Item 1.
Business
Cautionary Note Regarding Forward Looking Statements
This Annual Report on Form 10-K 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 and 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 Annual Report on Form 10-K. Important factors that could cause actual results to differ from our predictions include those discussed under “Risk Factors,” “Management’s Discussion and Analysis” and “Business.” 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. 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 Annual Report and in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov.
Where we say “we,” “us,” “our,” “Company” or “Implant Sciences,” we mean Implant Sciences Corporation and its subsidiaries.
General
Overview and Recent Developments
We develop, manufacture and sell sophisticated sensors and systems for the security, safety and defense 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.
We have developed proprietary technologies used in explosives and narcotics trace detection (“ETD” and “NTD”, respectively) applications and market and sell handheld ETD and desktop ETD and NTD systems that use our proprietary technologies. Our products are 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.
On September 30, 2013, the Service Technique de l’Aviation Civile in France certified our QS-B220 Desktop Explosives and Narcotics Detector for use in passenger and air cargo screening at airports throughout France, French territories and several European Union member nations. The QS-B220 received regulatory approval from the German Federal Ministry of the Interior for aviation security applications at German airports on March 25, 2014 for use at all non-passenger airport checkpoints for screening of deliveries, food service, and other airport service functions.
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On October 18, 2013, the QS-B220 was accepted into the “Qualified” section of the Air Cargo Screening Technology List published by the United States Transportation Security Administration (the “TSA”). With this acceptance, which follows the “Approved” status granted by the TSA in January 2013, the QS-B220 joined the list of products from which regulated parties, such as air carriers, independent cargo screening facilities and shippers, are encouraged to purchase security solutions.
On August 28, 2014, the QS-B220 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”). 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 May 13, 2014, we achieved registration status to ISO 9001:2008 and ISO 14001:2004 quality standards. ISO 9001 is currently the most rigorous international standard for Quality Management and Assurance and ISO 14001 is an Environmental Management System. ISO standards were developed by the International Organization for Standardization in Geneva, Switzerland to promote and facilitate international trade. More than 150 countries, including European Union members, the United States and Japan, recognize ISO standards.
History
Since our incorporation in 1984, we have operated as a multi-faceted company engaged in the development of ion-based technologies and providing commercial services and products to the semiconductor, medical device and security industries. In 2007, we made the strategic decision to focus exclusively on our security business and in 2007 and 2008 we divested our non-core semiconductor and medical businesses.
At present, we have developed portable systems, which have been marketed and sold both domestically and internationally since 2004, and a desktop system which we began shipping commercially in the third quarter of fiscal 2012. In order to reduce manufacturing costs and be responsive to large quantity orders, we use a contract manufacturer to manufacture our handheld ETD systems. We are presently manufacturing our desktop systems at our facility in Wilmington, Massachusetts. As we continue to sell and deliver our security products, we work both independently and in conjunction with various government agencies to develop the next generation of trace explosives detectors and to identify new applications for our proprietary technology.
In April 2008, we acquired all of the capital stock of Ion Metrics, Inc., located in San Diego, California. Ion Metrics develops mass sensor systems to detect and analyze chemical compounds such as explosives, chemical warfare agents, narcotics, and toxic industrial chemicals for the homeland defense, forensic, environmental, and safety/security markets. Ion Metrics miniaturized quadrupole mass spectrometry (“QMS”) detector technology provides high performance and reliability in combination with low manufacturing costs. We are currently developing interfaces for integrating the QMS detector into our future products.
Industry Overview
We believe that the market for security and inspection products will continue to be affected by the threat of terrorist incidents and by new government mandates and appropriations for security and inspection products in the United States and internationally.
The September 11, 2001 terrorist attacks on the World Trade Center and the Pentagon using hijacked airliners led to nationwide shifts in transportation and facilities security policies. Shortly following these attacks, the U.S. Congress passed the Aviation and Transportation Security Act and integrated many U.S. security-related agencies, including the Federal Aviation Administration, into the U.S. Department of Homeland Security (“DHS”). Under its directive from Congress, the DHS has undertaken numerous initiatives to prevent terrorists from entering the country, hijacking airliners, and obtaining and trafficking in weapons of mass destruction and their components, to secure sensitive U.S. technologies and to identify and screen high-risk cargo containers before they are loaded onto vessels destined for the U.S., among others. These initiatives, more fully described in the Strategic Border Initiative, the Customs-Trade Partnership Against Terrorism and the U.S. Customs and Border Protection Container Security Initiative, have resulted in an increased demand for security and inspection products both in the United States and other nations.
These government-sponsored initiatives have also stimulated security programs in other areas of the world as the U.S initiatives call on other nations to bolster their port security strategies, including acquiring or improving their security and inspection equipment. As a result, the international market for non-intrusive inspection equipment continues to expand as countries that ship goods directly to the United States are required to improve their security infrastructure.
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In 2007, the U.S. Congress passed legislation that mandated the inspection of international maritime cargo destined for the United States, domestic civil aviation cargo, and for radiological and nuclear threats in cargo entering the United States. In May 2012, the Transportation Security Administration announced that beginning December 3, 2012, air carriers are required to conduct 100% screening for explosives on international flights bound for the United States for all cargo shipments loaded on passenger aircraft fulfilling a requirement of the Implementing Recommendations of the 9/11 Commission Act. In addition, following recommendations outlined in the “9/11 Commission Report,” issued by the National Commission on Terrorist Attacks Upon the United States, federal law has required the screening of all cargo carried on passenger aircraft for flights originating in the United States since August 2010.
Furthermore, DHS’s Science and Technology Directorate has supported the development of new security inspection technologies and products. We participate in a number of such research and development efforts, including projects to develop new technologies for improving the accuracy of detection of trace amounts of explosives, narcotics and chemical agents; and improved sampling techniques for the application of trace detection to aviation and cargo screening. The Science and Technology Directorate has also initiated programs for the development of technologies capable of protecting highways, railways and waterways from terrorist attack.
In addition, the U.S. Department of Defense has also begun to invest more heavily in technologies and services that screen would-be attackers before they are able to harm U.S. and allied forces.
Similar initiatives by international organizations such as the European Union have also resulted in a growing worldwide demand for airline, cargo, port and border inspection technologies. For example, the European Union has tasked a working group to establish uniform performance standards for people, cargo, mail & parcel and hold baggage ETD screening systems, just as it has with X-Ray and liquid explosives detection systems. We anticipate that the promulgation of these new standards will establish performance baselines against which we will be able to direct certain of our research and development spending and market our products to customers located in the European Union. As a result of these and other changes, sales of our security products have improved. Major projects recently installed or currently underway include system installations at airports, ports and border crossings, government and military facilities and other locations, primarily in the international marketplace. We anticipate that there may be growing demand from governments and commercial enterprises for increasingly sophisticated screening solutions in the future.
Technology
Since 1999, we have performed research and development in the area of explosives trace detection (“ETD”). We have developed several proprietary technologies in key areas of ETD which we believe improve the harvesting, collection and detection of trace particles and vapors of explosives substances. More recently, we have adapted this technology for the detection of narcotics (“NTD”). Our intellectual property portfolio contains 23 security-related patents and patents pending: fifteen issued and active United States patents, six United States patents pending, and two licensed patents. We believe that our portfolio of patents and patents pending provides extensive protection in sample harvesting, sample detection and collection. A key to our past and future success is our ability to innovate and offer differentiation in these areas.
We compartmentalize ETD and NTD into four major areas: (i) harvest, (ii) transport, (iii) analysis, and (iv) reporting. These technologies are discussed in detail in the following sections.
Harvest - Aerosol Particle Release
Tiny particles of explosives and narcotics are “sticky” and may adhere to surfaces. Particles can be transferred if an object, such as fingers or clothing, comes in contact with a particle. We have demonstrated that a person touching an explosives and narcotics material can transfer particles to numerous other objects, leaving a trail of particles behind.
Our competitors commonly swipe a surface to be interrogated for explosives or narcotics particles with cloth or paper. We believe that this “contact” methodology provides an effective but inconsistent method of harvesting a trace sample as compared to an automated, non-contact collection of the sample. We have developed a method, which we believe to be more efficient, using an aerosol of fine dry ice particles. This technique, which is surprisingly inexpensive to use, could increase collection sensitivity substantially and eliminate direct contact with a surface. Our aerosol technology functions as a very gentle version of “sandblasting” and is safe for almost all surfaces. Since dry ice sublimes into gas, no residue is left behind, and the aerosol may be used indoors. We have four patents issued on this methodology.
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Transport
Vortex Sampling
Once the trace particle has been released from a surface, it must be transported to a collection point. Vortex sampling was the first of our sampling innovations. Our vortex is similar to a miniature tornado. A hollow spinning cylinder of air flowing outward surrounds and protects an inner vacuum flowing inward. It is this vortex sampling technology that enables particles released within the vortex, or blown into it, to be transported with high efficiency to a collection filter. We have three patents issued in the area of vortex sampling methodology.
Long-Life Sample Trap
Once particles have been liberated from the surface being interrogated for the presence of trace amounts of explosives or narcotics, the particles are transported to our innovative trapping filter, which is an ultra-fine stainless steel woven mesh. The trapping filter has a long usable life, which can span several years, requiring inexpensive, routine maintenance. We believe the trapping filter provides an innovative solution to the more costly consumables used by several of our competitors engaged in ETD and NTD using contact methodology for sampling and detection.
Analysis
Flash Desorption
Flash desorption is an optical method for converting the chemistry of a particle, such as the chemicals composing explosives or narcotics, into a vapor that can be subjected to analyses for the discrimination of chemical properties. In conventional trace chemical detectors, a sample is slowly warmed in an oven, producing diluted vapor with low chemical concentrations. Optical flash vaporization heats a sample within microseconds, producing a high sample concentration for detection.
This method is not appropriate with conventional sample collection methods, such as paper wipes, because the paper is white, and the light from the bright flash reflects off, producing little heating. However, by using our trapping filter, a very fast detection response can be achieved without loss in sensitivity. We have three patents issued in the area of flash desorption methodology.
Photonic Ionization
The conventional method of ionizing vapors for analysis uses a radioactive beta source. While equipment using radioactive sources are simple, effective, and need no electricity in the ionization process, there are important issues involving safety, licensing, regular verification of source integrity, and disposal. Some markets, such as the European Union, Japan and Australia, are known to reject instruments with radioactive sources. We believe that most markets would prefer not to have to address the issues surrounding ETD and NTD equipment with radioactive sources.
We have developed two types of electronic ionization utilizing photonic methods and high voltage non-radioactive spark sources for our instruments for applications requiring either the ionization of positive ions or negative ions. These ion sources may be found individually or in combination within our products, depending on the application for which the equipment is to be used. We have two patents issued and three patents pending in the area of photonic ionization.
Reporting
Reporting is that portion of the cycle that displays and stores information generated during the analysis phase. It is this information a system operator sees and indicates if an alarm condition exists or if the test is negative. Information can be displayed in both graphical and tabular formats. The reporting also indicates when the instrument is ready for the next sample as well as displaying built-in system diagnostics.
Intellectual Property
It is our policy to protect our proprietary position by, among other methods, filing United States patent applications. Our intellectual portfolio contains 23 security-related patents and patents pending: fifteen patents have been issued and are active, six patents are pending and we license two patents. The fifteen issued patents expire in the years 2022 through 2033.
We believe our patent portfolio provides extensive protection. We also rely on unpatented proprietary technology, trade secrets and know-how.
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Manufacturing
We manufacture our handheld security products primarily through a sole source contract manufacturer located locally in Worcester, Massachusetts. We also maintain an internal production group at our corporate headquarters in Wilmington, Massachusetts, which is responsible for pre-production logistics, oversight of contract manufacturing, quality control and inventory management. We believe our strategy to outsource manufacturing of our handheld products reduces manufacturing costs, improves scheduling flexibility, and allows us to focus our internal resources and management on product development, marketing, sales and distribution. Our desktop explosives and narcotics detection systems are manufactured at our facility in Wilmington, Massachusetts. We anticipate that, in the future, we will manufacture more of our products ourselves. Although we have various “sole-source” suppliers who supply key components for our products, we are not dependent on sole-source suppliers for any of the raw materials used in our products and do not anticipate material interruptions in the supplies of these raw materials.
Products
We have developed several explosives detection systems designed for use in aviation and transportation security, high threat facilities and infrastructure, military installations, customs and border protection, and mail and cargo screening. The systems use our proprietary Quantum SnifferTM technologies, including a photon-based, non-radioactive ion source in combination with ion mobility spectrometry (“IMS”), a classic detection tool sensitive to the unique speeds with which ions of various substances move through the air to electronically detect minute quantities of explosives vapor and particles.
Current Products
Quantum SnifferTM QS-H150 Portable Explosives Detector
The Quantum Sniffer QS-H150 Portable Explosives Detector employs a patented vortex collector for the simultaneous detection of explosives particulates and vapors with or without physical contact and in real-time. We believe that our advanced QS-H150 is more sensitive than other detection devices. The QS-H150 can detect vapors and nanogram quantities of explosives particulates for most explosives substances considered to be threats. Such substances include, but are not limited to, military and commercial explosives, improvised and homemade explosives, propellants and taggants.
The QS-H150 has automatic and continuous self-calibration. It monitors its environment, senses changes that would affect its accuracy, and re-calibrates accordingly. The system requires no user intervention and no calibration consumables. The detection process begins with the collection of a sample with our patented vortex collector. After collection, the sample is ionized photonically and analyzed using IMS technology. The presence of a threat substance is indicated by visible and audible alarms. The threat substance is then identified and displayed on the integrated LCD screen.
When detecting a threat substance, the QS-H150 rapidly alarms. This real-time detection limits equipment contamination and allows for fast clear-down. Operation and maintenance are cost-effective. Since there is no requirement for dopants, calibration consumables or verification consumables, the overall cost of consumables are minimized. Routine maintenance consists only of care and cleaning using common supplies, and desiccant replacement as required. No radioactive material is used in the QS-H150, so there are no associated certifications, licenses, inspections, or end-of-life disposal issues. In early 2010, the QS-H150 was “Designated” as Qualified Anti-Terrorism Technology by DHS under the Support Anti-terrorism by Fostering Effective Technology Act of 2002 (the “SAFETY Act”). The SAFETY Act creates certain liability limitations for claims arising out of, relating to, or resulting from an Act of Terrorism (as defined in §442(2) of the SAFETY Act) where qualified anti-terrorism technologies have been deployed.
Quantum SnifferTM QS-B220 Desktop Explosives and Narcotics Detector
Our new QS-B220 Desktop Explosives and Narcotics Detector uses dual IMS with non-radioactive ionization for the detection and identification of a wide range of military, commercial, and improvised explosives as well as narcotics. The QS-B220 uses a sample trap which is wiped on the surface to be interrogated for explosives or narcotics particles.
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The QS-B220 has automatic and continuous self-calibration. It monitors its environment, senses changes that would affect its accuracy, and re-calibrates accordingly. For detection, the sample is collected with a standard trap, ionized, and analyzed using IMS technology. The presence of a threat is indicated by visible and audible alarms, and the substance is identified and displayed on the integrated touch screen display. Users may save data locally or send data through standard interfaces such as USB and LAN. Multi-level password-protected data security is standard. We believe that the operation and maintenance of the QS-B220 are extremely cost-effective. Routine maintenance consists only of care and cleaning using common supplies, and desiccant replacement as required. No radioactive material is used in the QS-B220, so there are no associated certifications, licenses, inspections, or end-of-life disposal issues.
We introduced the QS-B220 at the Force Protection Equipment Demonstration, sponsored by the Department of Defense and Department of Energy, in May 2011. In September 2011, the QS-B220 received a “Developmental Testing & Evaluation (DT&E) Designation” from DHS under the SAFETY Act. We began commercial shipments of the QS-B220 in the third quarter of fiscal 2012.
On September 30, 2013, the Service Technique de l’Aviation Civile in France certified the QS-B220 for use in passenger and air cargo screening at airports throughout France, French territories and several European Union member nations. The QS-B220 received regulatory approval from the German Federal Ministry of the Interior for aviation security applications at German airports on March 25, 2014 for use at all non-passenger airport checkpoints for screening of deliveries, food service, and other airport service functions.
On October 18, 2013, the QS-B220 was accepted into the “Qualified” section of the Air Cargo Screening Technology List published by the United States Transportation Security Administration (the “TSA”). With this acceptance, which follows the “Approved” status granted by the TSA in January 2013, the QS-B220 joined the list of products from which regulated parties, such as air carriers, independent cargo screening facilities and shippers, are encouraged to purchase security solutions. In July 2013, the QS-B220 successfully completed Independent Testing and Evaluation with the Transportation Security Laboratory, the TSA’s testing body, and, in January 2014, the QS-B220 passed all requirements of the Qualification Testing and Evaluation portion of the checkpoint and checked baggage qualification tests at the TSA’s Systems Integration Facility.
On August 28, 2014, the QS-B220 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”). 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 purchased for aviation checkpoint and checked baggage procurements.
Products Under Development
Quantum Sniffer TM QS-H150E Portable Explosives and Narcotics Detector
We are developing a next-generation handheld detector that will use dual IMS non-radioactive ionization for the detection and identification of a wide range of military, commercial and improvised explosives, as well as narcotics. The QS-H150E will have automatic and continuous self-calibration, multi-level password-protected data security and will include a data management interface with data export to a network for recordkeeping, providing a link with the central command centers and logistics systems used by major carriers. We expect to begin shipment of the QS-H150E in the fourth quarter of fiscal 2015.
Miniature Mass Spectrometer
We initially developed our own proprietary IMS technology. We believe, however, that as market demand grows for greater precision of substance identification and the list of substances to be detected increases, more advanced detectors will be required.
Our acquisition of Ion Metrics enabled us to obtain miniaturized quadrupole mass spectrometry (“QMS”) detector technology. The QMS detector is roughly the size of an AA battery and has low manufacturing costs. When used in conjunction with an IMS, the QMS detector senses the molecular weight of the chemical species resulting in an “orthogonal” detection method in which a more fundamental characteristic of a substance is measured. We believe that, because it is unlikely that two substances would share the same mass and the same ion mobility in air, QMS detector technology improves the accuracy of detection and minimizes false alarms. We are currently developing interfaces for integrating the QMS detector into our future products.
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Hyphenated Detectors
Depending on the application and the number of “interfering” background chemicals, it may be necessary to incorporate additional “orthogonal” detection methods into our product line. The combination of multiple sensors in series in which all sensors must agree that a threat is present before a valid alarm is declared is commonly known as a “hyphenated” system. By measuring different properties of the same sample, interferents are separated from the target for detection and identification with minimum rates of false alarms.
We are currently developing hyphenated systems employing conventional ion mobility, differential mobility and quadrupole mass spectrometry. We have one patent issued in real-time trace detection by IMS and QMS and two hyphenated system patents pending. These methods focus on real-time detection, identification and analysis of trace amounts of narcotics, explosives and chemical agents.
We believe detection systems incorporating hyphenated detection methods could accelerate the expansion of our product line to more effectively address the needs of the security, safety and defense sector, as well as accelerate our entry into the narcotics, chemical warfare, biological warfare and toxic industrial chemical detection marketplaces. Combining new technologies with our other innovative products could enhance our competitive position while improving sales volumes and product margins in the future. We expect hyphenated systems to appear in our future product offerings. We have one patent issued and two patents pending in the area of hyphenated detectors.
Growth Strategy
Our growth strategy is to focus on penetrating the U.S. market through TSA “qualification” and the retention of key industry advisors, to capitalize on our expanded sales and marketing capabilities to drive and support sales growth in our international markets, and to leverage our core intellectual property to extend our product offerings and through licensing or joint development agreements. Each of these initiatives is described below.
Focus on Penetrating the U.S. Market Through Transportation Security Administration Qualification and the Retention of Key Advisors.
Since we made the strategic decision to focus exclusively on our security business, foreign sales have represented a large majority of our revenue. We believe, however, that our long-term success will depend substantially on our ability to penetrate the U.S. market for explosives trace detection equipment. We are therefore focused on obtaining the necessary approvals from the TSA.
On October 18, 2013, our QS-B220 Desktop Explosives and Narcotics Detector was accepted into the “Qualified” section of the Air Cargo Screening Technology List published by the United States Transportation Security Administration (the “TSA”). With this acceptance, which follows the “Approved” status granted by the TSA in January 2013, the QS-B220 joined the list of products from which regulated parties, such as air carriers, independent cargo screening facilities and shippers, are encouraged to purchase security solutions. We believe the TSA’s designation of the QS-B220 as “qualified” equipment on the Air Cargo Screening Technology List has allowed us to begin to address the U.S. market, both in domestic airports but also among freight-forwarders and originators of air cargo that are required to purchase “qualified” detection equipment.
On August 28, 2014, our QS-B220 desktop explosives trace detector 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”). We are now able to participate in TSA tenders for ETD purchased for aviation checkpoint and checked baggage procurements.
In addition, we believe that many state and local government agencies, unregulated businesses and foreign governments, which are not regulated by the TSA, also prefer to purchase “qualified” detection equipment. We believe, therefore, that achieving “qualified” designation may also accelerate our penetration of these markets.
Further, to assist with our effort to penetrate the U.S. market, we rely on a strategic advisor, Mo McGowan, who brings extensive experience in the security and defense industries. Mo McGowan, whom we originally retained in 2012, is recognized as one of the founders of the TSA, where he spent seven years, most recently in the role of Assistant Administrator for the Office of Security Operations, where he managed security operations. Mr. McGowan is providing his national security expertise to advance our explosives and narcotics trace detectors in the United States market, focusing on three principal segments: the military, homeland defense and security, and federal government security screening. We believe Mr. McGowan’s expertise is instrumental in support of our TSA regulatory and procurement process.
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Capitalize on Expanded Sales and Marketing Capabilities to Drive and Support Sales Growth in our International Markets.
Since 2011 we have expanded our sales and marketing staff as well as our global network of independent distributors. At June 30, 2014, we employed eight sales professionals, one of whom is focused solely on U.S. government opportunities, and three marketing professionals; and we were represented by 94 distributors. During fiscal 2013, we opened a marketing representative office in Shanghai, China, American Implant Sciences Shanghai Representative Office, staffed by our area vice president and a local marketing professional, and hired a director of sales for Russia and the Commonwealth of Independent States. Our sales staff and distribution network has been instrumental in helping us to penetrate key vertical markets around the world, such as force protection and law enforcement, transportation security, aviation security, and critical infrastructure and “VIP” protection. To further support our sales growth, during fiscal 2014, we expanded our service and training capabilities. We intend to continue to increase our sales and marketing staff, to expand our distribution network and continue to expand our service and training capabilities. At the same time, we believe that our existing distributors, many of whom are new relationships, will increase their own sales of our products into these and other vertical markets.
Leverage our Intellectual Property to Introduce New Products and Through Licensing and Joint Development Agreements.
In addition to the QS-H150E Portable Explosives Detector and the hyphenated detector systems currently under development and described more fully under “Products - Products Under Development,” we have developed proof of concepts of other solutions that leverage our patented non-contact detection technologies and intellectual property, including:
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An in-line ETD package scanner for use at security checkpoints;
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A “people portal” to screen individuals for the presence of trace particles of explosives; and
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A “vehicle portal” to identify trace particles of explosives on or in vehicles.
Although we will focus our sales efforts on our handheld and desktop systems for the foreseeable future, we will continue to explore the development of other solutions with the goal of introducing these or other trace detection products in the future.
We have also been in discussions with leading domestic and international security and defense companies concerning the implementation of our trace detection technology alongside existing third-party security systems. Future initiatives may include the joint development of security products with other companies, licenses of our intellectual property to other companies, and/or supplying our products on an “OEM” basis to other companies for inclusion within their own product offerings.
Marketing and Sales
We market and sell our products through direct sales and marketing staff located in the United States and in China, in addition to a global network of independent and specialized sales representatives and distributors. Presently, our marketing and sales staff includes eight sales professionals, one of whom is focused solely on U.S. government opportunities, and three marketing professionals. During fiscal 2014, we expanded upon our global network of independent distributors and as of June 30, 2014 were represented by 94 distributors.
We have not experienced, and do not expect to experience, in any material respect, seasonality in sales of our products.
Competition
We believe that Morpho Detection, Inc., Smiths Detection, Inc. and NucTech Company Limited are our primary competitors in trace explosives and narcotics detection markets throughout the world. Companies in our industry compete on the basis of product performance, functionality, quality and features; quality of customer support services, documentation and training; and the capability of the technology to appeal to broader applications beyond the inspection of passengers, baggage and cargo carried on airlines. Each of our principal competitors uses IMS technologies; however, they use a radioactive ion source to ionize the explosive molecules. We believe our technology differs from the competition in that we do not have a radioactive ion source; we have lower operating costs, and we can perform “real time” detection. We believe our patented technology provides our devices with greater operating advantages and fewer regulatory restrictions.
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Research and Development
Our technical staff consists of 26 scientists and engineers, three of whom hold Ph.D. degrees, and three of whom hold Masters degrees. All of our existing and planned products rely on proprietary technologies developed in our research and development laboratories. Our research and development efforts are generally self-funded, but may also be funded by corporate partners or by awards under the Small Business Innovative Research and other programs of the U.S. government. Under the Small Business Innovative Research program, we retain the right to patent any technology developed pursuant to the program, subject to the retention by the U.S. government of a royalty-free license to use the technology. We have obtained over $20 million in U.S. government grants and research contracts over the past 20 years. However, we did not have any U.S. government grants or research contracts in fiscal 2013 or fiscal 2014.
We spent approximately $4,787,000 and $4,754,000 on internally funded research and development in the fiscal years ended June 30, 2014 and 2013, respectively.
Government Regulation and Environmental Compliance
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the approval, manufacturing and marketing of security products.
Furthermore, our use, management, transportation, and disposal of certain chemicals and wastes are subject to regulation by several federal and state agencies depending on the nature of the chemical or waste material. Certain toxic chemicals and products containing toxic chemicals require special reporting to the U.S. Environmental Protection Agency and/or its state counterparts. Our costs to comply with these requirements have not been material. We are not aware of any specific environmental liabilities to which we are likely to be subject. Our future operations may require additional approvals from federal and/or state environmental agencies, the cost and effects of which cannot be determined at this time.
Employees
As of June 30, 2014, we had 67 full-time employees at our Massachusetts facility, five full-time employees in California and two full-time employees in Shanghai, China.
None of these employees are covered by a collective bargaining agreement, and management considers its relations with its employees to be good.
Geographic Areas
Our revenues are derived from both domestic and international sales. During the fiscal years ended June 30, 2014 and 2013, international sales represented approximately 76% and 88%, respectively, of our revenue. During the fiscal year ended June 30, 2014, a customer from Japan and a Taiwanese customer represented 18% and 11%, respectively, of our revenue. For the fiscal year ended June 30, 2013, a customer from India and a customer from France represented approximately 48% and 10% of our revenue, respectively.
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Item 1A.
Item 1A.
Risk Factors
An investment in our common stock involves a high degree of risk. Investors should carefully consider the following risk factors, in addition to the risks, uncertainties and assumptions described elsewhere in this Annual Report, in evaluating our Company and our business. If any of these risks, or other risks not presently known to us or that we currently believe are not significant, develops into an actual event, then our business, financial condition and results of operations could be adversely affected. If that happens, the market price of our common stock could decline.
Risks Related to our Liquidity
We will require additional capital to fund operations and continue the development, commercialization and marketing of our product. Our failure to raise capital could have a material adverse effect on our business.
Management continually evaluates operating expenses and plans to increase sales and increase cash flow from operations. Despite our current sales, expense and cash flow projections and the cash available from our line of credit with DMRJ Group LLC (“DMRJ”), we will require additional capital in the third quarter of fiscal 2015 to fund operations and continue the development, commercialization and marketing of our products. Our failure to achieve our projections and/or obtain sufficient additional capital on acceptable terms would have a material adverse effect on our liquidity and operations and could require us to file for protection under bankruptcy laws.
We will be required to repay our secured borrowings on March 31, 2015.
We will be required to repay all of our borrowings from DMRJ and from a group of institutional investors for which BAM Administrative Services LLC (“BAM”) acts as administrative agent, on March 31, 2015. Our obligations to BAM are secured by a security interest in substantially all of our assets. DMRJ agreed to subordinate its security interest in all of our assets to the security interest held by BAM (See Note 13).
As of June 30, 2014, our obligations to DMRJ under four senior secured promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $2,995,000, respectively. Further, as of June 30, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $8,283,000 and is included in current liabilities in the consolidated financial statements. As of June 30, 2014, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of June 30, 2014, our obligation under such notes for accrued interest amounted to approximately $867,000.
As of September 23, 2014, our obligations to DMRJ under the promissory notes and the credit facility approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $5,253,000, respectively. Further, as of September 23, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $9,235,000. As of September 23, 2014, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of September 23, 2014, our obligation under such notes for accrued interest approximated $717,000.
If we are unable to repay these amounts as required, refinance our obligations to DMRJ and/or the other institutional investors, or negotiate extensions of these obligations, DMRJ and/or BAM may seize our assets and we may be forced to file for protection under bankruptcy laws and to curtail or discontinue operations entirely.
Independent auditor report includes cautionary language on our ability to continue as a going concern.
The audit report issued by our independent registered public accounting firm issued on our audited financial statements for the fiscal year ended June 30, 2014 contains an explanatory paragraph regarding our ability to continue as a going concern. This explanatory paragraph indicates there is substantial doubt on the part of our independent registered public accounting firm as to our ability to continue as a going concern due to the risk that we may not have sufficient cash and liquid assets at June 30, 2014, to cover our operating capital requirements for the next twelve-month period and if sufficient cash cannot be obtained we would have to substantially alter our operations, or we may be forced to discontinue operations. Such an opinion from our independent registered public accounting firm may limit our ability to access certain types of financing, or may prevent us from obtaining financing on acceptable terms.
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Risks Related to Our Business
We have incurred substantial operating losses and we may never be profitable. There can be no assurance that our revenue will be maintained at the current level or increase in the future.
During the fiscal years ended June 30, 2014 and 2013, we had revenues of approximately $8,552,000 and $12,017,000, respectively. During the fiscal years ended June 30, 2014 and 2013, we had net losses of approximately $21,010,000 and $27,354,000, respectively. There is a risk that we will never be profitable. We plan to further increase our expenditures to complete the development and commercialization of our new products, and to broaden our sales and marketing capabilities. As a result, we believe we will likely incur losses through fiscal 2015. Our accumulated deficit as of June 30, 2014 and 2013 was approximately $167,886,000 and $146,876,000, respectively. Our ability to generate sufficient revenues to achieve profits will depend on a variety of factors, many of which are outside our control, including:
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our ability to obtain necessary government approvals for our products;
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changes in governmental (including foreign governmental) initiatives and requirements;
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changes in domestic and foreign regulatory requirements;
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the size of the markets we address;
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the existence of competition and other solutions to the problems we address;
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the extent of patent and intellectual property protection afforded to our products;
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the costs associated with equipment development, repair and maintenance; and our ability to manufacture and deliver products at prices that exceed our costs; and
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the cost and availability of raw material and intermediate component supplies.
Our operating results have fluctuated in the past from quarter to quarter and are likely to fluctuate significantly in the future due to a variety of factors, many of which are beyond our control, including:
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changing demand for our products and services;
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the timing of actual customer orders, including significant one-time orders from a single customer in a given quarter, and requests for product shipment and the accuracy of our forecasts of future production requirements;
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the reduction, rescheduling or cancellation of product orders by customers;
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difficulties in forecasting demand for our products and the planning and managing of inventory levels;
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the introduction and market acceptance of our new products and changes in demand for our existing products;
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changes in the relative portion of our revenue represented by our various products, services and customers, including the relative mix of our business across our target markets;
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changes in competitive or economic conditions generally or in our markets;
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competitive pressures on selling prices;
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the amount and timing of costs associated with product warranties and returns;
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changes in availability or costs of materials, components or supplies;
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changes in our product distribution channels and the timeliness of receipt of distributor resale information;
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the amount and timing of investments in research and development;
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difficulties in integrating acquired assets and businesses into our operations;
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charges to earnings resulting from the application of the purchase method of accounting following acquisitions; and
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non-cash charges to earnings resulting from recording stock-based compensation expense in our consolidated statement of income.
A substantial portion of our revenue in any quarter historically has been derived from orders booked and shipped in the same quarter, and historically, backlog has not been a meaningful indicator of revenues for a particular period. Accordingly, our sales expectations currently are based almost entirely on our internal estimates of future demand and not from firm customer orders.
As a result of these factors, many of which are difficult to control or predict, as well as the other risk factors discussed in this Annual Report, we may experience material adverse fluctuations in our future operating results on a quarterly or annual basis.
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Our markets are subject to technological change and our success will depend on our ability to develop and introduce new products.
The market for our security products is characterized by:
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changing technologies;
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changing customer needs;
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frequent new product introductions and enhancements;
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increased integration with other functions; and
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product obsolescence.
Our success will be dependent in part on the design and development of new products. To develop new products and designs for our security market, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to expand our technical and design expertise. The product development process is time-consuming and costly, and there can be no assurance that product development will be successfully completed, that necessary regulatory clearances or approvals will be granted on a timely basis, or at all, or that the potential products will achieve market acceptance. Our failure to develop, obtain necessary regulatory clearances or approvals for, or successfully market potential new products could have a material adverse effect on our business, financial condition and results of operations.
Economic, political and other risks associated with international sales and operations could adversely affect our sales.
Our revenues are derived from both domestic and international sales. During the fiscal years ended June 30, 2014 and 2013, international sales represented approximately 76% and 88%, respectively, of our revenue. During the fiscal year ended June 30, 2014, a customer from Japan and a Taiwanese customer represented 18% and 11%, respectively, of our revenue. For the fiscal year ended June 30, 2013, a customer from India and a customer from France represented approximately 48% and 10% of our revenue, respectively.
Although we anticipate increased U.S. market penetration as a result of TSA qualification, we also expect that revenues from international operations will continue to represent a substantial portion of our total revenue. Accordingly, our future results could be impacted by a variety of factors, including:
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changes in foreign currency exchange rates;
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changes in a country’s or region’s political or economic conditions, particularly in developing or emerging markets;
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potentially longer payment cycles of foreign customers and difficulty of collecting receivables in foreign jurisdictions;
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trade protection measures and import or export licensing requirements;
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U.S. government sanctions which prohibit the issuance of export licenses and the export of our products;
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differing legal and court systems;
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differing tax laws and changes in those laws;
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differing protection of intellectual property and changes in that protection; and
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different regulatory requirements and changes in those requirements.
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Our explosives detection products and technologies may not be accepted by government agencies or commercial consumers of security products, which could harm our future financial performance.
There can be no assurance that our explosives detection systems will generally achieve wide acceptance by government agencies, commercial consumers of security products, and market acceptance. The degree of market acceptance for our explosives detection products and services will also depend upon a number of factors, including the receipt and timing of regulatory approvals and the establishment and demonstration of the ability of our proposed device to detect trace explosives residues on personnel, baggage and other cargo. Our failure to develop a commercial product to compete successfully with respect to throughput, the ability to scan personnel, baggage and other cargo, and portability could delay, limit or prevent market acceptance. Moreover, the market for explosives detection systems, especially trace detection, is largely undeveloped, and we believe that the overall demand for explosives detection systems technology will depend significantly upon public perception of the risk of terrorist attacks. There can be no assurance that the public will perceive the threat of terrorist attacks to be substantial or that governmental agencies and private-industry will actively pursue explosives detection systems technology. Long-term market acceptance of our products and services will depend, in part, on the capabilities, operating features and price of our products and technologies as compared to those of other available products and services. As a result, there can be no assurance that currently available products, or products under development for commercialization, will be able to achieve market penetration, revenue growth or profitability.
If we cannot obtain the additional capital required to fund our operations on favorable terms, or at all, we may have to delay or reconsider our growth strategy.
Our growth strategy may require additional capital for, among other purposes, completing acquisitions of companies and customers’ product lines and manufacturing assets, integrating acquired companies and assets, acquiring new equipment and maintaining the condition of existing equipment. If cash generated internally is insufficient to fund capital requirements, or if we desire to make additional acquisitions, we will require additional debt or equity financing. Adequate financing may not be available or, if available, may not be available on terms satisfactory to us. If we raise additional capital by issuing equity or convertible debt securities, the additional securities will dilute the share ownership of our existing investors. In addition, we may grant future investors rights that are superior to those of our existing investors. If we fail to obtain sufficient additional capital in the future, we could be forced to curtail our growth strategy by reducing or delaying capital expenditures and acquisitions, selling assets or restructuring or refinancing our indebtedness.
We depend on outside suppliers and subcontractors, and our production and reputation could be harmed if they are unable to meet our volume and quality requirements and alternative sources are not available.
We have various “sole-source” suppliers who supply key components for our products. Our outside suppliers may fail to develop and supply us with products and components on a timely basis, or may supply us with products and components that do not meet our quality, quantity or cost requirements. If any of these problems occur, we may be unable to obtain substitute sources of these products and components on a timely basis or on terms acceptable to us, which could harm our ability to manufacture our own products and components profitably or on time, and to ship products to customers on time and generate revenues. In addition, if the processes that our suppliers use to manufacture products and components are proprietary, we may be unable to obtain comparable components from alternative suppliers.
We depend on a contract manufacturer, and our production and products could be harmed if it is unable or unwilling to meet our volume and quality requirements and alternative sources are not available.
We rely on a single contract manufacturer to provide manufacturing services for our handheld QS-H150 explosives detection products. If these services become unavailable, we would be required to identify and enter into an agreement with a new contract manufacturer or take the manufacturing in-house. From time to time in fiscal 2014, this manufacturer has limited the number of detectors it would manufacture due to our inability to pay for the detectors on a timely basis. In addition, this manufacturer has required that we prepay for materials and component parts in advance of procurement. The refusal to manufacture detectors for a substantial period, or the loss of our contract manufacturer altogether, could significantly disrupt production as well as increase the cost of production, thereby increasing the prices of our products. These changes could have a material adverse effect on our business and results of operations.
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We may not be able to protect our intellectual property rights.
Our ability to compete is affected by our ability to protect our intellectual property rights. We rely on a combination of patents, trademarks, copyrights, trade secrets, confidentiality procedures and non-disclosure and licensing arrangements to protect our intellectual property rights. Despite these efforts, we cannot be certain that the steps we take to protect our intellectual property will be adequate to prevent misappropriation of our technology or protect that proprietary information. We cannot assure you that any pending or future patent applications will be approved, or that any issued patents will not be challenged by third parties. The validity and breadth of claims in technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. Nor can we assure you that, if challenged, our patents will be found to be valid or enforceable, or that the patents of others will not have an adverse effect on our ability to do business. Although 76% of our revenue in fiscal 2014 was derived from international sales, we do not have any patents or patents pending outside of the United States. Moreover, the enforcement of laws protecting intellectual property in some of the countries in which we sell our products may be inadequate to protect our technology and proprietary information.
We may not have the resources to assert and protect our rights in our patents and other intellectual property. Any litigation or proceedings relating to our intellectual property rights, whether or not determined in our favor or settled by us, is costly and may divert the efforts and attention of our management and technical personnel.
We also rely on unpatented proprietary technology, trade secrets and know-how and no assurance can be given that others will not independently develop substantially equivalent proprietary information, techniques or processes, that such technology or know-how will not be disclosed or that we can meaningfully protect our rights to such unpatented proprietary technology, trade secrets, or know-how. Although we have entered into non-disclosure agreements with our employees and consultants, there can be no assurance that such non-disclosure agreements will provide adequate protection for our trade secrets or other proprietary know-how.
Our success will depend on our ability to obtain new patents and to operate without infringing on the proprietary rights of others.
Although we have fifteen United States patents issued and six United States patent applications pending for our explosives detection technology and processes, our success will depend, in part, on our ability to obtain the patents applied for and maintain trade secret protection for our technology and operate without infringing on the proprietary rights of third parties. No assurance can be given that any pending or future patent applications will issue as patents, that the scope of any patent protection obtained will be sufficient to exclude competitors or provide competitive advantages to us, that any of our patents will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held by us.
Furthermore, there can be no assurance that our competitors have not or will not independently develop technology, processes or products that are substantially similar or superior to ours, or that they will not duplicate any of our products or design around any patents issued or that may be issued in the future to us. In addition, whether or not patents are issued to us, others may hold or receive patents which contain claims having a scope that covers products or processes developed by us.
We may not have the resources to adequately defend any patent infringement litigation or proceedings. Any such litigation or proceedings, whether or not determined in our favor or settled by us, is costly and may divert the efforts and attention of our management and technical personnel. In addition, we may be required to obtain licenses to patents or proprietary rights from third parties. There can be no assurance that such licenses will be available on acceptable terms if at all. If we do not obtain required licenses, we could encounter delays in product development or find that the development, manufacture or sale of products requiring such licenses could be foreclosed. Accordingly, challenges to our intellectual property, whether or not ultimately successful, could have a material adverse effect on our business and results of operations.
Our future success depends on the continued service of management, engineering and sales personnel and our ability to identify, hire and retain additional personnel.
Our success depends, to a significant extent, upon the efforts and abilities of members of senior management. The loss of the services of one or more of our senior management or other key employees could adversely affect our business. We do not maintain key person life insurance on any of our officers, employees or consultants, with the exception of our Chief Executive Officer, for whom such a policy is maintained.
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There is intense competition for qualified employees in the security industry, particularly for highly skilled design, applications, engineering and sales people. We may not be able to continue to attract and retain technologists, managers, or other qualified personnel necessary for the development of our business or to replace qualified individuals who could leave us at any time in the future. Our anticipated growth is expected to place increased demands on our resources, and will likely require the addition of new management and engineering staff as well as the development of additional expertise by existing management employees. If we lose the services of or fail to recruit engineers or other technical and management personnel, our business could be harmed.
Periods of rapid growth and expansion could place a significant strain on our resources, including our employee base.
To manage any future growth effectively, we will be required to continue to improve our operational, financial and management systems. In doing so, we will periodically implement new software and other systems that will affect our internal operations regionally or globally.
Future growth would also require us to successfully hire, train, motivate and manage our employees. In addition, our continued growth and the evolution of our business plan will require significant additional management, technical and administrative resources. We may not be able to effectively manage the growth and evolution of our current business.
We are exposed to product liability claims that could place a substantial financial burden on us if we are sued.
The development and sale of explosives detection products entails an inherent risk of product liability. For example, if our products fail to adequately detect explosives, if we are unable to train technicians to properly use our products, or if the market determines or concludes that any of our products are not safe or effective for any reason, we may be exposed to product liability claims. We currently carry product liability insurance. No assurances can be given, however, that our product liability insurance will be adequate to pay any claims that might arise. A product liability claim, whether meritorious or not, could be time-consuming, distracting and expensive to defend, could be harmful to our reputation, could result in a diversion of management and financial resources away from our primary business and could result in product recalls. In any such case, there could be a material adverse effect on our business and results of operations and our business could fail.
We use hazardous materials in our research and manufacturing activities. Any liability resulting from the misuse of such hazardous materials could adversely affect our business.
Our research and manufacturing activities sometimes involve the use of various hazardous materials. Although we believe that our safety procedures for handling, manufacturing, distributing, transporting and disposing of such materials comply with the standards for protection of human health, safety, and the environment prescribed by local, state, federal and international regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. Nor can we eliminate the risk that one or more of our hazardous material or hazardous waste handlers may cause contamination for which, under laws imposing strict liability, we could be held liable. While we currently maintain insurance in amounts which we believe are appropriate in light of the risk of accident, we could be held liable for any damages that might result from any such event. Any such liability could exceed our insurance and available resources and could have a material adverse effect on our business and results of operations.
We incur substantial costs to operate as a public reporting company.
We incur substantial legal, financial, accounting and other costs and expenses to operate as a public reporting company. We believe that these costs are a disproportionately larger percentage of our revenues than they are for many larger companies. In addition, the rules and regulations of the Securities and Exchange Commission impose significant requirements on public companies, including ongoing disclosure obligations and mandatory corporate governance practices. Our limited senior management and other personnel need to devote a substantial amount of time to ensure ongoing compliance with these requirements. Our common stock is currently quoted on the OTC Bulletin Board and on OTC Markets Group’s OTCQB tier. Neither the OTC Bulletin Board nor OTC Markets Group’s OTCQB tier impose any specific quotation requirements other than that issuers must be current in their reporting to the Securities and Exchange Commission and, in the case of the OTCQB, a minimum bid price of $0.01 per share. If we are successful in listing our stock for trading on a national securities exchange or having our stock quoted on the Nasdaq Stock Market, we will be subject to additional disclosure and governance obligations. There can be no assurance that we will continue to meet all of the public company requirements to which we are subject on a timely basis, or at all, or that our compliance costs will not continue to be material.
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We have significant net operating loss carry forwards which may be impaired if we have a significant change in the stockholder base.
As of June 30, 2014, we had federal and state net operating loss carry forwards available to offset future taxable income of approximately $90,501,000 expiring between 2022 and 2034, and $61,377,000, expiring between 2015 and 2029, respectively. In the event that an “ownership change” occurs for purposes of Section 382 of the Internal Revenue Code, our ability to use these losses to offset future taxable income could be significantly limited. Any such limitation may result in the expiration of a portion of the carry forwards before we can use them. In general, an “ownership change” occurs if there is a change in ownership of more than 50% of our common stock during any cumulative three-year period. For this purpose, determinations of ownership changes are generally limited to shareholders deemed to own 5% or more of our common stock. Such a change in ownership may be triggered by regular trading activity in our common stock, which is generally beyond our control. We have not completed a study to assess whether one or more ownership changes have occurred since we became a loss corporation as defined in Section 382, but we believe that it is likely that an ownership change has occurred. If we are able to refinance our secured indebtedness or otherwise raise capital by issuing common stock or other securities that are convertible into common stock, a further “ownership change” may become more likely.
Risks Related to Competition
We may not be able to compete effectively against existing or new competitors.
We believe that our ability to compete in the explosive detection systems market is based upon such factors as: product performance, functionality, quality and features; quality of customer support services, documentation and training; and the capability of the technology to appeal to broader applications beyond the inspection of passengers, baggage, and cargo carried on airlines. Our competitors may have advantages over our existing technology with respect to these factors. There can be no assurance that we will be successful in convincing potential customers that our products will be superior to other systems given all of the necessary performance criteria, that new systems with comparable or greater performance, lower price and faster or equivalent throughput will not be introduced, or that, if such products are introduced, customers will not delay or cancel potential orders. Further, there can be no assurance that we will be able to bring to commercialization and further enhance our product to better compete on the basis of cost, throughput, accommodation of detection of passengers, baggage or other cargo carried onto airlines, or that we will otherwise be able to compete successfully with existing or new competitors.
Moreover, there can be no assurance that we will be able to price our products and services at or below the prices of competing products and technologies in order to facilitate market acceptance. Accordingly, our success will depend, in part, on our ability to respond quickly to technological changes through the development and introduction of new products and enhancements. Product development involves a high degree of risk, and there can be no assurance that our new product development efforts will result in any commercially successful products. Our failure to compete or respond to technological change in an effective manner would have a material adverse effect on our business and results of operations.
We may face pricing pressures that could prevent us from maintaining the prices of our products.
The sales process for our security products is typically a result of a request for quotations or tenders that are subjected to significant and time-consuming scrutiny prior to the determination of an award. In addition, we face aggressive cost-containment pressures from governmental agencies and the bidding process commonly involves several competitors, many of whom have greater financial and other resources that may enable them to submit bids at prices that might be significantly lower than the prices we may be able to offer. There can be no assurances that we will be able to maintain current prices in the face of continuing pricing pressures. Over time, the average price for our products may decline as the markets for these products become more competitive. Any material reduction in product prices could negatively affect our gross margin, necessitating a corresponding increase in unit sales to maintain any given level of sales.
Risks Related to Our Securities
Because our common stock is not traded on a national securities exchange or quoted on the Nasdaq Stock Market, our stock has limited liquidity and our ability to raise capital is impaired.
Our common stock was delisted by the NYSE Amex LLC in June 2009. 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.
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Our stock price is volatile.
The market price of our common stock has fluctuated significantly to date. In the past fiscal year, our stock price ranged from $0.72 to $1.30. The market price of our common stock may also fluctuate significantly in the future due to:
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variations in our actual or expected quarterly operating results;
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our ability to obtain necessary government approvals for our products;
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announcements or introductions of new products by us or by our competitors;
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technological innovations by our competitors or development setbacks by us;
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the commencement or adverse outcome of litigation;
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changes in analysts’ estimates of our performance or changes in analysts’ forecasts regarding our industry, competitors or customers;
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announcements of acquisitions or acquisition transactions; or
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general economic and market conditions.
In addition, the stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many security product companies. These fluctuations have often been unrelated or disproportionate to the operating performance of companies in our industry, and could harm the market price of our common stock.
Additional authorized shares of our common stock and preferred stock available for issuance may adversely affect the market.
We are authorized to issue 200,000,000 shares of our common stock. As of June 30, 2014, there were 63,634,171 and 63,623,626 shares of common stock issued and outstanding, respectively. However, the total number of shares of our common stock issued and outstanding does not include shares reserved in anticipation of the exercise of options, warrants, convertible debt instruments and convertible preferred stock. As of June 30, 2014, we had outstanding stock options and warrants to purchase approximately 21,929,176 shares of our common stock, the exercise price of which range between $0.08 per share to $10.00 per share, and we have reserved shares of our common stock for issuance in connection with the potential exercise of these instruments. As of June 30, 2014, the outstanding balance due under the senior secured convertible promissory notes issued to DMRJ and accrued and unpaid interest was $34,552,000, of which a $3,184,000 senior secured promissory and $2,175,288 of accrued and unpaid interest are convertible into shares of our common stock at $0.08 per share; a $12,000,000 senior convertible promissory note and $3,320,000 of accrued and unpaid interest is convertible into shares of Series H Convertible Preferred Stock, which preferred stock is convertible into shares of our common stock at $1.09 per share; and a $12,000,000 senior secured promissory note and $1,873,000 of accrued and unpaid interest is convertible into shares of Series I Convertible Preferred Stock, which preferred stock is convertible into shares of our common stock at $1.18 per share. To the extent such options, warrants or convertible notes are exercised or converted, and to the extent that additional shares are issued under strategic advisory agreements, the holders of our common stock will experience further dilution. Stockholders will also experience dilution upon the exercise of options that may be granted in the future under our stock option plans. In addition, in the event that any future financing or consideration for a future acquisition should be in the form of, be convertible into or exchangeable for, equity securities investors will experience additional dilution.
The exercise of our outstanding options and warrants, the conversion of convertible debt instruments and the issuance of shares of common stock under our advisory agreements will reduce the percentage of common stock held by our current stockholders. Further, the terms on which we could obtain additional capital during the life of the derivative securities may be adversely affected, and it should be expected that the holders of the derivative securities would exercise them at a time when we would be able to obtain equity capital on terms more favorable than those provided for by such derivative securities. As a result, any issuance of additional shares of common stock may cause our current stockholders to suffer significant dilution which may adversely affect the market.
In addition, we are authorized to issue 114,000 additional shares of preferred stock. Although we have no present plans to issue any additional shares of preferred stock, our Board of Directors has the authority, without stockholder approval, to create and issue one or more series of such preferred stock and to determine the voting, dividend and other rights of holders of such preferred stock, including the ratio or ratios at which any such shares of preferred stock may be convertible into common stock. The issuance of any of such series of preferred stock may cause the holders of our common stock to experience substantial further dilution and other adverse effects and could make a takeover of our company more difficult.
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Shares eligible for future sale may adversely affect the market.
From time to time, certain of our stockholders who acquired their shares directly from our company in privately negotiated transactions may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to effective registration statements under the Securities Act of 1933 and under Rule 144, promulgated under the Securities Act. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a six-month holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitation, by our stockholders that are non-affiliates that have satisfied a one-year holding period. Any substantial sale of our common stock pursuant to Rule 144 or pursuant to any resale registration statement may have material adverse effect on the market price of our securities.
There are limitations on director and officer liability which may limit our stockholders’ rights to recover for breaches of fiduciary duty.
As permitted by Massachusetts law, our Restated Articles of Organization, as amended, limit the liability of our directors for monetary damages for breach of a director's fiduciary duties except in certain instances. As a result of these limitations and Massachusetts law, stockholders may have limited rights to recover against directors for breaches of their fiduciary duties. In addition, our bylaws provide that we will indemnify our directors, officers, employees and agents if such persons acted in good faith and reasoned that their conduct was in our best interest.
The anti-takeover provisions of our Restated Articles of Organization and Massachusetts law may delay, defer or prevent a change of control.
Our Board of Directors has the authority to issue up to 114,000 additional shares of preferred stock and to determine the price, rights, preferences and privileges and restrictions, including voting rights, of those shares without any further vote or action by our stockholders. The rights of the holders of common stock will be subject to, and may be harmed by, the rights of the holders of the various series of preferred stock that we have issued to date and which may be issued in the future. The issuance of preferred stock may delay, defer or prevent a change in control because the terms of any issued preferred stock could potentially prohibit our consummation of any acquisition, reorganization, sale of substantially all of our assets, liquidation or other extraordinary corporate transaction, without the approval of the holders of the outstanding shares of preferred stock.
Our stockholders must give substantial advance notice prior to the relevant meeting to nominate a candidate for director or present a proposal to our stockholders at a meeting. These notice requirements could inhibit a takeover by delaying stockholder action. Massachusetts law may also discourage, delay or prevent someone from acquiring or merging with us.
A secured lender and our directors and executive officers have the right to acquire a majority of our shares through the conversion or exercise of other securities, which may delay, defer or prevent a change of control and/or will limit the ability of other stockholders to influence corporate matters.
As of September 23, 2014, DMRJ, one of our secured lenders, has the right to acquire up to 92,312,970 shares of our common stock upon the conversion debt and interest. Our directors and executive officers own, or have the right to exercise options within 60 days to acquire, up to 16,456,500 shares of our common stock. If all of these shares of common stock are issued, DMRJ and our directors and executive officers would own approximately 62.7% of our outstanding common stock. Accordingly, these stockholders could have a significant influence over, or have absolute control over, the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets and also could prevent or cause a change in control. The interests of these stockholders may differ from the interests of our other stockholders. Third parties may be discouraged from making a tender offer or bid to acquire us because of this concentration of ownership.
We have never paid dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future.
We have paid no cash dividends on our common stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, our agreements with our secured lenders prohibit the payment of cash dividends. As a result, capital appreciation, if any, of our common stock will be shareholders’ sole source of gain for the foreseeable future.
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Item 1B.
Item 1B.
Unresolved Staff Comments
Not Applicable.
Item 2.
Item 2.
Properties
We operate out of three locations. Our corporate offices are located in an approximately 58,000 square foot leased facility in Wilmington, Massachusetts. In addition to our corporate offices, this facility houses research and development, sales and marketing, and production. Our current lease expires in June 2020. We lease approximately 2,000 square feet of research and office space in San Diego, California, under a lease expiring in March 2016 and lease 300 square feet of office space in Shanghai, China, under a lease expiring in November 2014. We believe that each of these facilities is suitable for our anticipated requirements.
Item 3.
Item 3.
Legal Proceedings
In January 2011, Fulong Integrated Technique, Ltd. filed a complaint against us in the Middlesex Superior Court of the Commonwealth of Massachusetts, alleging non-payment of amounts owed for services provided to us in connection with the sale of handheld explosives detection equipment to a customer in China in the first quarter of fiscal 2009. Fulong sought general monetary damages, other statutory damages, attorneys’ fees and costs.
In March 2013, we entered into a settlement agreement with Fulong, which provided for the payment of $200,000 and the transfer of ownership of five QS-H150 detectors to Fulong. We recognized a non-cash benefit of $295,000 in general and administrative expenses in the year ended June 30, 2013 as a result of the settlement.
We may, from time to time, be involved in 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 4.
Item 4.
Mine Safety Disclosures
Not Applicable.
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PART II
Item 5.
Item 5.
Market Information for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock traded on the NYSE Amex LLC (formerly, the American Stock Exchange) under the symbol “IMX” until June 2009 and was delisted by the NYSE Amex on September 22, 2009. Our common stock has been quoted on the Over-The-Counter-Bulletin Board since May 2009 and is also quoted on the OTC Markets Group’s OTCQB tier under the symbol “IMSC”. The following table sets forth the high and low bid quotations for our common stock for each of the last two fiscal years, as reported on the OTC Bulletin Board. Quotations from the OTC Bulletin Board reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of September 23, 2014, we had approximately 132 stockholders of record. The last sale price as reported on the OTC Bulletin Board on September 23, 2014, was $1.27. We have never paid a cash dividend on our common stock and do not anticipate the payment of cash dividends in the foreseeable future. In addition, our agreements with our secured lenders prohibit the payment of cash dividends.
Securities Authorized for Issuance under Equity Compensation Plans as of the End of Fiscal 2014
Equity Compensation Plan Information
The table below sets forth certain information as of June 30, 2014 with respect to equity compensation plans under which our common stock is authorized for issuance:
_______________
(1)
This total includes shares to be issued upon exercise of outstanding options under the equity compensation plans that have been approved by our stockholders (i.e., our 2000 Incentive and Non-Qualified Stock Option Plan and our 2004 Stock Option Plan). Our 2004 Stock Option Plan has been approved by our stockholders, however a September 2012 amendment to the plan increasing the number of shares issuable under the plan from 4,000,000 shares to 20,000,000 shares, has not been approved by our stockholders.
(2)
Our 2000 Incentive and Non-Qualified Stock Option Plan expired in October 2010 and our 2004 Stock Option Plan expired in May 2014. In July 2014, we adopted our 2014 Stock Option Plan and reserved 15,000,000 shares of common stock for issuance thereunder. The 2014 Stock Option Plan has not been approved by our stockholders.
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Recent Sales of Unregistered Securities
In April 2014 and September 2014, DMRJ converted $116,000 and $212,000, respectively, of the accrued interest owed by us under a promissory note into 1,450,000 and 2,650,000 shares, respectively, of our common stock, at an adjusted conversion price of $0.08 per share. The issuance of these securities to DMRJ is exempt from registration under the Securities Act of 1933, as amended, pursuant to an exemption provided by Section 3(a)(9) and/or Section 4(2) of the Securities Act.
Item 6.
Item 6.
Selected Financial Data
Not Applicable.
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Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview
Since our incorporation in 1984, we have operated as a multi-faceted company engaging in the development of ion-based technologies and providing commercial services and products to the semiconductor, medical device and security industries. In fiscal 2009, we completed the divestiture of our semiconductor and medical business activities in order to focus on our security business.
Since 1999, we have been performing research to improve explosives trace detection (“ETD”) technology, and developing ETD products which can be used for detection of trace amounts of explosives. More recently, we have adapted this technology for the detection of narcotics (“NDT”). We now develop, manufacture and sell sophisticated sensors and systems for the security, safety and defense industries. We have developed handheld ETD systems, which have been marketed and sold both domestically and internationally, and a desktop ETD and NTD system which we began shipping commercially in the third quarter of fiscal 2012. 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.
Critical Accounting Policies
Our significant accounting policies are described in Note 2 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the fiscal year ended June 30, 2014. Our discussion and analysis of our financial condition and results of operations are based upon these financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, product returns, inventories, investments, derivative liabilities, conversion features of our debt agreements and warranty obligations. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. In the past, actual results have not been materially different from our estimates. However, results may differ from these estimates under different assumptions or conditions.
We have identified the following as critical accounting policies, based on the significant judgments and estimates used in determining the amounts reported in our financial statements:
·
Revenue Recognition. We recognize revenue when there is persuasive evidence of an arrangement with the customer that states a fixed or determinable price and terms, delivery of the product has occurred or the service performed is in accordance with the terms of the arrangement, and collectibility of the sale is reasonably assured. Revenues for which we have received payment, but are due to obligations under the sales agreement, are reflected on our balance sheet as deferred revenues.
·
Accounts Receivable and Allowance for Doubtful Accounts. We maintain allowances for estimated losses resulting from the inability of our customers to make required payments. Judgments are used in determining the allowance for doubtful accounts and are based on a combination of factors. Such factors include historical collection experience, credit policy and specific customer collection issues. In circumstances where we are aware of a specific customer’s inability to meet its financial obligations to us (e.g., due to a bankruptcy filing), we record a specific reserve for bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. We perform ongoing credit evaluations of our customers and continuously monitor collections and payments from our customers. While actual bad debts have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same bad debt rates that we have in the past. A significant change in the liquidity or financial position of any of our customers could result in the uncollectibility of the related accounts receivable and could adversely impact our operating cash flows in that period.
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·
Inventories. 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. In assessing the ultimate realization of inventories, management judgment is required to determine the reserve for obsolete or excess inventory. Inventory on hand may exceed future demand either because the product is obsolete, or because the amount on hand is more than can be used to meet future needs. We provide for the total value of inventories that we determine to be obsolete or excess based on criteria such as customer demand and changing technologies. We historically have not experienced significant inaccuracies in computing our reserves for obsolete or excess inventory.
·
Warranties. We provide for the estimated cost of product warranties at the time revenue is recognized. We record an estimate for warranty related costs at the time of sale based on our actual historical return rates and repair costs. While our warranty costs have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same warranty return rates or repair costs that we have in the past. A significant increase in warranty return rates or costs to repair our products could have a material adverse impact on our operating results for the period or periods in which such returns or additional costs materialize.
·
Income Taxes. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. We have recorded a full valuation allowance against our net deferred tax assets of $42,116,000 as of June 30, 2014, 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. In the event that actual results differ from these estimates or we adjust these estimates in future periods we may need to adjust our valuation allowance which could materially impact our financial position and results of operations.
·
Equity Transactions. We evaluate the proper classification of our equity instruments that embody an unconditional obligation requiring the issuer to redeem it by transferring assets at a determinable date or that contain certain conditional obligations, typically classified as equity, be classified as a liability. We record financing costs associated with our capital raising efforts in our statements of operations. These include amortization of debt issue costs such as cash, warrants and other securities issued to finders and placement agents, and amortization of preferred stock discount created by in-the-money conversion features on convertible debt and allocates the proceeds amongst the securities based on relative fair values or based upon the residual method. We based our estimates and assumptions on the best information available at the time of valuation, however, changes in these estimates and assumptions could have a material effect on the valuation of the underlying instruments.
·
Stock-Based Compensation. We account for employee and non-employee director stock-based compensation using the fair value method of accounting. Compensation cost arising from stock options to employees and non-employee directors is recognized using the straight-line method over the vesting period, which represents the requisite service or performance period. The calculation of stock-based compensation requires us to estimate several factors, most notably the term, volatility and forfeitures. We estimate the option term using historical terms and estimate volatility based on historical volatility of our common stock over the option’s expected term. Expected forfeitures based on historical forfeitures in calculating the expense related to stock-based compensation associated with stock awards. Our estimates and assumptions are based on the best information available at the time of valuation, however, changes in these estimates and assumptions could have a material effect on the valuation of the underlying instruments.
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Results of Operations
For the Year Ended June 30, 2014 vs. June 30, 2013
Revenues
Revenues for the year ended June 30, 2014 were $8,552,000 as compared with $12,017,000 for the comparable prior year period, a decrease of $3,465,000, or 28.8%. The decrease in revenue is due primarily to a 55.4% decrease in the number of QS-H150 handheld units sold in the year ended June 30, 2014, primarily due to the shipment of QS-H150 handheld units under our contract with the India Ministry of Defence in the year ended June 30, 2013, which resulted in a 57.5% decrease in QS-H150 revenues, and, to a lesser extent, decreased sales of parts and supplies in the year ended June 30, 2014, as compared to the comparable prior year period, and a 4.7% decrease in the average unit sell prices on sales of our QS-H150 handheld units, partially offset by a 210.3% increase in the number of QS-B220 desktop units sold in the year ended June 30, 2014, due to increased shipments to U.S. air cargo screening facilities, increased shipments into Latin America, Europe and agencies of the U.S. government, which resulted in a 207.6% increase in QS-B220 revenues.
Cost of Revenues
Cost of revenues for the year ended June 30, 2014 were $6,498,000 as compared with $8,588,000 for the comparable prior year period, a decrease of $2,090,000 or 24.3%. The decrease in cost of revenues recorded in the year ended June 30, 2014 is primarily due to decreased unit sales of our QS-H150 handheld units and a $664,000 decrease in stock-based compensation recorded on stock option grants to officers and directors in September 2012, partially offset by a $796,000 increase in manufacturing overhead due to an increase in manufacturing personnel costs and increased occupancy costs, as compared to the prior year period and a $160,000 increase in our provision for obsolete inventories.
Gross Margin
Gross margin for the year ended June 30, 2014 was $2,054,000 or 24.0% of revenues as compared with $3,429,000 or 28.5% of revenues for the comparable prior year period. The decrease in gross margin as a percent of revenues is primarily the result of increased manufacturing overhead due to a $796,000 increase in manufacturing personnel costs and increased occupancy costs, a $160,000 increase in our provision for obsolete inventory, partially offset by the $664,000 decrease in stock-based compensation recorded on stock option grants to officers and directors in September 2012, as compared to the prior year period.
Research and Development Expense
Research and development expense for the year ended June 30, 2014 was $4,787,000 as compared with $4,754,000 for the comparable prior year period, an increase of $33,000 or 0.7%. The increase in research and development expense is due primarily to a $360,000 increase in payroll and related benefit costs, a $194,000 increase in occupancy costs, a $54,000 increase in government testing fees and a $82,000 increase in prototype expense, offset partially by a $626,000 decrease in stock-based compensation recorded on the September 2012 officer and director option grants and a $32,000 decrease in material costs. We continue to expend funds to further the development of new products in the areas of explosives and narcotics detection, as well as expenses incurred to obtain the necessary approvals from the TSA and other non-U.S. government approvals. Spending on research and development will increase in the next nine to twelve months due to the ongoing development of the QS-B220 desktop detector, the development of the QS-H150E portable explosives and narcotics detector and continued development of a hyphenated system employing conventional ion mobility, differential mobility and quadrupole mass spectrometry.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses for the year ended June 30, 2014 were $11,388,000 as compared with $20,630,000 for the comparable prior year period, a decrease of $9,242,000, or 44.8%. The decrease in selling, general and administrative expenses is due primarily to a $9,969,000 decrease in stock-based compensation recorded on the September 2012 officer and director option grants, the imposition of liquidated damages of $298,000 under our contract with the India Ministry of Defence in the prior year period, a $174,000 decrease in bank charges, a $261,000 decrease in legal expenses, offset partially by a $399,000 increase in payroll, related benefit costs and travel expense resulting from the addition of sales personnel, a $649,000 increase in occupancy costs, due to the relocation of our corporate offices, the $295,000 benefit recognized as a result of the litigation settlement with Fulong in the prior year period, a $297,000 increase in stock-based compensation on non-employee warrants, a $62,000 increase in variable selling expenses due to increased non-employee sales commissions, a $191,000 increase in selling expenses due to the opening of our Shanghai representative office, increased participation at industry trade shows and an increase in demonstration units provided to our sales force and a $64,000 increase in depreciation expense.
Other Expense, net
For the year ended June 30, 2014, other expense was $6,889,000 as compared with other expense of $5,399,000, for the comparable prior year period, an increase of $1,490,000. The increase is due to increased interest expense on higher borrowings under our credit facilities.
Net Loss
Our net loss for the year ended June 30, 2014 was $21,010,000 as compared with a net loss of $27,354,000 for the comparable prior year period, a decrease of $6,344,000, or 23.2%. The decrease in the net loss is primarily due to the decrease in stock-based compensation recorded on the September 2012 officer and director option grants in the year ended June 30, 2014, partially offset by increased operating expenses and increased interest expense.
Liquidity and Capital Resources
As of June 30, 2014, we had cash of approximately $391,000, an increase of $311,000 when compared with cash of $80,000 at June 30, 2013.
On March 31, 2015, we must repay in full our obligations to DMRJ under four secured promissory notes and a revolving credit facility. Our obligations to DMRJ are secured by security interests in substantially all of our assets. As of June 30, 2014, our obligations to DMRJ under the promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $2,995,000, respectively. Further, as of June 30, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $8,283,000 and is included in current liabilities in the consolidated financial statements.
As of September 23, 2014, our obligations to DMRJ the promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $5,253,000, respectively. Further, as of September 23, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $9,235,000, reflecting increased borrowing under the revolving credit facility to fund working capital due to increased working capital requirements.
On March 31, 2015, we must repay in full our obligations under the senior secured promissory notes for which BAM is the agent. Our obligations to the investors are secured by security interests in substantially all of our assets. As of June 30, 2014, our obligations under these promissory notes were $20,000,000. Further, as of June 30, 2014, our obligation under such notes for accrued interest amounted to $867,000 and is included in current liabilities in the consolidated financial statements.
As of September 23, 2014, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of September 23, 2014, our obligation under such notes for accrued interest approximated $717,000.
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During the year ended June 30, 2014, we had net cash outflows of $9,989,000 from operating activities as compared to net cash outflows from operating activities of $10,890,000 for the comparable prior year period. The $901,000 decrease in net cash outflows used in operating activities during the year ended June 30, 2014, as compared to the comparable prior year period, was due to the following changes in working capital: (i) a $669,000 decrease in accounts receivable, compared to a $1,035,000 increase in the prior period, due to the timing of our product shipments during the year ended June 30, 2012; (ii) a $723,000 increase in inventories compared to a $1,048,000 decrease in the prior period, due primarily to the November 2012 shipment of our order with India Ministry of Defence and increased QS-B220 inventory; (iii) an increase in accrued expenses of $4,703,000, compared to a $2,569,000 increase in the prior period, due to primarily to increased accruals for unpaid interest on borrowings from our secured lenders; (iv) a $516,000 increase in deferred revenue, compared to a $972,000 decrease in deferred revenue in the prior year period, due primarily to the release of the India Ministry of Defence advance deposit due to the November 2012 shipment and increased deferrals of extended warranty revenues; (v) an $85,000 decrease in prepaid expenses, compared to a $455,000 decrease in prepaid expenses, due to the decreases in prepaid inventory; and, (vi) a $1,522,000 increase in accounts payable, compared to a $305,000 decrease in the prior period, due to increased operating expenses and increased inventories.
During the year ended June 30, 2014, we had net cash outflows of $287,000 from investing activities as compared to net cash inflows of $710,000 from investing activities for the prior year period. The $997,000 increase in net cash used in investing activities during the year ended June 30, 2014, as compared to the prior year period, was primarily due to the receipt of $121,000 in restricted funds, compared to the receipt of restricted funds of $841,000 in the prior year period, primarily due to the cancelation of the letter of credit providing security for the India Ministry of Defence advance deposit resulted in the release of $937,000 held in a restricted deposit, by a $258,000 increase in purchases of equipment and fixtures, due to the July 2013 move to our new corporate offices and the build out of our manufacturing facility and a $19,000 decrease in proceeds from the sale of equipment.
During the year ended June 30, 2014 we had net cash inflows of $10,585,000 from financing activities as compared to net cash inflows of $10,176,000 from financing activities for the comparable prior year period. The $409,000 increase in net cash from financing activities during the year ended June 30, 2014, as compared to the comparable prior year period, was primarily due to the receipt of $20,000,000 under a note purchase agreement with several institutional investors, a $9,408,000 decrease in borrowings under our credit facility with DMRJ, compared to an increase in borrowings of $10,172,000 in the prior fiscal year, due to the repayment of the DMRJ line of credit from the BAM loan proceeds and a $30,000 increase in proceeds received due to the exercise of stock options, partially offset by a $41,000 increase in principal repayments of capital lease obligations.
Credit Facilities with DMRJ Group LLC and BAM
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.
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. 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 13 of Notes to Consolidated Financial Statements, accompanying this Annual Report. There can be no assurance that we will be successful in refinancing or extending our obligations to our secured lenders.
Our ability to comply with our debt covenants in the future depends on our ability to generate sufficient sales and to control expenses, and will require that we seek additional capital through private financing sources. 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, 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. The failure to refinance or otherwise 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 file for protection under bankruptcy laws.
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Any failure to comply with our debt covenants, to achieve our projections and/or obtain sufficient capital on acceptable terms would have a material adverse impact on our liquidity, financial condition and operations and could force us to curtail or discontinue operations entirely and/or file for protection under bankruptcy laws. Further, upon the occurrence of an event of default under certain provisions of our agreements with our secured lenders, 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.
Based on current sales, operating expense and cash flow projections, and the cash available from our line of credit, management believes there are plans in place to sustain operations for the next several months. These plans depend on a substantial increase in sales of our handheld trace explosives detector product and our desktop explosives and narcotics trade detector product. However, there can be no assurances that sales will materialize as forecasted, and/or that management will be successful in refinancing or extending our obligations to our secured lenders, which mature on March 31, 2015. To further sustain us, improve our cash position, and enable us to grow while reducing debt, management plans to continue to seek additional capital through private financing sources. However, there can be no assurance that management will be successful in executing these plans. Management will continue to closely monitor and attempt to control our costs and actively seek needed capital through sales of our products, equity infusions, government grants and awards, strategic alliances, and through our lenders.
Despite our current sales, expense and cash flow projections and the cash available from our line of credit with DMRJ, we will require additional capital in the third quarter of fiscal 2015 to fund operations and continue the development, commercialization and marketing of our products. Our failure to achieve our projections and/or obtain sufficient additional capital on acceptable terms would have a material adverse effect on our liquidity and operations and could require us to file for protection under bankruptcy laws. These conditions raise substantial doubt as to our ability to continue as a going concern.
Off-Balance Sheet Arrangements
As of June 30, 2014, we had two irrevocable standby letters of credit outstanding in the approximate amount of $595,000. These letters of credit (1) provide performance security equal to 5% of the amount of our contract with the India Ministry of Defence, and (2) provide warranty performance security equal to 5% of the contract amount, under the terms of the contract. We have amended each of the letters of credit, extending the expiration dates to November 4, 2014 and May 4, 2015, respectively.
As of June 30, 2014, 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, 2016, including interim reporting periods therein, 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.
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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 become 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. We are currently evaluating the impact of this accounting guidance and do not expect any significant 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 alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued (or available to be 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. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The following documents are filed as part of this report on Form 10-K
Page
Report of Marcum LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets at June 30, 2014 and 2013
Consolidated Statements of Operations for the years ended June 30, 2014 and 2013
Consolidated Statements of Stockholders’ Deficit for the years ended June 30, 2014 and 2013
Consolidated Statements of Cash Flows for the years ended June 30, 2014 and 2013
Notes to Consolidated Financial Statements
Item 9.
Item 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K 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 9A for a more complete understanding of the matters covered by such certifications.
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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 June 30, 2014. 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. Our Chief Executive Officer and Chief Financial Officer concluded that we did maintain effective internal control over financial reporting as of June 30, 2014 and further concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the interim or annual consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2014 based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. Based on this assessment, our management concluded that, as of June 30, 2014, our internal control over financial reporting was effective based on those criteria. This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that permit us to provide only management’s report in this Annual Report.
Changes in Internal Control Over Financial Reporting
There were no changes to our internal control over financial reporting during the fourth quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None.
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PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this Item 10 is incorporated by reference to our definitive proxy statement to be filed with the Commission on or before October 28, 2014.
Item 11.
Item 11.
Executive Compensation
The information required by this Item 11 is incorporated by reference to our definitive proxy statement to be filed with the Commission on or before October 28, 2014.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item 12 is incorporated by reference to our definitive proxy statement to be filed with the Commission on or before October 28, 2014.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by this Item 13 is incorporated by reference to our definitive proxy statement to be filed with the Commission on or before October 28, 2014.
Item 14.
Item 14.
Principal Accounting Fees and Services
The information required by this Item 14 is incorporated by reference to our definitive proxy statement to be filed with the Commission on or before October 28, 2014.
- 32 -
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
The following are filed as part of this Form 10-K:
(1)
Financial Statements: For a list of financial statements which are filed as part of this Annual Report on Form 10-K, see Page 27.
(2)
Exhibits
Exhibit No.
Ref. No.
Description
2.1
Xenation License Agreement and related Security Agreement, each dated June 30, 2008, between Implant Sciences Corporation and International Brachytherapy, s.a.
2.2
Ytterbium License Agreement and related Security Agreement, each dated June 30, 2008, between Implant Sciences Corporation and International Brachytherapy, s.a.
3.1
Restated Articles of Organization, as amended, of Implant Sciences Corporation.
3.2
Amended and Restated By-Laws of Implant Sciences Corporation.
4.1
Specimen certificate for the Common Stock of Implant Sciences Corporation.
10.1
1998 Incentive and Nonqualified Stock Option Plan.*
10.2
Form of Incentive Stock Option under the 1998 Incentive and Nonqualified Stock Option Plan.*
10.3
Form of Nonqualified Stock Option under the 1998 Incentive and Nonqualified Stock Option Plan.*
10.4
Form of Nonqualified Stock Option for Non-Employee Directors under the 1998 Incentive and Nonqualified Stock Option Plan.*
10.5
2000 Incentive and Non-Qualified Stock Option Plan of Implant Sciences Corporation.*
10.6
2004 Stock Option Plan of Implant Sciences Corporation, as amended through March 14, 2011.*
10.7
Amendment to 2004 Stock Option Plan of Implant Sciences Corporation, effective September 7, 2012.*
10.8
2006 Employee Stock Purchase Plan of Implant Sciences Corporation.*
10.9
Implant Sciences Corporation’s 2014 Stock Option Plan
10.10
Implant Sciences Corporation Change of Control Payment Plan.*
10.11
Amended and Restated Employment Agreement, dated as of June 25, 2013, between Implant Sciences Corporation and Glenn D. Bolduc.*
10.12
Employment Agreement between Implant Sciences Corporation and William McGann, dated March 19, 2012.*
10.13
Employment Agreement between Implant Sciences Corporation and Darryl Jones, dated May 7, 2012.*
10.14
Lease, dated December 11, 2008, between Implant Sciences Corporation and Wakefield Investments, Inc.
10.15
First Amendment, dated February 1, 2010, to Lease between Implant Sciences Corporation and Wakefield Investments, Inc.
10.16
Lease, dated April 1, 2013, between the Implant Sciences Corporation and Wakefield Investments, Inc.
10.17
Note and Warrant Purchase Agreement, dated as of December 10, 2008, between Implant Sciences Corporation and DMRJ Group LLC.
10.18
Senior Secured Convertible Promissory Note, dated December 10, 2008, in the principal amount of $5,600,000, issued by Implant Sciences Corporation to DMRJ Group LLC (superseded by Exhibit 10.24).
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10.19
Warrant to Purchase Shares of Common Stock, dated December 10, 2008, issued by Implant Sciences Corporation to DMRJ Group LLC (superseded by Exhibit 10.25).
10.20
Security Agreement, dated as of December 10, 2008, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.21
Patent Security Agreement, dated as of December 10, 2008, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.22
Guaranty, dated as of December 10, 2008, of the obligations of Implant Sciences Corporation by C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp. in favor of DMRJ Group LLC.
10.23
Letter Agreement, dated as of March 12, 2009, between Implant Sciences Corporation and DMRJ Group LLC.
10.24
Amended and Restated Senior Secured Convertible Promissory Note, dated December 10, 2008, in the principal amount of $5,600,000, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.25
Amended and Restated Warrant to Purchase Shares of Common Stock, dated March 12, 2009, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.26
First Amendment, dated July 1, 2009, to Note and Warrant Purchase Agreement, dated as of December 10, 2008, between Implant Sciences Corporation and DMRJ Group LLC.
10.27
Senior Secured Promissory Note, dated July 1, 2009, in the principal amount of $1,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.28
Credit Amendment, dated September 4, 2009, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation, IMX Acquisition Corp. and DMRJ Group LLC.
10.29
Promissory Note, dated September 4, 2009, in the maximum principal amount of $3,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC (superseded by Exhibit 10.34).
10.30
Security Agreement, dated as of September 4, 2009, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.31
Patent Security Agreement, dated as of September 4, 2009, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and DMRJ Group LLC, as secured party.
10.32
Guaranty, dated as of September 4, 2009, of the obligations of Implant Sciences Corporation by C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp. in favor of DMRJ Group LLC.
10.33
Omnibus Waiver and First Amendment to Credit Agreement and Third Amendment to Note and Warrant Purchase Agreement, dated as of January 12, 2010 between Implant Sciences Corporation and DMRJ Group LLC.
10.34
Amended and Restated Promissory Note, dated as of January 12, 2010, in the maximum principal amount of $5,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC (superseded by Exhibit 10.36).
10.35
Omnibus Second Amendment to Credit Agreement and Fourth Amendment to Note and Warrant Purchase Agreement, dated as of April 23, 2010 between Implant Sciences Corporation and DMRJ Group LLC.
10.36
Amended and Restated Promissory Note, dated as of April 23, 2010, and effective as of April 7, 2011, in the maximum principal amount of $10,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC (superseded by Exhibit 10.39).
- 34 -
10.37
Omnibus Third Amendment to Credit Agreement and Fifth Amendment to Note and Warrant Purchase Agreement, dated as of September 30, 2010 between Implant Sciences Corporation and DMRJ Group LLC.
10.38
Omnibus Fourth Amendment to Credit Agreement and Sixth Amendment to Note and Warrant Purchase Agreement, dated as of March 30, 2011 between Implant Sciences Corporation and DMRJ Group LLC.
10.39
Amended and Restated Promissory Note, dated as of March 30, 2011 in the maximum principal amount of $15,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC (superseded by Exhibit 10.42).
10.40
Omnibus Fifth Amendment to Credit Agreement and Seventh Amendment to Note and Warrant Purchase Agreement, dated as of April 7, 2011 between Implant Sciences Corporation and DMRJ Group LLC.
10.41
Omnibus Sixth Amendment to Credit Agreement and Eighth Amendment to Note and Warrant Purchase Agreement, dated as of September 29, 2011 between Implant Sciences Corporation and DMRJ Group LLC.
10.42
Amended and Restated Promissory Note, dated as of September 29, 2011 in the maximum principal amount of $23,000,000, issued by Implant Sciences Corporation to DMRJ Group LLC.
10.43
Omnibus Seventh Amendment to Credit Agreement and Ninth Amendment to Note and Warrant Purchase Agreement, dated as of October 13, 2011 between Implant Sciences Corporation and DMRJ Group LLC.
10.44
Omnibus Eighth Amendment to Credit Agreement and Tenth Amendment to Note and Warrant Purchase Agreement, dated as of February 21, 2012 between Implant Sciences Corporation and DMRJ Group LLC.
10.45
Omnibus Ninth Amendment to Credit Agreement and Eleventh Amendment to Note and Warrant Purchase Agreement, dated as of September 5, 2012 between Implant Sciences Corporation and DMRJ Group LLC.
10.46
Senior Secured Convertible Promissory Note, dated as of September 5, 2012, issued by Implant Sciences Corporation.
10.47
Omnibus Tenth Amendment to Credit Agreement and Twelfth Amendment to Note and Warrant Purchase Agreement, dated as of February 28, 2013 between Implant Sciences Corporation and DMRJ Group LLC.
10.48
Senior Secured Convertible Promissory Note, dated as of February 28, 2013, issued by Implant Sciences Corporation
10.49
Omnibus Eleventh Amendment to Credit Agreement and Thirteenth Amendment to Note and Warrant Purchase Agreement, dated as of November 14, 2013 between Implant Sciences Corporation and DMRJ Group LLC.
10.50
Note Purchase Agreement dated as of March 19, 2014, between Implant Sciences Corporation, certain Investors and the Agent.
10.51
Form of Senior Secured Promissory Note issued pursuant to the Note Purchase Agreement.
10.52
Letter dated as of March 19, 2014, from the Agent to Implant Sciences Corporation waiving certain financial covenants through March 31, 2015.
10.53
Security Agreement dated as of March 19, 2014, among Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp., as grantors, and the Agent.
10.54
Guaranty dated as of March 19, 2014, of the obligations of Implant Sciences Corporation by C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp. in favor of the Agent and the Investors.
- 35 -
10.55
Omnibus Twelfth Amendment to Credit Agreement and Fourteenth Amendment to Note and Warrant Purchase Agreement dated as of March 19, 2014 between Implant Sciences Corporation and DMRJ Group LLC.
10.56
Intercreditor Agreement dated as of March 19, 2014, by and between the Agent and DMRJ Group, LLC, and acknowledged and agreed by Implant Sciences Corporation, C Acquisition Corp., Accurel Systems International Corporation and IMX Acquisition Corp.
10.57
Agreement for Consulting Services between Implant Sciences Corporation and Robert Liscouski, dated as of April 1, 2011.*
10.58
Convertible Promissory Note, dated November 1, 2009 issued to Michael C. Turmelle.
21.1
Subsidiaries of Implant Sciences Corporation.
23.1
**
Consent of Marcum LLP.
31.1
**
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
**
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
***
Certification of the Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
***
Certification of the Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
****
XBRL Instance Document.
101.SCH
****
XBRL Taxonomy Extension Schema Document.
101.CAL
****
XBRL Taxomony Extension Calculation Linkbase Document.
101.LAB
****
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
****
XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF
****
XBRL Taxonomy Extension Definition Linkbase Document.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated June 27, 2008 and filed on July 9, 2008 and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2013, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 12, 2007 and filed December 18, 2007, and incorporated herein by reference.
Filed as an Exhibit to Amendment No. 1 to Implant Sciences Corporation’s Registration Statement on Form SB-2 (Registration No. 333-64499), filed on December 21, 1998, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form SB-2 (Registration No. 333-64499), filed on September 29, 1998, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form S-8, filed on December 12, 2003, and incorporated herein by reference.
Filed as Appendices A and B to Implant Sciences Corporation’s definitive proxy statement, filed February 16, 2012, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 7, 2012 and filed on September 13, 2012, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Registration Statement on Form S-8, filed on July 26, 2007, and incorporated herein by reference.
- 36 -
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 2, 2014 and filed on July 8, 2014, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 1, 2013 and filed July 1, 2013, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated March 19, 2012 and filed March 23, 2012, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated May 7, 2012 and filed May 11, 2012, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 11, 2008 and filed on December 17, 2008, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation Annual Report on Form 10-K for the fiscal year ended June 30, 2010, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Annual Report on Form 10-K for the year ended June 30, 2013, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated December 10, 2008 and filed December 16, 2008, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated March 12, 2009 and filed March 18, 2009, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated July 1, 2009 and filed July 8, 2009, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 4, 2009 and filed September 11, 2009, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated January 13, 2010 and filed January 14, 2010, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated April 23, 2010 and filed April 28, 2010, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 30, 2010 and filed October 6, 2010, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated March 30, 2011 and filed April 4, 2011, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2011, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated April 7, 2011 and filed April 12, 2011, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 29, 2011 and filed September 30, 2011, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated October 13, 2011 and filed October 19, 2011, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated February 21, 2012 and filed February 24, 2012, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated September 5, 2012 and filed on September 11, 2012, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated February 28, 2013 and filed March 1, 2013, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated November 18, 2013 and filed November 18, 2013, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Form 8-K dated March 19, 2014 and filed March 26, 2014, and incorporated herein by reference.
- 37 -
Filed as an Exhibit to Implant Sciences Corporation’s Annual Report on Form 10-K for the year ended June 30, 2011, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, and incorporated herein by reference.
Filed as an Exhibit to Implant Sciences Corporation Annual Report on Form 10-K for the year ended June 30, 2012, and incorporated herein by reference.
*
Indicates a management contract or compensatory plan or arrangement.
**
Filed herewith.
***
In accordance with Item 601(b)(32)(ii) of Regulation S-K, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-K and will not be deemed to be “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filings under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
****
In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” or part of a registration statement for purposes of Sections 11 and 12 of the Securities Act, shall not be deemed “filed” for purposes of Section 18 of the Exchange Act and is not otherwise subject to liability under these sections, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act, except as expressly set forth by specific reference in such filing.
- 38 -
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Implant Sciences Corporation:
We have audited the accompanying consolidated balance sheets of Implant Sciences Corporation as of June 30, 2014 and 2013 and the related consolidated statements of operations, changes in stockholders’ deficit, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Implant Sciences Corporation as of June 30, 2014 and 2013 and the consolidated results of its operations and its cash flows for the years then ended, in conformity with U.S. accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has had recurring net losses and continues to experience negative cash flows from operations. As of September 23, 2014, the Company’s principal obligation to its primary lenders was approximately $53,437,000 and accrued interest of approximately $10,163,000. The Company is required to repay all borrowings and accrued interest to these lenders on March 31, 2015. These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Marcum LLP
Boston, Massachusetts
September 29, 2014
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
Description of Business
Implant Sciences Corporation provides systems and sensors for the homeland security market and related industries. We have developed and acquired technologies using ion mobility spectrometry to develop a product line for use in trace explosives and narcotics detection. We currently market and sell our existing trace explosives and narcotics detector products while continuing to make significant investments in developing the next generation of these products.
Our fiscal year ends on June 30. References herein to fiscal 2014 and fiscal 2013 refer to the fiscal years ended June 30, 2014 and 2013, respectively.
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 March 19, 2014, we amended our credit agreements with DMRJ pursuant to which, amongst other matters, we extended the maturity date of all of our indebtedness from March 31, 2014 to March 31, 2015 (see Note 13).
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. 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.
Despite our current sales, expense and cash flow projections and $17,512,000 in cash available from our line of credit with DMRJ, at September 23, 2014, we will require additional capital in the third quarter of fiscal 2015 to fund operations and continue the development, commercialization and marketing of our products. Our failure to achieve our projections and/or obtain sufficient additional capital on acceptable terms would have a material adverse effect on our liquidity and operations and could require us to file for protection under bankruptcy laws.
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.
In addition, while we strive to bring new products to market, we are subject to a number of risks similar to the risks faced by other technology-based companies, including risks related to: (a) our dependence on key individuals and collaborative research partners; (b) competition from substitute products and larger companies; (c) our ability to develop and market commercially usable products and obtain regulatory approval for our products under development; and (d) our ability to obtain substantial additional financing necessary to adequately fund the development, commercialization and marketing of our products. For the year ended June 30, 2014, we reported a net loss of $21,010,000 and used $9,989,000 in cash for operations. As of June 30, 2014, the Company had an accumulated deficit of approximately $167,886,000 and a working capital deficit of $62,045,000. Management continually evaluates its operating expenses and its cash flow from operations. Failure of the Company to achieve its projections will require that we seek additional financing or discontinue operations.
As of June 30, 2014, our obligations to DMRJ under four promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $2,995,000, respectively. Further, as of June 30, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $8,283,000 and is included in current liabilities in the consolidated financial statements. As of June 30, 2014, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of June 30, 2014, our obligation under such notes for accrued interest amounted to approximately $867,000.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 23, 2014, our obligations to DMRJ under the promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $5,253,000 respectively. Further, as of September 23, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $9,235,000. As of September 23, 2014, our obligations under the senior secured promissory notes for which BAM is the agent were $20,000,000. Further, as of September 23, 2014, our obligation under such notes for accrued interest amounted to approximately $717,000.
These conditions raise substantial doubt as to our ability to continue as a going concern.
Our ability to comply with our debt covenants in the future depends on our ability to generate sufficient sales and to control expenses, and will require that we seek additional capital through private financing sources. 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, 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. The failure to refinance or otherwise 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 file for protection under bankruptcy laws.
Based on current sales, operating expense and cash flow projections, and the cash available from our line of credit, management believes there are plans in place to sustain operations for the next several months. These plans depend on a substantial increase in sales of our handheld trace explosives detector product and our desktop explosives and narcotics trade detector product. However, there can be no assurances that sales will materialize as forecasted, and/or that management will be successful in refinancing or extending our obligations to our secured lenders, which mature on March 31, 2015. To further sustain us, improve our cash position, and enable us to grow while reducing debt, management plans to continue to seek additional capital through private financing sources. However, there can be no assurance that management will be successful in executing these plans. Management will continue to closely monitor and attempt to control our costs and actively seek needed capital through sales of our products, equity infusions, government grants and awards, strategic alliances, and through our lending institutions.
We have suffered recurring losses from operations. Our 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.
Security product sales tend to have a long sales cycle, and are often subject to export controls. In an effort to identify new opportunities and stimulate sales, we have hired additional sales personnel during fiscal 2013 who have specific industry experience. However, there can be no assurance that these efforts will increase revenue.
We have a history of being active in submitting proposals for government sponsored grants and contracts and successful in being awarded grants and contracts from government agencies. However, we have recorded no revenues from government contracts, due to the expiration of several contracts and our inability to secure new contracts. Management will continue to pursue these grants and contracts to support our research and development efforts primarily in the areas of trace explosives detection.
We are currently expending significant resources to develop the next generation of our current products and to develop new products. We will require additional funding in order to continue the advancement of the commercial development and manufacturing of the explosives detection system. We will attempt to obtain such financing by: (i) government grants, (ii) private financing, or (iii) strategic partnerships. However, there can be no assurance that we will be successful in our attempts to raise such additional financing.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We will require substantial funds for further research and development, regulatory approvals, and the marketing of our explosives detection products. Our capital requirements depend on numerous factors, including but not limited to the progress of our research and development programs; the cost of filing, prosecuting, defending and enforcing any intellectual property rights; competing technological and market developments; changes in our development of commercialization activities and arrangements; and the hiring of additional personnel, and acquiring capital equipment. Our failure to achieve our projections and/or obtain sufficient additional capital on acceptable terms would have a material adverse effect on our liquidity and operations and could require us to file for protection under bankruptcy laws.
Equity Transactions
We evaluate the proper classification of our equity instruments that embody an unconditional obligation requiring the issuer to redeem it by transferring assets at a determinable date or that contain certain conditional obligations, typically classified as equity, be classified as a liability. We record financing costs associated with our capital raising efforts in our statements of operations. These include amortization of debt issue costs such as cash, warrants and other securities issued to finders and placement agents, and amortization of preferred stock discount created by in-the-money conversion features on convertible debt and the allocation of the proceeds amongst the securities based on relative fair values or based upon the residual method. We based our estimates and assumptions on the best information available at the time of valuation, however, changes in these estimates and assumptions could have a material effect on the valuation of the underlying instruments.
2.
Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include our operations in Massachusetts, California and Shanghai, China, and those of our wholly-owned subsidiaries. All intercompany transactions and accounts have been eliminated in consolidation.
Accounting Principles
The consolidated financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).
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, accounting for derivatives, and impairment of intangibles 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.
Foreign Currency Translation
The assets and liabilities of our Shanghai representative office are translated into U.S. dollars at current exchange rates as of the balance sheet date, expenses are translated at average monthly exchange rates. Net unrealized translation gains or losses associated with the Shanghai office are recorded directly to other comprehensive income. Realized gains and losses from foreign currency transactions were not material for any of the periods presented. We have short-term inter-company receivables from our Shanghai office which are adjusted each period for changes in foreign currency exchange rates with a corresponding entry recorded as a component of the consolidated statement of operations.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Retroactive Adjustment
In January 2013, we filed Articles of Amendment to our Restated Articles of Organization with the Commonwealth of Massachusetts to effect an increase in the total number of shares of common stock we are authorized to issue to 200,000,000 shares and to reduce the par value of our common stock from $0.10 per share to $0.001 per share. All share information has been retroactively adjusted to reflect the change in the par value of our common stock.
Cash and Cash Equivalents
We consider any securities with original maturities of 90 days or less at the time of investment to be cash equivalents.
Fair Value Measurements
Accounting Standards Codification (“ASC”) 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.
Fair Value of Financial Instruments
Our financial instruments at June 30, 2014 and 2013 include cash equivalents, restricted cash, accounts receivable accounts payable and borrowings under our senior secured convertible promissory note, senior secured promissory note and a revolving line of credit. The carrying amounts of cash and cash equivalents, restricted cash, receivables 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 13, 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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides the non-recurring fair value measurements of assets and liabilities as of June 30, 2014:
The following table provides the non-recurring fair value measurements of assets and liabilities as of June 30, 2013:
Inventories
Inventories consist of raw materials, work-in-process and finished goods. Work-in-process and finished goods includes labor and overhead, and are stated at the lower of cost (first in, first out) or market.
Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and amortization, are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to seven years. Equipment purchased under capital leases and leasehold improvements are amortized based upon the lesser of the term of the lease or the useful life of the asset and such expense is included in depreciation expense. Expenditures for repairs and maintenance are charged to expense as incurred.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warranty Costs
We accrue warranty costs in the period the related revenue is recognized and adjust the reserve balance as needed to address potential future liabilities.
The following table presents the activity in our warranty reserve for the years ended June 30, 2014 and 2013:
Income Taxes
The liability method is used to account for income taxes. Deferred tax assets and liabilities are determined based on differences between the financial reporting and income tax bases of assets and liabilities as well as net operating loss and tax credit carry forwards and are measured using the enacted tax rates and laws that will be in effect when the differences reverse. Deferred tax assets may be reduced by a valuation allowance to reflect the uncertainty associated with their ultimate realization.
Patent Costs
As of June 30, 2014, there were fifteen active patents issued. We expense legal costs and fees associated with patent applications and patent maintenance as incurred.
Intangible Assets and Impairment of Long-Lived Assets
We evaluate finite-lived intangible assets for impairment as events and circumstances indicate that the carrying amount may not be recoverable and at a minimum at each balance sheet date in accordance with Accounting Standards Codification (“ASC”) 350 “Intangibles - Goodwill and Other” (“ASC 350”). Long-lived assets, which includes property and equipment are evaluated for impairment as events and circumstances indicated that the carrying amount may not be recoverable and at a minimum at each balance sheet date in accordance with ASC 360 “Property, Plant and Equipment.” We evaluate the realizability of our long-lived assets based on profitability and undiscounted cash flow expectations for the related asset or subsidiary.
ASC 350 requires that intangible assets with indefinite lives be measured for impairment at least annually or whenever events indicate that there may be an impairment. We recognize an impairment of a long-lived asset if the carrying value of the long-lived asset is not recoverable from its estimated future cash flows. We measure an impairment loss as the difference between the carrying amount of the asset and its estimated fair value.
Concentration of Credit Risk and Major Customers
Financial instruments that potentially subject us to concentration of credit risk consist of trade receivables.
We grant credit to our customers, primarily large corporations, foreign governments and the U.S. government. We perform periodic evaluations of customer’s payment history and generally do not require collateral. Receivables are generally due within thirty days. Credit losses have historically been minimal, which is consistent with our expectations. Allowances are provided for estimated amounts of accounts receivable which may not be collected.
As of June 30, 2014, we had two irrevocable standby letters of credit outstanding in the approximate amount of $595,000. These letters of credit (1) provide performance security equal to 5% of the amount of our contract with the India Ministry of Defence, and (2) provide warranty performance security equal to 5% of the contract amount, under the terms of the contract. We have amended each of the letters of credit, extending the expiration dates to November 4, 2014 and May 4, 2015, respectively.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We have no other significant off-balance sheet risk such as foreign-exchange contracts, option contracts or other foreign hedging arrangements.
We place our cash with financial institutions which we believe are of high credit quality.
Our revenues are derived from both domestic and international sales. During the fiscal years ended June 30, 2014 and 2013, international sales represented approximately 76% and 88%, respectively, of our revenue. During the fiscal year ended June 30, 2014, a customer from Japan and a Taiwanese customer represented 18% and 11%, respectively, of our revenue. For the fiscal year ended June 30, 2013, a customer from India and a customer from France represented approximately 48% and 10% of our revenue, respectively.
At June 30, 2014, three customers accounted for approximately $341,000 of accounts receivable, or 63% of accounts receivable outstanding as of that date. At June 30, 2013, three customers accounted for approximately $1,029,000 of accounts receivable, or 85% of accounts receivable outstanding as of that date. We rely on a single contract manufacturer to provide manufacturing services for our handheld explosives detection product. If these services become unavailable, we would be required to identify and enter into an agreement with a new contract manufacturer or take the manufacturing in-house. From time to time in fiscal 2014, this manufacturer has limited the number of detectors it would manufacture due to our inability to pay for the detectors on a timely basis. In addition, this manufacturer has required that we prepay for materials and component parts in advance of procurement. The refusal to manufacture detectors for a substantial period, or the loss of our contract manufacturer altogether, could significantly disrupt production as well as increase the cost of production, thereby increasing the prices of our products. These changes could have a material adverse effect on our business and results of operations.
Stock-Based Compensation
For the fiscal years ended June 30, 2014 and 2013, we recorded stock-based compensation expense for options that vested of approximately $2,649,000 and $13,908,000, respectively, as follows:
As of June 30, 2014, the Company has approximately $1,207,000 of unrecognized compensation cost related to stock options that is expected to be recognized as expense over a weighted average period of 1.1 years.
The valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option pricing model is utilized to derive an estimated fair value. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In calculating the estimated fair value of our stock options we use the Black-Scholes pricing model, which requires the consideration of the following six variables for purposes of estimating fair value:
·
the stock option exercise price;
·
the expected term of the option;
·
the grant price of the our common stock, which is issuable upon exercise of the option;
·
the expected volatility of our common stock;
·
the expected dividends on our common stock; and
·
the risk free interest rate for the expected option term.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each option granted during fiscal years 2014 and 2013 is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
Stock Option Exercise Price and Grant Date Price of Common Stock. The closing market price of our common stock on the date of grant.
Expected Term. The expected term of options granted is calculated using our historical option exercise transactions and reflects the period of time that options granted are expected to be outstanding.
Expected Volatility. The expected volatility is a measure of the amount by which our stock price is expected to fluctuate during the expected term of options granted. We determine the expected volatility solely based upon the historical volatility of our common stock over a period commensurate with the option’s expected term. We do not believe that the future volatility of our common stock over an option’s expected term is likely to differ significantly from the past.
Expected Dividends. We have never declared or paid any cash dividends on any of our capital stock and do not expect to do so in the foreseeable future. Accordingly, we use an expected dividend yield of zero to calculate the grant-date fair value of a stock option.
Risk-Free Interest Rate. The risk-free interest rate is the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the option’s expected term on the grant date.
We were also required to estimate the level of award forfeitures expected to occur and record compensation expense only for those awards that are ultimately expected to vest. This requirement applies to all awards that are not yet vested. We have determined, based on actual forfeitures, that our forfeiture rate is approximately 10%. We revisit this assumption periodically and as changes in the composition of our option pool dictate.
Changes in the inputs and assumptions as described above can materially affect the measure of estimated fair value of share-based compensation. We anticipate the amount of stock-based compensation will increase in the future as additional options are granted.
Revenue Recognition
We recognize revenue when there is persuasive evidence of an arrangement with the customer which states a fixed or determinable price and terms, delivery of the product has occurred or the service has been performed in accordance with the terms of the sale, and collectibility of the related receivable is reasonably assured. We provide for estimated returns at the time of shipment based on historical data. Shipping costs charged to the customer are included in revenues and are not significant.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We allocate consideration for each deliverable as a separate unit of accounting based on its relative selling price. We determine selling price using vendor specific objective evidence (“VSOE”), if it exists, and otherwise third party evidence (“TPE”). If neither VSOE nor TPE of selling price exists for a unit of accounting, we use estimated selling price (“ESP”). We generally expect that we will not be able to determine TPE due to the nature of the markets in which we compete, and, as such, we typically determine selling price using VSOE or if not available, ESP. VSOE is the price charged when the same or similar product or service is sold separately. If a product or service is seldom sold separately, it is unlikely that we can determine VSOE for the product or service. TPE is determined based on prices charged by competitors of us for a similar deliverable when sold separately. Generally we are not able to use TPE, as we are usually not able to obtain sufficient information on competitor pricing to substantiate TPE. The objective of ESP is to determine the price at which we would transact if the product or service were sold on a standalone basis. We determine ESP for product or services based on the specific facts and circumstances of the arrangement. Maintenance or service revenues are recognized over the term of the contract.
Contract revenue under fixed price and cost-plus agreements with the Department of Defense and the Department of Homeland Security are recognized as eligible research and development expenses are incurred. Our obligation with respect to these agreements is to perform the research on a best-efforts basis.
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 contractual agreements.
Accounts Receivable
Contract revenue under cost sharing research and development agreements is recognized as eligible expenses are incurred. Invoicing of research and development contracts occurs in accordance with the terms of the contract. Revenue recognized but unbilled is recorded as unbilled accounts receivable. At June 30, 2014 and 2013, there were no unbilled accounts receivable. Generally, there are no prerequisites necessary to invoice.
We grant credit to domestic and foreign customers and perform ongoing credit evaluations of our customers’ financial condition. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon specific customer collection issues.
Research and Development Costs
All costs of research and development activities are expensed as incurred. We spent approximately $4,787,000 and $4,754,000 on internally funded research and development in the fiscal years ended June 30, 2014 and 2013, respectively.
Software Development Costs
The development costs of new software and substantial enhancements to existing software are expensed as incurred until technological feasibility has been established, at which time any additional costs are capitalized. We believe technological feasibility has been established at the time at which a working model of the software has been completed. Costs eligible for capitalization have been immaterial.
Advertising Costs
Advertising costs are expensed when incurred and are included in selling, general and administrative expense. Advertising costs were immaterial for the years ended June 30, 2014 and 2013.
Shipping and Handling
We account for shipping and handling cost within our cost of revenues.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basic and Diluted Earnings Per Share
Basic earnings per share is computed by dividing net income (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 June 30, 2014 and 2013, potentially dilutive shares would have been 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.
Diluted loss per share:
Numerator:
Net loss
$
(21,010
)
$
(27,354
)
Denominator:
Weighted average shares
60,753,054
49,124,942
Effect of dilutive securities:
Stock options
-
-
Warrants
-
-
Convertible debt
-
-
Convertible preferred stock
-
-
-
-
Weighted average shares and equivalents
60,753,054
49,124,942
Diluted loss per share
$
(0.35
)
$
(0.56
)
Common stock equivalents excluded from the earnings per share calculation for the years ended June 30, 2014 and 2013 were as follows:
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2016, including interim reporting periods therein, 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 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 become 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. We are currently evaluating the impact of this accounting guidance and do not expect any significant 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 alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued (or available to be 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. We are currently evaluating the impact of this accounting guidance and do not expect any significant impact on our consolidated financial statements.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3.
Restricted Cash and Investments - Current and Long-Term
As of both June 30, 2014 and 2013, we had restricted cash and investments, with maturities of less than one year, of $312,000 and $433,000, respectively, and restricted investments with maturities of more than one year, of $312,000. Restricted cash and investments consisted of the following:
Pursuant to our September 2009 credit agreement with DMRJ, we agreed to cause all of our receivables and collections to be deposited in a bank deposit account pledged to DMRJ pursuant to a blocked account agreement. All funds deposited in the blocked collections account are applied towards the repayment of our obligations to DMRJ under the revolving line of credit. Until the line of credit and all of our obligations thereunder have been paid and satisfied in full, we will have no right to access or make withdrawals from the blocked account without DMRJ’s consent. As of June 30, 2014 and 2013, the balance in the blocked collections account was $0 and $121,000, respectively.
The restricted investments of $624,000 held in certificates of deposit collateralize our performance under irrevocable letters of credit issued in April 2010, aggregating to $595,000, in connection with our contract with the India Ministry of Defence, plus the bank required collateralization deposit of $19,000. These letters of credit (1) provide performance security equal to 5% of the amount of our contract with the India Ministry of Defence; and (2) provide warranty performance security equal to 5% of the contract amount the terms of the contract. We have amended each of the letters of credit, extending the expiration dates to November 4, 2014 and May 4, 2015, respectively. On May 1, 2013, a third letter of credit providing security for the advance deposit was cancelled, resulting in the release of $937,000 held in a certificate of deposit. The funds had been applied to reduce our obligation for accrued interest and borrowings under the credit facility with DMRJ.
4.
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 for excess and slow-moving inventories, consist of the following:
As of June 30, 2014 and 2013, our reserves for excess and slow-moving inventories were $213,000 and $73,000, respectively.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5.
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following:
6.
Property, Plant and Equipment, net
Property and equipment consist of the following:
Depreciation expense for the fiscal years ended June 30, 2014 and 2013 was approximately $154,000 and $84,000, respectively. During the fiscal year ended June 30, 2013, we recognized a gain of $9,000 on the disposition of property, plant and equipment with a cost of approximately $161,000 and no net book value. During the fiscal year ended June 30, 2014, we recognized a $56,000 loss on the disposition of property, plant and equipment with a cost of approximately $135,000 and a net book value of $57,000.
7.
Accrued Expenses
Accrued expenses consist of the following:
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8.
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 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.
Reconciliation between our effective tax rate and the United States statutory rate is as follows:
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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Significant components of our deferred tax assets and deferred tax liabilities as of June 30, 2014 and 2013 consists of the following:
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 $2,006,000 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.
The following table summarizes the changes in our deferred tax valuation allowance for the years ended June 30, 2014 and 2013:
As of June 30, 2014, 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 $42,116,000 as of June 30, 2014, 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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
We have not completed 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 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. We adopted the accounting standards related to accounting for uncertainty in income taxes recognized in an enterprise’s financial statements on April 1, 2007. At the adoption date and as of June 30, 2014, 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 2011 through 2014 are subject to examination by the federal and state taxing authorities. There are no income tax examinations currently in process.
For the years ended June 30, 2014 and 2013, 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%.
9.
Commitments and Contingencies
Capital and Operating Leases
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 lease research and office space in San Diego, California, lease expires on March 31, 2016 and lease 300 square feet of office space in Shanghai, China, under a lease expiring on November 30, 2014. Total rent expense, including assessments for maintenance and real estate taxes for the years ended June 30, 2014 and 2013, was $919,000 and $395,000, respectively.
In April 2007, in conjunction with our plans to conduct research, development and minor manufacturing work in New Mexico, we executed an operating lease which was initially to expire on May 1, 2010. The lease allowed for early termination, which we elected in February 2008. As a result of the early termination, we are responsible for reimbursing the landlord for certain leasehold improvements over a 24-month period. As of June 30, 2014, the balance due is approximately $27,000 and is included in current liabilities.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future minimum rental payments required under capital and operating leases with non-cancelable terms in excess of one year at June 30, 2014, together with the present value of net minimum lease payments, are as follows:
(In thousands)
Capital Lease Payments
Operating Lease Payments
Years ending June 30:
$
$
2019 and thereafter
1,298
$
3,680
Less: Amounts representing interest
(22
)
Present value of future minimum lease payments
Less: Current portion
(45
)
Long-term obligation under capital leases
$
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, which we intend to incorporate into future security product offerings.
For the years ended June 30, 2014 and 2013, payments under a license agreement amounted to $150,000 and $125,000, respectively.
10.
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.
During the fiscal years ended June 30, 2014 and 2013, international sales represented approximately 76% and 88%, respectively, of our revenue. During the fiscal year ended June 30, 2014, a customer from Japan and a Taiwanese customer represented 18% and 11%, respectively, of our revenue. For the fiscal year ended June 30, 2013, a customer from India and a customer from France represented approximately 48% and 10% of our revenue, respectively.
11.
Related Party Transactions
Robert Liscouski, a member of our Board of Directors, had served as a partner at Secure Strategy Group, a homeland security-focused banking and strategic advisory firm that has been retained by us to assist with our efforts to acquire additional capital. During the years ended June 30, 2014 and 2013, this advisory firm was paid $0 and $66,000, respectively. We terminated our relationship with Secure Strategy Group on March 31, 2013. On March 5, 2014, we executed a settlement agreement and release with Secure Strategy Group and recognized a non-cash benefit of $118,000 in our consolidated statement of operations and comprehensive income and, as of June 30, 2014, our obligation to Secure Strategy Group was $0.
In April 2011, we entered into an advisory and consulting agreement with Mr. Liscouski to assist our U.S. government sales and marketing team with our efforts to advance our interests with the U.S. government. During the years ended June 30, 2014 and 2013, Mr. Liscouski was paid $180,000 and $180,000, respectively. As of June 30, 2014, we had no obligation to Mr. Liscouski.
Mr. Liscouski also serves as a senior partner at Edge360, a leading security technology and situational awareness solutions provider to the homeland security marketplace that has been retained by us. During the fiscal years ended June 30, 2014 and 2013, this advisory firm was paid $4,000 and $27,000, respectively. On August 31, 2013, we terminated our relationship with Edge360 and, as of June 30, 2014, we had no obligation to Edge360.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12.
Notes Payable
In June 2009, Michael Turmelle, a member of our Board of Directors, loaned $100,000 to us.
As of June 30, 2014 and 2013, we had no obligation under the note for borrowed funds. As of June 30, 2014 and 2013, our obligation to Mr. Turmelle for accrued interest approximated $0 and $11,000, respectively.
13.
Long-Term Debt and Credit Arrangements
Med-Tec Payment Obligation
In July 2003, we entered into an asset purchase agreement with Med-Tec Iowa, Inc. (“Med-Tec”), our former exclusive distributor of prostate seeds, to purchase Med-Tec’s customer lists and to release each other from further obligations under an earlier distribution agreement. The purchase price of $1,250,000, which was payable in varying amounts over 28 months, with the final payment payable on December 1, 2005, was recorded at the present value of the future payment stream, using a rate of 10.24%, which equaled $1,007,000. This amount was recorded as an intangible asset and was fully amortized over an estimated useful life of 29 months. The outstanding and past due principal balance, as of June 30, 2014 and 2013, was approximately $15,000 and $19,000, respectively.
Term Debt and Revolving Credit Facility with DMRJ Group, 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.
In September 2011, we amended each of our credit instruments with DMRJ. Pursuant to those amendments: (i) the maturity of our indebtedness to DMRJ was extended from September 30, 2011 to March 31, 2013; (ii) DMRJ waived our compliance with certain financial covenants in the notes and all related credit agreements through maturity; (iii) our line of credit under the September 2009 credit agreement was increased from $15,000,000 to $23,000,000; and (iv) we were required to repay sufficient amounts of our outstanding indebtedness under the notes and related credit agreements and other amounts owing to DMR such that as of December 31, 2011, the outstanding obligations to DMRJ shall not exceed $15,000,000.
In October 2011, we further amended each of our credit instruments with DMRJ, to eliminate the obligation to repay any portion of our outstanding indebtedness to DMRJ by December 31, 2011.
In February 2012, we amended each of our credit instruments with DMRJ, to extend the maturity of all of our indebtedness to DMRJ to September 30, 2012.
In September 2012, we further amended each of our credit instruments with DMRJ. Pursuant to those amendments: (i) we extended the maturity date of all of our indebtedness from September 30, 2012 to March 31, 2013 and (ii) issued to DMRJ a second senior secured convertible promissory note in the principal amount of $12,000,000 (the “September 2012 Note”).
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The second senior secured convertible promissory note bears interest at the rate of 15% per annum. The principal balance of this note, together with all outstanding interest and all other amounts owed thereunder, was due and payable on March 31, 2013. The second senior secured 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 second senior secured convertible promissory note originally gave DMRJ the option to require us to repurchase any or all of the shares of Series H Preferred Stock owned by DMRJ, at the Series H Original Issue Price per share, if we did not (i) by March 31, 2013, have at least one of our products receive qualified or approved status on the “Transportation Security Administration Air Cargo Screening Technology List (ACSTL) - For Passenger Aircraft” or placed on the Transportation Security Administration’s “Explosive Trace Detector Qualified Product List (QPL)”; or (ii) achieve revenues of at least $7,500,000 per fiscal quarter, commencing with fiscal quarter ending June 30, 2013. As described below, the note was subsequently amended to eliminate this option.
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.
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 updated 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.
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.
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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On February 28, 2013, we further amended each of our credit instruments with DMRJ. Pursuant to those amendments:
·
the maturity of all of our indebtedness to DMRJ was extended from March 31, 2013 to March 31, 2014;
·
DMRJ waived our compliance with certain financial covenants in each of our promissory notes and all related credit agreements through the new maturity date;
·
DMRJ’s option to require us to repurchase any or all of the shares of Series H Convertible Preferred Stock ) which may be issued upon conversion of the September 2012 Note was eliminated;
·
we issued to DMRJ a third senior secured convertible promissory note dated February 28, 2013, in the aggregate principal amount of $12,000,000. Payment for the February 2013 Note was made by the cancellation of $12,000,000 of principal of the outstanding indebtedness under our credit agreement;
·
DMRJ acquired the option to convert the amended and restated senior secured convertible promissory note dated March 12, 2012 (the “March 2012 Note”) into shares of Series J Convertible Preferred Stock in lieu of shares of Common Stock; and
·
the March 2012 Note and the September 2012 Note were amended to permit us to prepay any or all of our indebtedness thereunder on 30 days’ prior notice.
The third senior secured convertible promissory note bears interest at the rate of 15% per annum. The principal balance of this note, together with all outstanding interest and all other amounts owed thereunder, will be due and payable on March 31, 2015. The third senior secured convertible promissory 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”). We may prepay this note on 30 days prior notice.
As amended, the March 2012 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 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 updated 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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 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.
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 $.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 2012 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 2012 Note was convertible directly into shares of Common Stock at a conversion price of $.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.
As of June 30, 2014, there were no shares of Series H Preferred Stock, Series I Preferred Stock or Series J Preferred Stock outstanding.
On November 14, 2013, we amended each of our credit agreements with DMRJ to extend the maturity date of all of our indebtedness to DMRJ from March 31, 2014 to September 30, 2014.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 19, 2014, we further amended each of our credit instruments with DMRJ. Pursuant to those amendments:
·
the maturity of all of our indebtedness to DMRJ was extended from September 30, 2014 to March 31, 2015;
·
DMRJ waived our compliance with certain financial covenants in each of our promissory notes and all related credit agreements through the new maturity date;
·
DMRJ consented to the execution and delivery of the note purchase agreement with BAM and agreed to waive all prepayment limitations and prepayment notice requirements set forth in any of the credit documents to which DMRJ and the company are parties with respect to the repayments and prepayments financed by the sale of the notes.
·
DMRJ agreed to subordinate its first position security interest in all of our assets to BAM.
Further, upon the occurrence of an event of default under certain provisions of our agreements with DMRJ, 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.
As of June 30, 2014, our obligations to DMRJ under the promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $2,995,000, respectively. Further, as of June 30, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $8,283,000 and is included in current liabilities in the consolidated financial statements.
As of September 23, 2014, our obligations to DMRJ under the promissory notes and a revolving line of credit approximated $3,184,000, $12,000,000, $12,000,000, $1,000,000 and $5,253,000 respectively. Further, as of September 23, 2014, our obligation to DMRJ for accrued interest under these instruments approximated $9,235,000.
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.
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.
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.
As of June 30, 2014, our obligations under these promissory notes were $20,000,000. Further, as of June 30, 2014, our obligation under such notes for accrued interest amounted to $867,000 and is included in current liabilities in the consolidated financial statements.
As of September 23, 2014, our obligations under these promissory notes were $20,000,000. Further, as of September 23, 2014, our obligation under such notes for accrued interest approximated $717,000.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14.
Stock Options and Warrants
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 option pricing model.
Common Stock Options
In December 2000, we adopted the 2000 Incentive and Non-Qualified Stock Option Plan (the “2000 Plan”). The 2000 Plan provides for the grant of incentive stock options and non-qualified stock options to employees and affiliates. The exercise price of the options equal 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 5% 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. The Committee may in its discretion provide upon the grant of any option that we may repurchase, upon terms and conditions determined by the Committee, all or any number of shares purchased upon exercise of such option. A total of 600,000 shares were originally reserved for issuance under the 2000 Plan. In December 2003, our stockholders approved an increase in the 2000 Plan from 600,000 shares to 1,000,000 shares. In December 2004, our stockholders approved an increase in the 2000 Plan from 1,000,000 shares to 1,500,000 shares. The 2000 Plan expired in October 2010, as such no further options grants may be issued under this plan.
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 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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 and approved the following grants of options under the amended plan:
Named Executives and Directors
Shares Granted
Glenn D. Bolduc
5,442,490
Dr. William J. McGann
1,498,972
Roger P. Deschenes
1,058,498
Dr. Darryl K. Jones
1,258,498
Michael C. Turmelle
640,949
Howard Safir
303,399
Robert P. Liscouski
806,798
John A. Keating
303,399
Todd A. Silvestri
730,949
Brenda L. Baron
730,949
Estate of Joseph E. Levangie
525,099
13,300,000
The September 2012 amendment has not been approved by our stockholders.
Each of the options has an exercise price of $1.40 per share. One-half of options granted to each of Messrs. Bolduc, Deschenes, Silvestri and Ms. Baron were immediately exercisable and the other one-half became exercisable on September 7, 2013. One-third of the new options granted to each of Dr. McGann and Dr. Jones were immediately exercisable, one-third became exercisable on September 7, 2013, and the remaining one-third became exercisable on September 7, 2014, subject to acceleration of vesting upon a “Change in Control.” Options granted to Messrs. Turmelle, Safir, Liscouski, Keating and the Estate of Mr. Levangie are immediately exercisable in full. All of the options will expire on September 6, 2022, subject to earlier expiration with respect to Messrs. Bolduc, McGann, Deschenes, Jones, Silvestri and Ms. Baron in connection with the termination or cessation of their respective employment with the company.
On September 7, 2012, the Board of Directors adopted the Implant Sciences Corporation Change of Control Payment Plan, the purpose of which is to reward management for the increases in shareholder value generated between January 2009 and the present.
On January 2, 2009, the closing price of our common stock on the NYSE Amex LLC was $0.18 per share. On the date the plan was adopted, the closing price of the common stock on the OTC Markets Group’s OTCPK tier was $1.40. Our Board of Directors believes that this increase in shareholder value is directly attributable to the dedication and hard work of our management team, employees and directors. Accordingly, our management and directors have not significantly benefitted from the increase in shareholder value between January 2009 and the present, and the plan is intended to provide value to our management and directors equivalent to the value they would have earned had they owned a more significant portion of our equity.
Pursuant to the plan, the Board established a target level of stock ownership for each officer as a percentage of our fully diluted capitalization, and a corresponding ownership percentage for directors. To reflect the increase in shareholder value between January 2009 and the adoption of the plan, the Board determined that each officer and director should be allocated a “Change of Control Payment” equal to the product of (x) the closing price of our common stock on September 7, 2012 (i.e., $1.40) less a “floor price,” multiplied by (y) the number of additional stock options granted to each participant on the same date. The floor price applicable to directors and officers who served us at the beginning of the turn-around is $0.20, i.e., slightly above the closing price of the common stock on January 2, 2009. The floor prices for Dr. McGann and Dr. Jones are $0.51 and $0.67, respectively, reflecting the closing prices of the common stock on the dates those officers joined us. The benefits under the plan are payable upon, and only upon, a “Change of Control,” as defined in the plan, involving the company. Accordingly, the payment of the benefits allocated under the plan will be further deferred until such time that all shareholders receive payments for or in respect of their common stock in a transaction constituting a Change of Control.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 6, 2014, our Board of Directors approved the following grant of options:
Named Executives and Directors
Shares Granted
Glenn D. Bolduc
75,000
Dr. William J. McGann
75,000
Roger P. Deschenes
50,000
Dr. Darryl K. Jones
50,000
Michael C. Turmelle
25,000
Howard Safir
25,000
Robert P. Liscouski
25,000
John A. Keating
25,000
Todd A. Silvestri
50,000
Brenda L. Baron
50,000
450,000
Each of the options has an exercise price of $0.79 per share and all of the options will expire on March 5, 2024.
The options shall vest and become exercisable in full upon the later of (i) the addition of our QS-B220 product to the Transportation Security Administration Qualified Product List for passenger checkpoint screening and (ii) our receipt of an initial order under an indefinite delivery / indefinite quantity contract with the Transportation Security Administration. ASC718 “Compensation - Stock Compensation” requires that recognition of compensation expense for an award with a performance condition shall be based on the probable outcome of that performance condition. We have determined that it is probable that both performance conditions will be satisfied within one year from the date of grant and have accrued stock-based compensation in our consolidated statements of operations and comprehensive loss for the year ended June 30, 2014.
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. At June 30, 2014, no option awards have been granted under the 2014 Plan. The 2014 Plan has not been approved by our stockholders.
As of June 30, 2014, there were options outstanding to purchase 18,420,316 shares of our common stock at exercise prices ranging from $0.08 to $10.00.
We issued 407,066 and 1,421,183 shares of common stock during the years ended June 30, 2014 and 2013, respectively, as a result of the exercise of options by employees and consultants.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the activity of the 2000 and 2004 Stock Option Plans for the year ended June 30, 2014:
The following table presents the activity of the 2000 and 2004 Stock Option Plans for the year ended June 30, 2013:
The weighted average grant date fair value of options granted for the years ended June 30, 2014 and 2013 were $0.72 and $1.22, respectively. See Note 2 for further discussion on the methods and assumptions used in determining the fair value of our options.
The following table sets forth information regarding outstanding options at June 30, 2014:
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of June 30, 2014 there was $1,207,000 of total unrecognized compensation expense related to unvested share based compensation arrangements under the various share-based compensation plans. This expense is expected to be recognized as follows:
Years Ending June 30: (In thousands)
$
$
1,207
As of June 30, 2014, the unrecognized compensation expense related to stock option awards is expected to be recognized as expense over a weighted-average period of 1.1 years.
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the closing price of the common stock on June 30, 2014 of $1.04 and the exercise price of each in-the-money option) that would have been received by the option holders had all option holders exercised their options on June 30, 2014. Total intrinsic value of stock options exercised under the stock option plans for the years ended June 30, 2014 and 2013 was $233,000 and $1,557,000, respectively. The total fair value of stock options that vested during the years ended June 30, 2014 and 2013 was $460,000 and $9,622,000, respectively.
Stock Purchase Warrants and Stock Issuances
In April 2013, we issued 600,000 shares of common stock having a value of $660,000 and warrants to purchase an aggregate of 2,000,000 shares of our common stock to two advisors, in consideration of services rendered to us under two advisory and consulting services agreements. The issued shares were valued at the closing stock price of $1.10 per share at April 1, 2013.
As of June 30, 2014, there were warrants outstanding to purchase 3,568,860, shares of our common stock at exercise prices ranging from $0.54 to $1.22 expiring at various dates between June 26, 2015 and April 1, 2021.
We estimated the fair value of the warrants issued during fiscal 2014 and fiscal 2013 using the Black-Scholes option pricing model with the following input assumptions:
We issued one warrant in fiscal 2014 and eight warrants in fiscal 2013. For the years ended June 30, 2014 and 2013, we recorded non-cash charges for warrants that vested of $1,058,000 and $696,000, respectively, in our consolidated statements of operations.
The following table presents the weighted average exercise price of warrants outstanding at June 30, 2014:
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the warrant activity for the years ended June 30, 2014 and 2013:
Employee Stock Purchase Plan
In December 2006, we adopted the 2006 Employee Stock Purchase Plan. This plan provides a method whereby our employees have an opportunity to acquire an ownership interest in the company through the purchase of shares of our common stock through payroll deductions. After 12 months of employment, an employee is eligible to participate and can defer up to 10% of their wages into this plan, with a maximum of $25,000 in any calendar year. The purchase price of the common stock is calculated at the lower of 85% of the closing price of the stock on the first day of the plan period or the last day of the plan period. The plan periods are January 1 to June 30 and July 1 to December 31. Fractional shares are not issued. Participants may withdraw at any time by giving written notice to us and will be credited the amounts of deferrals in their account. The maximum number of shares eligible to be issued under the 2006 Plan is 500,000. As of June 30, 2014 and 2013, a total of 380,543 shares are available for issuance under the 2006 Plan.
We issued no shares of common stock during the years ended June 30, 2014 and 2013, under the employee stock purchase plan.
15.
Benefit Plans and Employment Agreements of Executive Officers
We have a defined contribution plan, the Implant Sciences Corporation 401(k) Profit Sharing Plan, established under Section 401(k) of the Internal Revenue Code. All full-time employees who are 21 years of age are eligible to participate on the beginning of the first month after 30 days of employment. The company’s contributions are discretionary. We made no matching contributions during either fiscal 2014 or 2013.
In February 2009, we entered into a new three-year employment agreement with Mr. Glenn D. Bolduc our President and Chief Executive Officer, pursuant to which Mr. Bolduc initially received a base salary of $275,000 per year, commencing on January 1, 2009. After the third year, the agreement will automatically renew for additional one-year periods. The agreement also provided for Mr. Bolduc to be eligible to receive incentive compensation in an amount of up to 50% of his base salary, upon the achievement of certain performance milestones established by the Board of Directors and a car allowance. Incentive compensation, if any, for subsequent fiscal years was based on performance milestones to be established by mutual agreement between us and Mr. Bolduc.
On June 25, 2013, we amended and restated the employment agreement with Mr. Bolduc. The new agreement will remain in effect through June 30, 2016, after which, the agreement will automatically renew for additional one-year periods unless notice of non-renewal is given by either party.
The agreement establishes Mr. Bolduc’s base salary at the rate of $400,000 per year, which amount is equal to Mr. Bolduc’s annualized base salary immediately prior to the agreement. Mr. Bolduc’s base salary is subject to annual review, and any increases will be made in the discretion of the Board of Directors upon the recommendation of the Compensation Committee.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The new agreement also provides that Mr. Bolduc is eligible to receive cash bonuses of up to 50% of his annualized base salary for the fiscal year ended June 30, 2014 and for subsequent fiscal years. The amount of the bonus payable with respect to any fiscal year, if any, will be determined by the Board, in its sole discretion, provided that no bonus will be payable unless we achieve certain revenue and adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) targets established by the Board for the respective fiscal year . We did not achieve these targets and no bonus was payable to Mr. Bolduc for the fiscal year ended June 30, 2014. In August 2013, however, the Board agreed to pay Mr. Bolduc a bonus of $50,000 with respect to the fiscal year ended June 30, 2013 if the company receives certain governmental approvals for its QS-B220 desktop explosives and narcotics detector by December 31, 2013 and enters into a procurement contract with a specific agency of the United States government on or before February 1, 2014 (the “Bonus Milestones”). We did not achieve these milestones and no bonus was payable to Mr. Bolduc for the fiscal year ended June 30, 2013. During the year ended June 30, 2013, Mr. Bolduc was paid bonuses of $136,250 and $162,500, representing bonuses earned in our fiscal years ended June 30, 2009 and June 30, 2012, respectively.
Mr. Bolduc received no additional long-term and/or equity incentive compensation in connection with the agreement. He will be eligible to receive such additional compensation as the Board may, in its sole discretion, award from time to time. In addition, Mr. Bolduc may participate in our employee fringe benefit programs or programs readily available to employees of comparable status and position.
We may terminate the agreement at any time without cause, on 30 days’ prior written notice. The agreement provides, however, for the payment of 18 months’ salary and a pro rata portion of any bonus compensation earned during the year of termination, as well as the continuation of certain benefits for 12 months, as separation payments in the event that Mr. Bolduc’s employment is terminated by us without “cause” or Mr. Bolduc resigns for “good reason” (as those terms are defined in the agreement). The agreement also provides that, if Mr. Bolduc resigns for “good reason,” all stock options and shares of restricted stock then held by Mr. Bolduc will become fully vested and exercisable as of the date of such resignation.
In the event that, within 12 months after a “change of control” (as that term is defined in the Company’s Change of Control Plan, as adopted by the Board on September 7, 2012), Mr. Bolduc’s employment is terminated without cause, or Mr. Bolduc resigns for good reason, the agreement provides (i) for the payment of 36 months’ salary and a pro rata portion of any bonus compensation earned during the year of termination, and (ii) that all stock options and shares of restricted stock then held by Mr. Bolduc will become fully vested and exercisable as of the date of such termination or resignation.
We will not be required to continue to pay any amounts to Mr. Bolduc or to continue to provide certain benefits following termination of the agreement unless Mr. Bolduc executes a general release in favor of us substantially in the form annexed to the agreement and the period during which Mr. Bolduc may revoke the release has expired without any such revocation.
The Agreement includes certain restrictions against competition and solicitation of our employees and customers for a period of one year after Mr. Bolduc’s resignation or termination.
In March 2012, we entered into a three-year employment agreement with Dr. William J. McGann, our Chief Operating Officer, pursuant to which Dr. McGann receives a base salary of $250,000 per year, commencing on April 2, 2012. After the third year, the agreement will automatically continue unless notice of termination is given by either party. We may terminate the agreement at any time without cause, on 30 days’ written notice. The agreement, however, provides for payment of twelve months’ salary and a pro rata portion of any bonus compensation earned during the year of termination, as well as the continuation of certain benefits, as separation payments in the event that Dr. McGann employment is terminated by us without “cause” or Dr. McGann resigns for “good reason” (as those terms are defined in the agreement). Dr. McCann’s base salary is subject to annual review, and any increases will be made in the discretion of the Board of Directors upon the recommendation of the Compensation Committee.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The agreement provides for Dr. McGann to be eligible to receive incentive compensation in an amount of up to $137,500 for the fiscal year ended June 30, 2014 upon the achievement of certain performance milestones to be established by the Board of Directors. We did not achieve these milestones and no bonus was payable to Dr. McGann for the fiscal year ended June 30, 2014. In August 2013, however, the Board agreed to pay Dr. McGann a bonus of $41,250 with respect to the fiscal year ended June 30, 2013 if the company achieves the Bonus Milestones described above. We did not achieve these milestones and no bonus was payable to Dr. McGann for the fiscal year ended June 30, 2013. Incentive compensation, if any, for subsequent fiscal years will be based on performance milestones to be established by mutual agreement between the Company and Dr. McGann within 60 days after commencement of each such fiscal year.
The agreement also provides that within 30 days after the completion of an equity financing, the gross proceeds of which to the Company are not less than $15,000,000, the Company will grant Dr. McGann an incentive stock option to purchase that number of shares of common stock of the Company which, together with all other option and equity awards previously issued by the Company, will equal approximately 1% of the Company’s fully diluted equity.
In May, 2012, we entered into a three-year employment agreement with Dr. Darryl Jones, our Vice President of Sales and Marketing, pursuant to which Dr. Jones will receive a base annual salary of $235,000 per year, commencing on May 7, 2012. After the third year, the agreement will automatically continue unless notice of termination is given by either party. We may terminate the agreement at any time without cause, on 30 days’ written notice. The agreement, however, provides for payment of twelve months’ salary and a pro rata portion of any bonus compensation earned during the year of termination, as well as the continuation of certain benefits, as separation payments in the event that Dr. Jones employment is terminated by us without “cause” or Dr. Jones resigns for “good reason” (as those terms are defined in the agreement). Dr. Jones’s base salary is subject to annual review, and any increases will be made in the discretion of the Board of Directors upon the recommendation of the Compensation Committee.
The agreement provides for Dr. Jones to be eligible to receive incentive compensation in an amount of up to $122,500 for the fiscal year ended June 30, 2014 upon the achievement of certain performance milestones to be established by the Board of Directors. We did not achieve these milestones and no bonus was payable to Dr. Jones for the fiscal year ended June 30, 2014. In August 2013, however, the Board agreed to pay Dr. Jones a bonus of $29,375 with respect to the fiscal year ended June 30, 2013 if the company achieves the Bonus Milestones described above. We did not achieve these milestones and no bonus was payable to Dr. Jones for the fiscal year ended June 30, 2013. Incentive compensation, if any, for subsequent fiscal years will be based on performance milestones to be established by mutual agreement between the Company and Dr. Jones within 60 days after commencement of each such fiscal year.
The agreement also provides that within 30 days after the completion of an equity financing, the gross proceeds of which to the Company are not less than $15,000,000, the Company will grant Dr. Jones an incentive stock option to purchase that number of shares of common stock of the Company which, together with all other option and equity awards previously issued by the Company, will equal approximately 1% of the Company’s fully diluted equity.
16.
Legal Proceedings
In January 2011, Fulong Integrated Technique, Ltd. filed a complaint against us in the Middlesex Superior Court of the Commonwealth of Massachusetts, alleging non-payment of amounts owed for services provided to us in connection with the sale of handheld explosives detection equipment to a customer in China in the first quarter of fiscal 2009. Fulong sought general monetary damages, other statutory damages, attorneys’ fees and costs.
In March 2013, we entered into a settlement agreement with Fulong, which provided for the payment of $200,000 and the transfer of ownership of five QS-H150 detectors to Fulong. We recognized a non-cash benefit of $295,000 in general and administrative expenses in the year ended June 30, 2013 as a result of the settlement.
We are not currently a party to any 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.
IMPLANT SCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17.
Subsequent Events
On July 1, 2014, we remitted $858,333 in payment of interest accrued under our senior secured promissory note with BAM funding for which was obtained under our credit facility with DMRJ.
On July 2, 2014, our Board of Directors adopted the Company’s 2014 Stock Option Plan, reserving 15,000,000 shares of the our common stock for issuance thereunder and approved stock option awards to non-employee directors, executive management and employees that aggregated to 4,210,000 shares.
The following grants of options to our named executives and directors were approved by our Board of Directors:
Named Executives and Directors
Shares Granted
Glenn D. Bolduc
300,000
Dr. William J. McGann
300,000
Roger P. Deschenes
300,000
Dr. Darryl K. Jones
300,000
Michael C. Turmelle
300,000
Howard Safir
300,000
Robert P. Liscouski
300,000
John J. Hassett
100,000
John A. Keating
300,000
Todd A. Silvestri
300,000
Brenda L. Baron
300,000
3,100,000
Each of these options has an exercise price of $1.10 per share.
On September 2, 2014, DMRJ converted $212,000 of the accrued interest owed by us under a promissory note into 2,650,000 shares of our common stock, at an adjusted conversion price of $0.08 per share. The issuance of these securities to DMRJ is exempt from registration under the Securities Act of 1933, as amended, pursuant to an exemption provided by Section 3(a)(9) and/or Section 4(2) of the Securities Act.
We have evaluated subsequent events after the balance sheet date through the date these financial statements were issued, for appropriate accounting and disclosure and concluded that there were no other subsequent events requiring adjustment or disclosure in these financial statements.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Dated: September 29, 2014
/s/ Glenn D. Bolduc
Glenn D. Bolduc
President, Chief Executive Officer
(Principal Executive Officer and)
Chairman of the Board
Dated: September 29, 2014
/s/ William J. McGann
William J. McGann
Chief Operating Officer and
Director
Dated: September 29, 2014
/s/ Roger P. Deschenes
Roger P. Deschenes
Vice President, Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)
Dated: September 29, 2014
/s/ Michael C. Turmelle
Michael C. Turmelle
Director
Dated: September 29, 2014
/s/ Robert P. Liscouski
Robert P. Liscouski
Director
Dated: September 29, 2014
/s/ Howard Safir
Howard Safir
Director
Dated: September 29, 2014
/s/ John A. Keating
John A. Keating
Director
Dated: September 29, 2014
/s/ John J. Hassett
John J. Hassett
Director