| SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | Basis of Presentation The financial statements
are prepared under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
Topic 105-10, Generally Accepted Accounting Principles Principles of Consolidation The consolidated financial
statements include the accounts of the Company and its wholly owned subsidiaries. The Company’s wholly-owned subsidiaries
are: XImage Corporation, a California Corporation; ImageWare Systems ID Group, Inc., a Delaware corporation (formerly Imaging Technology
Corporation); I.W. Systems Canada Company, a Nova Scotia unlimited liability company; ImageWare Digital Photography Systems, LLC,
a Nevada limited liability company (formerly Castleworks LLC); Digital Imaging International GmbH, a company formed under German
laws; and Image Ware Mexico S de RL de CV, a company formed under Mexican laws. All significant intercompany transactions and balances
have been eliminated. Operating Cycle Assets and liabilities related
to long-term contracts are included in current assets and current liabilities in the accompanying consolidated balance sheets,
although they will be liquidated in the normal course of contract completion which may take more than one operating cycle. Use of Estimates The preparation of the consolidated
financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements,
and the reported amounts of revenue and expense during the reporting period. Significant estimates include the evaluation of our
ability to continue as a going concern, the allowance for doubtful accounts receivable, deferred tax asset valuation allowances,
recoverability of goodwill, assumptions used in the Black-Scholes model to calculate the fair value of share based payments, fair
value of financial instruments issued with and affected by the Series C Preferred Financing (defined below), fair value of Series
A Preferred (defined below), assumptions used in the application of revenue recognition policies, assumptions used in the derivation
of the Company’s incremental borrowing rate used in the computation of the Company’s operating lease liabilities and
assumptions used in the application of fair value methodologies to calculate the fair value of pension assets and obligations.
Actual results could differ from estimates. Accounts Receivable In the normal course of
business, the Company extends credit without collateral requirements to its customers that satisfy pre-defined credit criteria.
Accounts receivable are recorded net of an allowance for doubtful accounts. Accounts receivable are considered delinquent when
the due date on the invoice has passed. The Company records its allowance for doubtful accounts based upon its assessment of various
factors. The Company considers historical experience, the age of the accounts receivable balances, the credit quality of its customers,
current economic conditions and other factors that may affect customers’ ability to pay to determine the level of allowance
required. Accounts receivable are written off against the allowance for doubtful accounts when all collection efforts by the
Company have been unsuccessful. Inventories Finished goods inventories
are stated at the lower of cost, determined using the average cost method, or net realizable value. See Note 6. Property, Equipment and Leasehold Improvements Property and equipment,
consisting of furniture and equipment, are stated at cost and are being depreciated on a straight-line basis over the estimated
useful lives of the assets, which generally range from three to five years. Maintenance and repairs are charged to expense as incurred.
Major renewals or improvements are capitalized. When assets are sold or abandoned, the cost and related accumulated depreciation
are removed from the accounts and the resulting gain or loss is recognized. Expenditures for leasehold improvements are capitalized.
Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term
or the estimated useful lives of the improvements. Revenue Recognition. ASC ASC 606 In accordance with ASC 606,
revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects
the consideration we expect to be entitled to in exchange for those goods or services. The core principle of the
standard is that we should recognize revenue to depict the transfer of promised goods or services to customers in an amount that
reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve that core principle,
we apply the following five step model:
1. Identify the contract with the customer;
2. Identify the performance obligation in the contract;
3. Determine the transaction price;
4. Allocate the transaction price to the performance obligations in the contract; and
5. Recognize revenue when (or as) each performance obligation is satisfied. At contract inception, we
assess the goods and services promised in a contract with a customer and identify as a performance obligation each promise to transfer
to the customer either: (i) a good or service (or a bundle of goods or services) that is distinct or (ii) a series of distinct
goods or services that are substantially the same and that have the same pattern of transfer to the customer. We recognize revenue
only when we satisfy a performance obligation by transferring a promised good or service to a customer. Determining the timing of
the satisfaction of performance obligations as well as the transaction price and the amounts allocated to performance obligations
requires judgement. We disclose disaggregation
of our customer revenue by classes of similar products and services as follows:
● Software licensing and royalties;
● Computer hardware and identification media;
● Services; and
● Post-contract customer support. Software licensing and royalties Software licenses consist
of revenue from the sale of software for identity management applications. Our software licenses are functional intellectual property
and typically provide customers with the right to use our software in perpetuity as it exists when made available to the customer.
We recognize revenue from software licensing at a point in time upon delivery, provided all other revenue recognition criteria
are met. Royalties consist of revenue
from usage-based arrangements and guaranteed minimum-based arrangements. We recognize revenue for royalty arrangements at the later
of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated
has been satisfied. Computer hardware
and identification media We generate revenue from
the sale of computer hardware and identification media. Revenue for these items is recognized upon delivery of these products to
the customer, provided all other revenue recognition criteria are met. Services Services revenue is comprised
primarily of software customization services, software integration services, system installation services and customer training.
Revenue is generally recognized upon completion of services and customer acceptance provided all other revenue recognition criteria
are met. Post-contract customer
support (“PCS”) Post contract customer support
consists of maintenance on software and hardware for our identity management solutions. Arrangements with
multiple performance obligations A performance obligation
is a promise in a contract to transfer a distinct good or service to the customer. In addition to selling software licenses, hardware
and identification media, services and post-contract customer support on a standalone basis, certain contracts include multiple
performance obligations. For such arrangements, we allocate revenue to each performance obligation based on our best estimate of
the relative standalone selling price. The standalone selling price for a performance obligation is the price at which we would
sell a promised good or service separately to a customer. The primary methods used to estimate standalone selling price are as
follows: (i) the expected cost-plus margin approach, under which we forecast our expected costs of satisfying a performance obligation
and then add an appropriate margin for that distinct good or service and (ii) the percent discount off of list price approach. Contract costs We recognize an asset for
the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year.
We apply a practical expedient to expense costs as incurred for costs to obtain a contract when the amortization period is one
year or less. At December 31, 2018, we had recorded approximately $147,000 in contract costs relating to capitalized commissions.
During the year ended December 31, 2019, we recognized approximately $29,000 of capitalized contract costs as expense. Such expense
is included as a component of operating expense and is included under the caption “Sales and marketing” in our consolidated
statement of operations for the year ended December 31, 2019. We recorded no additional contract costs in the year ended December
31, 2019. We recognized approximately $132,000 of revenue during the year ended December 31, 2019 that was related to contract
costs at the beginning of the period. Other items We do not offer rights of
return for our products and services in the normal course of business. Sales tax collected from
customers is excluded from revenue. The adoption of ASC 606 as of January 1, 2018
resulted in a cumulative positive adjustment to beginning accumulated deficit and accounts receivable of approximately $96,000.
The following table sets forth our disaggregated revenue for the years ended December 31, 2019 and 2018:
Year Ended December 31,
Net Revenue 2019 2018
(dollars in thousands)
Software and royalties $ 489 $ 1,334
Hardware and consumables 96 133
Services 338 294
Maintenance 2,583 2,643
Total net revenue $ 3,506 $ 4,404 Fair Value of Financial Instruments For certain of the Company’s
financial instruments, including accounts receivable, accounts payable, accrued expense, and deferred revenue, the carrying amounts
approximate fair value due to their relatively short maturities. Lease Liabilities and Operating Lease
Right-of-Use Assets The Company is a party to
certain contractual arrangements for office space which meet the definition of leases under Accounting Standards Codification (“ ASC ASC 842 A package of practical
expedient to not reassess:
● Whether a contract is or contains a lease
● Lease classification
● Initial direct costs Goodwill The
Company annually, or more frequently if events or circumstances indicate a need, tests the carrying amount of goodwill for
impairment. The Company performs its annual impairment test in the fourth quarter of each year. In December 2018, the Company adopted
the provisions of ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”
The provisions of ASU 2017-04 eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill
impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying
amount over its fair value. Entities that have reporting units with zero or negative carrying amounts, will no longer be required
to perform a qualitative assessment assuming they pass the simplified impairment test. The Company continues to have only
one reporting unit, Identity Management, which at December 31, 2019, had a negative carrying amount of approximately $8,762,000.
Based on the results of the Company’s impairment testing, the Company determined that its goodwill was not impaired
as of December 31, 2019 and December 31, 2018. Intangible and Long-Lived Assets Intangible assets are carried
at their cost less any accumulated amortization. Any costs incurred to renew or extend the life of an intangible or
long-lived asset are reviewed for capitalization. The Company evaluates long-lived assets for impairment whenever events or
changes in circumstances indicate their net book value may not be recoverable. When such factors and circumstances exist, the Company
compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated
useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the
fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period
in which the determination is made. As of December 31, 2019, and through the date of this Annual Report, the Company’s management
believes there is no impairment of its long-lived assets. There can be no assurance, however, that market conditions will not change
or demand for the Company’s products under development will continue. Either of these could result in future impairment of
long-lived assets. Derivative Liabilities The
Company accounts for its derivative instruments under the provisions of ASC 815, “ Derivatives and Hedging The Company determined that the conversion option,
redemption option and participating dividend feature contained in the Series C Preferred host instrument required bifurcation.
The Company valued the bifurcatable features at fair value. Such liabilities aggregated approximately $833,000 at inception and
are classified as current liabilities on the Company’s consolidated balance sheets under the caption “Derivative liabilities”.
The Company will revalue these features at each balance sheet date and record any change in fair value in the determination of
period net income or loss. Such amounts are recorded in the caption “Change in fair value of derivative liabilities”
in the Company’s consolidated statements of operations. During the twelve months ended December 31, 2019, the Company recorded
a decrease to these derivative liabilities using fair value methodologies of approximately $696,000. As a result of this decrease,
such liabilities aggregated approximately $369,000 at December 31, 2019. During the twelve months ended December 31, 2018, the
Company recorded an increase to these derivative liabilities using fair value methodologies of approximately $232,000 which resulted
in a December 31, 2018 aggregated balance of approximately $1,065,000 Concentration of Credit Risk Financial instruments which
potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The
Company places its cash with high quality financial institutions and at times during the years ended December 31, 2019 and 2018,
exceeded the FDIC insurance limits of $250,000. Sales are typically made on credit and the Company generally does not require collateral.
The Company performs ongoing credit evaluations of its customers’ financial condition and maintains an allowance for doubtful
accounts. The Company considers historical experience, the age of the accounts receivable balances, the credit quality of its customers,
current economic conditions and other factors that may affect customers’ ability to pay to determine the level of allowance
required. Accounts receivable are presented net of an allowance for doubtful accounts of approximately $7,000 and $0 at December
31, 2019 and 2018, respectively. For the year ended December
31, 2019, two customers accounted for approximately 37% or $1,301,000 of total revenue and had trade receivables of approximately
$161,000 as of the end of the year. For the year ended December 31, 2018, one customer accounted for approximately
36% or $1,573,000 of total revenue and had trade receivables of approximately $0 as of the end of the year. Stock-Based Compensation At December 31, 2019, the
Company had one stock-based compensation plan for employees and nonemployee directors, which authorizes the granting of various
equity-based incentives including stock options and restricted stock. The Company estimates the
fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC 718, “ Compensation
– Stock Compensation ASC 718 requires the use
of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option-pricing
model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required
to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best
measure of expected volatility is based on the historical weekly volatility of the Company’s Common Stock. Historical volatility
factors utilized in the Company’s Black-Scholes computations for options granted during the years ended December 31, 2019
and 2018 ranged from 64% to 57%. The Company has elected to estimate the expected life of an award based upon the SEC approved
“simplified method” noted under the provisions of Staff Accounting Bulletin Topic 14. The expected term used by the
Company during the years ended December 31, 2019 and 2018 was 5.17 years. The difference between the actual historical expected
life and the simplified method was immaterial. The interest rate used is the risk-free interest rate and is based upon U.S. Treasury
rates appropriate for the expected term. Interest rates used in the Company’s Black-Scholes calculations for the years ended
December 31, 2019 and 2018 averaged 2.58%. Dividend yield is zero as the Company does not expect to declare any dividends on the
Company’s common shares in the foreseeable future. In addition to the key assumptions
used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has
adopted the provisions of ASU 2016-09 and will continue to use an estimated annualized forfeiture rate of approximately 0% for
corporate officers, 4.1% for members of the Board of Directors and 6.0% for all other employees. The Company reviews the expected
forfeiture rate annually to determine if that percent is still reasonable based on historical experience. Restricted stock units are
recorded at the grant date fair value with corresponding compensation expense recorded ratably over the requisite service period. Income Taxes The Company accounts for
income taxes in accordance with ASC 740, Accounting for Income Taxes, (ASC 740) ASC 740 requires a company
to first determine whether it is more-likely-than-not (defined as a likelihood of more than fifty percent) that a tax position
will be sustained based on its technical merits as of the reporting date, assuming that taxing authorities will examine the position
and have full knowledge of all relevant information. A tax position that meets this more-likely-than-not threshold is then measured
and recognized at the largest amount of benefit that is greater than fifty percent likely to be realized upon effective settlement
with a taxing authority. The amount accrued for uncertain tax positions was $0 at December 31, 2019 and 2018. The Company’s uncertain
tax position relative to unrecognized tax benefits and any potential increase in these liabilities relates primarily to the allocations
of revenue and costs among the Company’s global operations and the impact of tax rulings made during the period affecting
its tax positions. The Company’s existing tax positions could result in liabilities for unrecognized tax benefits. The Company
recognizes interest and/or penalties related to uncertain tax positions in income tax expense. The amount of interest and penalties
accrued as of December 31, 2019 and 2018 was $0. Significant judgment is required in evaluating the Company’s
uncertain tax positions and determining the Company’s provision for income taxes. No assurance can be given that the final
tax outcome of these matters will not be different from that which is reflected in the Company’s historical income tax provisions
and accruals. The Company adjusts these items in light of changing facts and circumstances. To the extent that the final tax outcome
of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period
in which such determination is made. Foreign Currency Translation The financial position and
results of operations of the Company’s foreign subsidiaries are measured using the foreign subsidiary’s local currency
as the functional currency. Revenue and expense of such subsidiaries have been translated into U.S. dollars at weighted-average
exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the balance
sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of shareholders’
equity, unless there is a sale or complete liquidation of the underlying foreign investments. The Company translates foreign currencies
of its German, Canadian and Mexican subsidiaries. The cumulative translation adjustment, which is recorded in accumulated other
comprehensive loss, decreased approximately $1,000 for the year ended December 31, 2019, and increased approximately $27,000 for
the year ended December 31, 2018. Comprehensive Loss Comprehensive loss
consists of net gains and losses affecting shareholders’ deficit that, under generally accepted accounting principles, are
excluded from net loss. For the Company, the only items are the cumulative translation adjustment and the additional minimum liability
related to the Company’s defined benefit pension plan, recognized pursuant to ASC 715-30, “ Compensation - Retirement
Benefits - Defined Benefit Plans – Pension Advertising Costs The Company expenses advertising
costs as incurred. The Company incurred approximately $5,000 in advertising expense during the years ended December 31, 2019 and
December 31, 2018. Loss Per Share Basic loss per common share
is calculated by dividing net loss available to common shareholders for the period by the weighted-average number of common shares
outstanding during the period. Diluted loss per common share is calculated by dividing net loss available to common shareholders
for the period by the weighted-average number of common shares outstanding during the period, adjusted to include, if dilutive,
potential dilutive shares consisting of convertible preferred stock, convertible lines of credit, stock options and warrants, calculated
using the treasury stock and if-converted methods. For diluted loss per share calculation purposes, the net loss available
to common shareholders is adjusted to add back any preferred stock dividends in the consolidated statements of operations for the
respective periods.
(Amounts in thousands, except share and per share amounts)
Year Ended December 31,
Numerator for basic and diluted loss per share: 2019 2018
Net loss $ (11,581 ) $ (12,550 )
Preferred dividends, deemed dividends and accretion (5,670 ) (3,913 )
Net loss available to common shareholders $ (17,251 ) $ (16,463 )
Denominator for basic and diluted loss per share — weighted-average shares outstanding 104,372,048 95,210,572
Basic and diluted loss per share:
Net loss available to common shareholders $ (0.17 ) $ (0.17 )
Basic and diluted loss per share:
Net loss available to common shareholders $ (0.17 ) $ (0.17 )
The following potential
dilutive securities have been excluded from the computations of diluted weighted-average shares outstanding as their effect would
have been antidilutive:
Potential Dilutive Securities: Common Share Equivalents at December 31, 2019 Common Share Equivalents at December 31, 2018
Convertible redeemable preferred stock – Series A 32,580,000 32,580,000
Convertible redeemable preferred stock – Series B 46,029 46,029
Convertible redeemable preferred stock – Series C 10,000,000 10,000,000
Stock options 7,204,672 7,227,248
Warrants 1,733,856 1,813,856
Total Potential Dilutive Securities 51,564,557 51,667,133 Recently Issued Accounting Standards From time to time, new accounting
pronouncements are issued by the FASB or other standard setting bodies, which are adopted by us as of the specified effective date.
Unless otherwise discussed, the Company’s management believes the impact of recently issued standards not yet effective will
not have a material impact on the Company’s consolidated financial statements upon adoption. FASB ASU No. 2016-13 Financial Instruments—Credit
Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. FASB ASU No. 2018-13 “Fair Value Measurement (Topic 820) —Disclosure Framework —Changes
to the Disclosure Requirements for Fair Value Measurement” ASU 2018-13 FASB ASU No. 2018-14 “Compensation —Retirement Benefits —Defined Benefit Plans
—General (Subtopic 715-20) —Disclosure Framework —Changes to the Disclosure Requirements for Defined Benefit
Plans” ASU 2018-14 FASB ASU No. 2018-15 “Intangibles —Goodwill and Other —Internal-Use Software
(Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service
Contract” ASU 2018-15 FASB ASU No. 2018-18 Collaborative Arrangements (Topic 808): Clarifying the Interaction
Between Topic 808 and Topic 606 FASB ASU No. 2019-12 Income Taxes (Topic 740) |
