expense.

Six Months Ended December 31, 2016 vs. December 31, 2015

Revenues

Revenues for the six months ended December 31, 2016 were $16,687,000 as compared with $24,685,000 for the comparable prior year period, a decrease of $7,998,000 or 32.4%. The decrease in revenue is due primarily to a 31.2% decrease in the number of QS-B220 desktop units sold during the six months ended December 31, 2016, due primarily to decreased shipments to Europe due the fulfillment of customer delivery requirements in the comparable prior period to comply with the European Civil Aviation Conference (“ECAC”) Common Evaluation Process of Security Equipment mandate for airport checkpoint screening of passengers and baggage, and to a lesser extent, decreased shipment to Asia, Africa, South America and non-US government domestic shipments in the current six month period.  The average unit sales prices for the QS-B220 decreased 12.6% in the six months ended December 31, 2016, which when combined with the unit volume decrease, resulted in a 39.9% decrease in QS-B220 revenues. Factors impacting our average unit sales prices are mainly due to the competitive market conditions in Europe and Asia, offset partially by a decrease in early payment discounts to certain distributors to hasten collection of our accounts receivable, which discounts amounted to $307,000 in the six months ended December 31, 2015.

Sales of our QS-H150 handheld systems decreased 30.0% in the six months ended December 31, 2016, due to a 29.4% decrease in the number of QS-H150 handheld units sold in the six months ended December 31, 2016, compared to the prior period, due to decreased shipments to Asia and Africa and, to a lesser extent, by a 0.9% decrease in the average unit sales prices.  

Sales of parts and supplies increased by $999,000 to $2,523,000 from $1,525,000, or 65.4%, in the six months ended December 31, 2016, due primarily to increased sales of consumables and other supplies that shipped due to the increased installed base of QS-B220 desktop units.

Service revenues decreased 38.9% in the six months ended December 31, 2016, due to commencement of service revenues under our initial delivery order with the TSA. Included in the prior comparable period were service revenues related to system improvements and training related documentation required under the TSA delivery order. The decrease in service revenues was partially offset, during the three months ended December 31, 2016, by revenues recognized due to the commencement of activities under a cost-plus fixed-fee contract with the U.S. Department of Homeland Security (“DHS”), effective on August 24, 2016, to develop next generation explosives trace detection screening systems.

Sales of QS-B220 were favorably impacted in the comparable prior period due to the acceptance of the QS-B220 into the “Qualified” section of the TSA’s Air Cargo Screening Technology List and achieving European Civil Aviation Conference (“ECAC”) Common Evaluation Process of Security Equipment for airport checkpoint

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screening of passengers and baggage. Competitive market conditions are expected to continue to have a negative impact on our average unit sales prices for the foreseeable future.

Cost of Revenues

Cost of revenues for the six months ended December 31, 2016 were $11,310,000 as compared with $14,575,000 for the comparable prior year period, a decrease of $3,265,000 or  22.4 %. The decrease in cost of revenues recorded in the six months ended December 31, 2016 is primarily due to decreased unit sales of our QS-B220 desktop units and, to a lesser extent, decreased unit sales of our QS-H150 handheld units.

Gross Margin

Gross margin for the six months ended December 31, 2016 was $5,377,000 or 32.2 % of revenues as compared with $10,110,000 or 41.0% of revenues for the comparable prior year period. The decrease in gross margin as a percent of revenues is primarily due to a 12.6% decrease in the average unit sales price on sales of our QS-B220 in the current six month period, due to competitive market conditions in Europe and Asia, increased sales to agencies of the U.S. Government and foreign government agencies at lower average unit sales prices, decreased manufacturing overhead absorption, due to decreased QS-B220 unit volume, by a 0.9% decrease in the average unit sales price on sales of our QS-H150 units and lower margins under a cost-plus fixed-fee contract with the U.S. Department of Homeland Security.

Research and Development Expense

Research and development expense for the six months ended December 31, 2016 was $1,857,000 as compared with $1,984,000 for the comparable prior year period, a decrease of $127,000 or 6.4 %. The decrease in research and development expense is primarily due to a the reclassification of $139,000 of research and development expense incurred under a cost-plus fixed-fee contract with the DHS to cost of revenue, an $86,000 decrease in stock-based compensation and a $61,000 decrease in travel expenses. These decreases are partially offset by an $186,000 increase in payroll and related fringe benefit expense.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the six months ended December 31, 2016 were $11,275,000 as compared with $7,256,000 for the comparable prior year period, an increase of $4,019,000 or 55.4%. The increase in selling, general and administrative expenses is due primarily to a $4,841,000 increase in legal fees and expenses attributable to the negotiation and execution of the asset purchase agreement with L-3, and legal fees incurred with respect to the voluntary relief petitions filed under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware and plaintiff’s counsel fee and expenses, resulting from the Miller litigation, a $525,000 increase in consulting expenses due to the issuance of shares of our common stock to two advisors for services rendered under the advisory and consulting services agreements, a $109,000 increase in bank fees associated with increased credit card processing fees due to increased consumable revenues, a $151,000 increase in travel expense incurred to support domestic QS-B220 system installations, a $41,000 increase in bad debt expense, and a $52,000 increase in rent expense, offset in part by a $930,000 decrease in payroll and benefit costs due to the provision of $960,000 for  incentive compensation and a $200,000 sign on bonus for Mr. Liscouski, our President, in the comparable prior year period a $91,000 decrease in stock-based compensation on employee stock options, and a $503,000 decrease in sales commissions due to decreased revenues.

Other Expense

For the six months ended December 31, 2016, other expense was $17,839,000 as compared with other expense of $5,094,000 for the comparable prior year period, an increase of $12,745,000. The increase is due to increased interest expense on higher borrowings under our credit facilities with DMRJ and the debtor-in-possession credit facility, and, to a lesser extent, the 1% increase in the BAM interest rate which took effect on April 1, 2016.    For the six months ended December 31, 2016 interest expense increased $26,281,000 to $31,375,000  from $5,094,000 in the prior year, due to higher borrowings under our credit facility with DMRJ, due to the March 31, 2016, amendment to our credit facility with DMRJ and Montsant whereby we further amended each of our credit instruments with DMRJ and Montsant, which were entered into on April 6, 2016 and effective March 31, 2016, pursuant to which we agreed to prepay the interest due on each of the March 2009 Note, the September 2012 Note and the February 2013 Notes from the date of the amendment through June 30, 2016 by increasing the outstanding aggregate principal amount under each such Note which increased the aggregate principal balance owed to DMRJ by $14,593,000 and, borrowings under the debtor-in-possession financing, which was inclusive of $83,000 of default interest, interest incurred under our borrowings with the debtor-in-possession credit facility and, to a lesser extent, interest incurred under our Purchase Agreement with RCA.

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We recorded non-cash interest charges of $9,217,000 and $15,703,000 in our condensed consolidated statements of operations for the six months ended December 31, 2016 on the note conversion beneficial conversion feature and warrant derivative liability, respectively, both of which are related to our July 20, 2016 amendment to our credit facility with DMRJ and Montsant. For the six months ended December 31, 2016, we recorded a non-cash benefit of $13,536,000 to adjust the fair value of the warrant derivative liability as of that date.

Net Loss

Our net loss for the six months ended December 31, 2016 was $25,594,000 as compared with a net loss of $4,224,000 for the comparable prior year period, an increase of $21,370,000 or 505.9%. The increase in the net loss is primarily due to the non-cash interest charges recorded on the note conversion beneficial conversion feature and warrant derivative liability, decreased revenues and gross margin, an increase in legal expense recorded in the current period associated with the sale of our assets and the voluntary relief petitions filed under Chapter 11, and an increase in interest expense, offset partially the non-cash benefit of $13,536,000 recorded to adjust the fair value of the warrant derivative liability.

Liquidity and Capital Resources

As of December 31, 2016 and June 30, 2016, we had cash and cash equivalents of $3,354,000 and $1,338,000, respectively.

In connection with the Chapter 11 filings, we filed a motion seeking the approval of the Bankruptcy Court for a super-priority senior secured loan of $5.7 million (the “Original DIP Loan”) between the Debtors and DIP SPV I, L.P., as the debtor-in-possession lender (the “Original DIP Lender”) pursuant to a Senior Secured Super-Priority Debtor-in-Possession Loan and Security Agreement entered into by the Debtors and the Original DIP Lender on October 10, 2016 (as amended on November, 3, 2016, the “Original DIP Agreement”).  The Original DIP Loan would bear interest at 12% and included a one-time closing fee of $199,500 on the closing date of the Original DIP Loan and an exit fee equal to $427,500, less any interest, other that default interest (which was at a rate of 24%), paid to the Original DIP Lender as of the termination date of the Original DIP Loan. The Original DIP Loan was payable in full upon the consummation of the sale under the Purchase Agreement with L-3 or a sale to any other winning bidder in the Bankruptcy Court auction.  On October 13, 2016, we borrowed $1,500,000 under the Original DIP Loan.

On November 7, 2016, as a result of an auction process run in accordance with the requirements of the Bankruptcy Code, the Debtors terminated the Original DIP Agreement and entered into a replacement Senior Secured, Super-Priority Debtor-in-Possession Loan and Security Agreement (the “New DIP Agreement”) with Tannor Partners Credit Fund, LP (the “New DIP Lender”), which New DIP Agreement was approved by the Bankruptcy Court on an interim basis pursuant to an order dated as of November 7, 2016 for the initial loan amount of $5,700,000.  Under the New DIP Agreement, subject to the terms and conditions thereof, the New DIP Lender lent up to a total of $8.0 million to the Borrowers, with the initial installment of $5,700,000 paid upon the Bankruptcy Court entering the interim order for the New DIP Agreement and the remaining $2,300,000 paid upon the Bankruptcy Court entering the final order for the New DIP Agreement.  The New DIP Agreement was substantially identical to the Original DIP Agreement, except for the amounts of the closing fee and the exit fee, which was $35,000 and $425,000 (minus any interest other than default interest), respectively.  On November 8, 2016, we borrowed $5,700,000 under the New DIP Agreement and borrowed an additional $2,300,000 on November 30, 2016.  In connection with the termination of the Original DIP Agreement, the Company paid $1,610,769 to the Original DIP Lender and its advisors to satisfy outstanding obligations under the Original DIP Agreement, including $74,354 for expense reimbursement for the Original DIP Lender’s advisors.

On or about December 8, 2016, New DIP Lender asserted that we were not in compliance with Section 7.1(a) of the New DIP Agreement, wherein the net cash receipts for the cumulative period commencing on November 7, 2016 and ending on November 30, 2016 were required be equal to or exceed 85% of the budgeted cash receipts amount (the “DIP Budget”), which event constituted an event of default under the New DIP Agreement.  Effective as of December 1, 2016 the interest rate under the New DIP Agreement increased 12.0% to 24.0%. Subject to the terms of a Stipulation and Order entered in the Bankruptcy Case, we agreed with the New DIP Lender to waive such asserted default in exchange for an agreement by us to pay an additional $96,000 of interest, which interest was not credited against the exit fee.

The total amount borrowed under the New DIP Agreement together with accrued interest were paid in full effective January 5, 2017, upon the closing of the Transaction with L-3.  

We were required to repay all of our borrowings from DMRJ and Montsant on October 31, 2016 and from a group of institutional investors for which BAM Administrative Services LLC (“BAM”) acts as administrative agent,

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on October 30, 2016. Our obligations to BAM are secured by a security interest in substantially all of our assets. DMRJ and Montsant agreed to subordinate their security interest in all of our assets to the security interest held by BAM (See Note 12 to the condensed consolidated financial statement).

The payment of our indebtedness to DMRJ and Montsant are stayed pending the conclusion of the bankruptcy proceedings.

Our obligations to DMRJ are secured by security interests in substantially all of our assets. As of December 31, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of December 31, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $9,129,000 and is included in current liabilities in the consolidated financial statements.

As of December 31, 2016, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of December 31, 2016, our obligation to Montsant for accrued interest under this instrument was approximately $405,000.

As of February 13, 2017, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of February 13, 2017, our obligation to DMRJ for accrued interest under these instruments approximated $10,012,000. Please refer to Note 14 to the condensed consolidated financial statements for a discussion of the August 2016 conversions of principal indebtedness by DMRJ.

As of February 13, 2017, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of February 13, 2017, our obligation to Montsant for accrued interest under this instrument approximated $502,000.

Our obligations to a group of institutional investors for which BAM acts as administrative agent are secured by security interests in substantially all of our assets. As of December 31, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2016, our obligation under such notes for accrued interest amounted to approximately $4,113,000 and is included in current liabilities in the consolidated financial statements.

As of December 31, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2016, our obligation under such notes for accrued interest amounted to approximately $4,113,000.

The total amount borrowed under the BAM senior secured promissory notes together with accrued interest were paid in full effective January 5, 2017 upon the closing of the Transaction with L-3.

Each of these notes and the credit facility are described in Note 12 to the condensed consolidated financial statements, accompanying this Quarterly Report.

During the six months ended December 31, 2016, we had net cash outflows of $5,916,000 from operating activities as compared to net cash outflows from operating activities of $1,373,000 for the comparable prior year period. The $4,543,000 increase in net cash outflows used in operating activities during the six months ended December 31, 2016, as compared to the prior year period, was due to the following changes in working capital: (i) a $3,283,000 decrease in accounts receivable, compared to a $5,237,000 increase in the prior period, due to decreased product shipments during the latter part of the quarter ended December 31, 2016; (ii) a $5,952,000 increase in inventories compared to a $1,479,000 increase in the prior period, due primarily to increased inventory procured during the three months ended December 31, 2016 to comply with the terms of the Asset Purchase Agreement with L-3; (iii) an increase in accrued expenses of $8,249,000, compared to a $7,885,000 increase in the prior period, by an increase in accrued expenses in the prior period, an increase in our accrued interest due to higher borrowings under our credit facilities with DMRJ and the increase in the BAM interest rate and increased legal fees, offset partially by decreased provisions for incentive compensation recorded in the six months ended December 31, 2016;  (iv) a $345,000 increase in deferred revenue, compared to a $1,854,000 decrease in deferred revenue in the prior year period, due primarily to the application of ECAC customer advance deposits received in the quarter ended June 30, 2015, against accounts receivables resulting from shipments in the six months ended December 31, 2015; and, (v) a $1,704,000 increase in accounts payable, compared to a $1,942,000 increase in the prior period, due to increased inventory related payables and increased legal fees.

During the six  months ended December 31, 2016, we had net cash outflows of $37,000 from investing activities as compared to net cash outflows of $65,000 from investing activities for the prior year period. The $28,000 decrease in net cash used in investing activities during the six months ended December 31, 2016, as

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compared to the prior year period, was primarily due to decreased purchases of equipment in the six months ended December 31, 2016.

Credit Facilities with DMRJ Group LLC, Montsant Partners LLC and BAM Administrative Services LLC

In December 2008, we entered into a note and warrant purchase agreement with DMRJ, pursuant to which we issued a senior secured convertible promissory note in the principal amount of $5,600,000 and a warrant to purchase 1,000,000 shares of our common stock.  Thereafter, we entered into a series of amendments, waivers and modifications of this facility. The notes matured on October 31, 2016, but payment has been stayed pending conclusion of bankruptcy.  

On May 4, 2015, we entered into an assignment agreement with DMRJ and Montsant, wherein DMRJ assigned its rights, title and interest in the senior secured promissory note dated December 10, 2008 and appointed DMRJ as its collateral agent under the promissory note agreement. The note matured on October 31, 2016, but payment has been stayed pending conclusion of bankruptcy.

DMRJ and Montsant are funds managed by Platinum Partners Value Arbitrage Fund LP.

In March, 2014, we entered into a note purchase agreement with a group of institutional investors and BAM, an administrative agent for the investors, pursuant to which we issued senior secured promissory notes in the aggregate principal amount of $20,000,000. The notes bear interest at 16% per annum and mature on October 30, 2016.  We used all of the proceeds from the sale of the notes to repay (i) $17,624,000 of our outstanding indebtedness to DMRJ under revolving promissory note (ii) $1,809,000 of interest outstanding under that facility and (iii) $567,000 of interest outstanding under our senior secured convertible promissory note. Due to the filing of the voluntary relief petitions under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”), we were deemed to be in default under our note purchase agreement with BAM and our interest rate was increased to 18.5% effective as of October 10, 2016.

The payment of our indebtedness to DMRJ and Montsant are stayed pending the conclusion of the bankruptcy proceedings.

See Note 12 to the condensed consolidated financial statements, accompanying this Quarterly Report. There can be no assurance that we will be successful in refinancing or extending our obligations to our secured lenders or reorganize the indebtedness under bankruptcy.  

$2.5 million of the cash proceeds from the Transaction with L-3 are being held in an escrow account to secure the Debtors’ obligations for the purchase price adjustments under the Asset Purchase Agreement for the Debtors’ net working capital, which adjustments are expected to be completed in the first half of calendar 2017.

The payment of our secured obligations with DMRJ and Montsant will be stayed until such time that the Official Committee of Equity Holders has concluded their activities to assert certain estate claims and causes of action and challenge the validity, enforceability, and perfection of certain prepetition secured claims, which challenge period was extended by the bankruptcy court up to and including January 23, 2017. Interest on our debt obligations with DMRJ and Montsant will continue to accrue until such time that the obligations are paid by us. There can be no assurances that we will achieve our forecasted financial results or that we will be able to raise additional capital to operate our business.  Any such failure would have a material adverse impact on our liquidity and financial condition and could force us to curtail or discontinue operations entirely.  Further, upon the occurrence of an event of default under certain provisions of our credit agreements with DMRJ, Montsant and BAM, we could be required to pay default rate interest equal to the lesser of 2.5% per month and the maximum applicable legal rate per annum on the outstanding principal balance. The failure to cure an event of default or negotiate further extensions of our obligations to our secured lenders would have a material adverse impact on our liquidity and financial condition and could force us to curtail or discontinue operations entirely and/or could require us to convert our voluntary filing under bankruptcy laws from Chapter 11 to Chapter 7. .

On August 24, 2016, a Cayman Islands court appointed an insolvency specialist, RHSW Caribbean, to liquidate the assets of Platinum Partners Value Arbitrage Fund LP (“Platinum”).  On October 18, 2016, RHSW Caribbean

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filed a Chapter 15 bankruptcy petition with the United States Bankruptcy Court for the District of Southern New York, which seeks to protect Platinum's U.S. assets from its creditors while an insolvency proceeding is underway in the Cayman Islands.

Various events could have an impact on the timing and structure of the company’s emergence from Chapter 11. We are incurring and expect to continue to incur increased legal and financial adviser costs associated with the bankruptcy proceedings following the closing of the Transaction with L-3. These ongoing costs raise doubt as to our ability to successfully emerge from Chapter 11 and provide a recovery to equity holders.

Off-Balance Sheet Arrangements

As of December 31, 2016, we had one irrevocable standby letter of credit outstanding in the approximate amount of $297,000. The letter of credit provides warranty performance security equal to 5% of the contract amount with the India Ministry of Defence. We have amended the letter of credit, extending the expiration date to April 15, 2017.

As of December 31, 2016, we did not have any other off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition”. The FASB issued ASU 2014-09 to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods therein, which is effective for our fiscal year beginning July 1, 2018, the first day of our 2019 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In June 2014, the FASB issued Accounting Standards Update 2014-12, Compensation-Stock Compensation (“ASU 2014-12”). The FASB issued ASU 2014-12 to provide specific guidance on share-based payment awards that provide for achievement of a specific performance target that could be achieved after the requisite service period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period should be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. Earlier adoption is permitted. ASU 2014-12 may be applied prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this guidance should be recognized in the financial statements as an adjustment to the opening retained earnings balance at that date. The adoption of ASU 2014-12 did not have a material impact on our consolidated financial statements.

In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40) (“ASU 2014-15”). ASU 2014-15 provides guidance to U.S. GAAP about management’s responsibility to evaluate whether there is a substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This new rule requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles currently in U.S. auditing standards. Specifically, ASU 2014-15 (1) defines the term substantial doubt, (2) requires an evaluation of every reporting period including interim periods, (3) provides principles for considering the mitigating effect of management’s plan, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) requires an express statement and other disclosures when substantial doubt is not

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alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued. This guidance is effective for annual periods ending after December 15, 2016, which is effective for our fiscal year beginning July 1, 2016, the first day of our 2017 fiscal year. The adoption of ASU 2014-15 did not have a material impact on our consolidated financial statements.

In July 2015, the FASB issued Accounting Standards Update 2015-11, Inventory (Topic 330) (“ASU 2015-11”). ASU 2015-11 was issued to more closely align the measurement of inventory in U.S. GAAP with the measurement of inventory in International Financial Reporting Standards. The core principle of this updated   guidance is that an entity should measure inventory at the lower of cost or net realizable value.  Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in ASU 2015-11 apply to inventory that is measured using the first-in, first-out or average cost methods. ASU 2015-11 amends some of the guidance in Topic 330 to more clearly articulate the requirements for the measurement and disclosure of inventory, but the clarifications are not intended to result in any changes in practice other than the change in the subsequent measurement guidance from the lower of cost or market to the lower of cost or net realizable value for inventory.  There are no other substantive changes to the guidance on the measurement of inventory. This guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, which is effective for our fiscal year beginning July 1, 2017, the first day of our 2018 fiscal year. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.

In August 2015, the FASB issued Accounting Standards Update 2015-15, Interest – Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (“ASU 2015-15”). ASU 2015-15 states that Staff at the Securities and Exchange Commission would not object to an entity deferring or presenting debt issuance costs as an asset and subsequently amortizing deferred debt issuance cost ratably over the term of the line-of-credit arrangement, regardless of whether there were outstanding borrowings under the arrangement.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain statements that are “forward-looking” within the meaning of the federal securities laws. These forward looking statements and other information are based on our beliefs as well as assumptions made by us using information currently available.

The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events, are subject to certain risks, uncertainties and assumptions, and are not guaranties of future performance. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, intended or using other similar expressions.

We are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Report on Form 10-Q.  Important factors that could cause actual results to differ from our predictions include those discussed under this “Management’s Discussion and Analysis” and under “Risk Factors,” as well as those discussed under “Risk Factors,” “Management’s Discussion and Analysis” and “Business” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016.  Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized, nor can there be any assurance that we have identified all possible issues which we might face.  In addition, assumptions relating to budgeting, marketing, product development and other management decisions are subjective in many respects and thus susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our marketing, capital expenditure or other budgets, which may in turn affect our financial position and results of operations.  Our expectations regarding the potential sale of the assets of the explosives detection business and our intent to acquire another business. For all of these reasons, the reader is cautioned not to place undue reliance on forward-looking statements contained herein, which speak only as of the date hereof.  We assume no responsibility to update any forward-looking statements as a result of new information, future events, or otherwise except as required by law.  

We urge readers to review carefully the risk factors described in this Quarterly Report, in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016 and in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov.

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Item 4.

Controls and Procedures

The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q include, in paragraph 4 of such certifications, information concerning our disclosure controls and procedures, and internal control over financial reporting. Such certifications should be read in conjunction with the information contained in this Item 4 for a more complete understanding of the matters covered by such certifications.

Disclosure Controls and Procedures.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2016.  The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions to be made regarding required disclosure.  It should be noted that any system of controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met and that management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As a result of material weaknesses described in our Annual Report on Form 10-K for the year ended June 30, 2016, our Chief Executive Officer and Chief Financial Officer concluded that, we did not maintain effective internal control over financial reporting as of December 31, 2016 and further concluded that, as of such date, our disclosure controls and procedures were not effective at the reasonable assurance level.

Furthermore, this Quarterly Report on Form 10-Q is being filed late due to the added responsibilities of our finance staff related to bankruptcy reporting obligations.

Remediation

We are committed to remediating the material weaknesses identified in internal controls over financial reporting and have begun the process to remediate these material weaknesses, however the timing of completing our remediation efforts is uncertain. Our efforts have focused on instituting mitigating controls to address segregation of duties and undertake a thorough review of the finance functions position responsibilities and the hiring of additional staff; implement additional controls to address system access deficiencies; establish independent review and verification procedures for our vendor and customer master files; enhance the documentation to support review occurrences and approval procedures; and, commence regular periodic reviews of our internal controls over financial reporting with our Board of Directors and Audit Committee to address the inadequate risk oversight function and institute procedures to evaluate and report on risks to financial reporting, including the documentation and completion of a comprehensive risk assessment to identify all potential risk areas and evaluate the adequacy of our controls to mitigate these risks.  

Changes in Internal Control Over Financial Reporting

During the three months ended December 31, 2016, we have implemented additional controls to address system access deficiencies, hired additional finance staff and have begun instituting mitigating controls to address segregation of duty issues. The additional staff will allow us to address the insufficient segregation of duties, oversight of work performed and allow us to continue to institute additional compensating or mitigating controls and will also allow us to document internal control support occurrences and approval procedures. We have instituted systems access controls and mitigating controls to system access. There are no other changes 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

On March 23, 2015, Bernard Miller (“Mr. Miller”), individually and on behalf of all others similarly situated shareholders of the company, filed a complaint against Dr. William J. McGann, Messrs. Glenn D. Bolduc, John H. Hassett, John A. Keating, Robert P. Liscouski, Howard Safir and Michael C. Turmelle and the Company in the Suffolk Superior Court of the Commonwealth of Massachusetts, seeking derivative action as a result of director breaches of fiduciary duty and unjust enrichment.  Amongst other things, the plaintiff requested that the court compel the Company to hold an annual stockholders’ meeting; subject the September 2012 Amendment to the 2004 Plan to a vote at the next annual stockholders’ meeting; rescind the stock option awards granted under the September 2012 Amendment to 2004 Plan in the event that the amendment is not approved by a majority of our stockholders’; impose a trust, in favor of the Company, for any benefits improperly received; and award costs and expenses, including reasonable attorney fees.

On July 1, 2015 we held our 2015 Annual Meeting of Stockholders. Stockholders approved an amendment to the Company’s 2004 Stock Option Plan to increase the aggregate number of shares of the Company’s common stock, par value $0.001 per share available for issuance under the Plan by 16,000,000 shares to 20,000,000 shares and approved the Company’s Amended and Restated 2014 Stock Option Plan.

On May 22, 2015, a motion to dismiss the Complaint with prejudice was served on the plaintiff and subsequently filed with the Court. On July 21, 2015, the Court endorsed an Order of Stipulation the parties entered into. The Stipulation provides, among other things, that the Complaint is dismissed with prejudice and the Motion to Dismiss is moot. On December 17, 2015, the Court ruled that the Plaintiff’s counsel was entitled to a fee of $70,000 together with costs of approximately $6,000. During the fiscal year ended June 30, 2016, we recorded a charge of $76,000 in our condensed consolidated statement of operations and comprehensive loss.

On October 10, 2016, in connection with the Asset Purchase Agreement with L-3, the Company and its subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court.

On November 21, 2016, the LOI with Zapata was terminated, and Zapata subsequently filed a claim with the Bankruptcy Court  seeking a breakup fee related to the cancellation of the acquisition.  The Company disputes any payment obligations it may have to Zapata in connection with the LOI or the termination thereof.

We are not currently a party to any other legal proceedings, other than routine litigation incidental to our business that which we believe will not have a material effect on our business, assets or results of operations.  From time to time, we are subject to various claims, legal proceedings and investigations covering a wide range of matters that arise in the ordinary course of our business activities.  Each of these matters may be subject to various uncertainties.

We may, from time to time, be involved in other actual or potential proceedings that we consider to be in the normal course of our business.  We do not believe that any of these proceedings will have a material adverse effect on our business. We are not a party to any other legal proceedings, other than ordinary routine litigation incidental to our business, which we believe will not have a material effect on our business, assets or results of operations.

Item 1A.

Risk Factors

Other than as set forth below, there have not been any material changes from the risk factors previously disclosed under Item 1A of our Annual Report on Form 10-K, for the fiscal year ended June 30, 2016.

We may not be able to achieve our strategic objectives, including the acquisition of another business.

With respect to acquisitions and divestitures, we may not achieve expected returns and other benefits as a result of various factors, including integration and challenges of assimilating personnel and technology.  When we decide to sell assets or a business, we may encounter difficulty in finding buyers or executing alternative exit strategies in a timely manner, which could delay the accomplishment of our objectives.  Alternatively, we may dispose of a business or assets at a price or on terms that are less than we anticipated. After reaching an agreement with a buyer or seller, the acquisition or sale of a business, such as the proposed sale of the ETD business or a potential acquisition, may be subject to regulatory and governmental approval and the satisfaction of pre-closing conditions, which may prevent us from completing the transaction. We may not have the resources to successfully conclude an acquisition. The sale of a business or assets may involve guarantees, indemnities or other financial obligations.  Under these arrangements, the performance of the divested business or other conditions outside of our control could affect our future financial results.

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At the present time, we are a shell company with no operations.  We are actively considering various acquisition targets and other business opportunities.  We hope to acquire one or more operating businesses or consummate a business opportunity within the next twelve months. However, we cannot guarantee that we will successfully consummate an acquisition or other business opportunity within such timeframe, or at all.

Our secured borrowings matured on October 30, 2016 and October 31, 2016.

All of our borrowings from DMRJ and Montsant  under (i) a senior secured promissory note dated July 1, 2009 with DMRJ, (ii) a credit agreement dated September 4, 2009 with DMRJ, (iii) to Montsant under an amended and restated senior secured convertible promissory note dated March 12, 2009 (the “March 2009 Note”), (iv) to DMRJ under a senior secured convertible promissory note dated September 5, 2012 (the “September 2012 Note”) and (v) to DMRJ under a senior secured convertible promissory note dated February 28, 2013 (the “February 2013 Note”) matured on October 31, 2016.

Our secured borrowings from a group of institutional investors for which BAM Administrative Services LLC (“BAM”) acts as administrative agent matured on October 30, 2016 and our secured borrowings with DMRJ and Montsant, matured on October 31, 2016. DMRJ and Montsant agreed to subordinate their security interest in all of our assets to the security interest held by BAM (See Note 12 to the condensed consolidated financial statements).

The payment of our indebtedness to DMRJ and Montsant are stayed pending the conclusion of the bankruptcy proceedings.

Our obligations to DMRJ are secured by a security interests in substantially all of our assets. As of December 31, 2016, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of December 31, 2016, our obligation to DMRJ for accrued interest under these instruments approximated $9,129,000 and is included in current liabilities in the condensed consolidated financial statements.

As of December 31, 2016, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of December 31, 2016, our obligation to Montsant for accrued interest under this instrument approximated was $405,000.

As of February 13, 2017, our obligations to DMRJ under each of the three promissory notes and a revolving line of credit approximated $11,970,000, $17,523,000, $1,000,000 and $17,662,000, respectively. Further, as of February 13, 2017, our obligation to DMRJ for accrued interest under these instruments approximated $10,012,000. Please refer to Note 14 to the condensed consolidated financial statements for a discussion of the August 2016 conversions of principal indebtedness by DMRJ.

As of February 13, 2017, our obligations to Montsant under a promissory note approximated $5,284,000. Further, as of February 13, 2017, our obligation to Montsant for accrued interest under this instrument approximated $502,000.

Our obligations to a group of institutional investors for which BAM acts as administrative agent are secured by security interests in substantially all of our assets. As of December 31, 2016, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of December 31, 2016, our obligation under such notes for accrued interest amounted to approximately $4,113,000 and is included in current liabilities in the condensed consolidated financial statements.

The total amount borrowed under the BAM senior secured promissory notes together with accrued interest were paid in full effective January 5, 2017 upon the closing of the Transaction with L-3.

If we are unable to repay these amounts as required, refinance our obligations to DMRJ, Montsant and/or the other institutional investors, or negotiate extensions of these obligations, DMRJ, Montsant and/or BAM or reorganize the Company in Bankruptcy and have a reorganization Plan approved by the Bankruptcy Court, we may be forced to convert the Chapter 11 cases to Chapter 7d.

Management continually evaluates operating expenses and plans to increase sales and increase cash flow from operations. Despite our projected sales, expense and cash flow projections and the cash available from our New DIP Loan, we may not have sufficient capital to continue our operations. There can be no assurance that DMRJ will continue or is able to make advances under our revolving line of credit. Our failure to achieve our projections, to obtain sufficient additional capital on acceptable terms or successfully complete the sale of our ETD business to L-3 would have a material adverse effect on our liquidity and operations and could require us to file for protection under Chapter 7 of the U.S. bankruptcy laws. Furthermore, we are incurring increased legal costs and financial adviser costs associated with the activities of the Official Committee of Equity Holders appointed by the U.S. Trustee. These conditions raise substantial doubt as to our ability to continue as a going concern.

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Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 6.

Exhibits

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SIGNATURES

Pursuant to the requirements of 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.

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