NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE YEARS ENDED DECEMBER 31, 2019 AND 2018
1.
SUMMARY
OF BUSINESS AND DESCRIPTION OF GOING CONCERN
Description of Business and Going Concern
MobileSmith, Inc.
(referred to herein as the “Company,” “us,”
“we,” or “our”) was incorporated as
Smart Online, Inc. in the State of Delaware in 1993. The Company
changed its name to MobileSmith, Inc. effective July 1, 2013.
The same year the Company focused exclusively on development of
do-it-yourself customer facing platform that enabled organizations
to rapidly create, deploy, and manage custom, native smartphone and
tablet apps deliverable across iOS and Android mobile platforms
without writing a single line of code. During 2017 the
Company concluded that it had its highest rate of success with
clients within the Healthcare industry and concentrated its
development and sales and marketing efforts in that industry.
During 2018 we further refined our Healthcare offering and
redefined our product - a suite of e-health mobile solutions that
consist of a catalog of ready to deploy mobile app solutions (App
Blueprints) and support services. In 2019 we consolidated
our current solutions under a single offering branded
Peri™. Peri™ is a cloud-based surgical and clinical
procedure application architected to accomplish the following
:
- Run on a
platform integrated with future MobileSmith
applications;
- Incorporate
MobileSmith developed or licensed healthcare service
applications;
- Securely link
those services to Electronic Medical Records ("EMR") platforms;
and
- Produce a mobile
app based set of pre and postoperative instructions (which we refer
to as Clinical Pathways), that establish a direct two-way clinical
procedure management process between a patient and a healthcare
provider and by doing so improves patient engagement for the
benefit of the patient and improves clinical outcomes measured in
procedure cancellations and post procedure readmissions for
the benefit of a provider.
The
accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of
business. During the years ended December 31, 2019 and 2018, the
Company incurred net losses, as well as negative cash flows from
operations, and at December 31, 2019 and 2018, had deficiencies in
working capital. The financial statements do not include any
adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts or classification of
liabilities that might be necessary should the Company be unable to
continue as a going concern.
The Company’s continuation as a going
concern depends upon its ability to generate sufficient cash flows
to meet its obligations on a timely basis, to obtain additional
financing as may be required, and ultimately to attain profitable
operations and positive cash flows. Since November 2007, the
Company has been funding its operations, in part, from the proceeds
of the issuance of notes under a convertible secured subordinated
note purchase agreement facility which was established in 2007 (the
"2007 NPA"), an unsecured convertible subordinated note purchase
agreement facility established in 2014 (the "2014 NPA") and
subordinated promissory notes to related
parties.
As of December 31, 2019, the Company had
$41,080,000 of combined face value outstanding under the 2007 and
2014 NPAs. The Company is entitled to request additional
notes in an amount not exceeding $17,945,000, subject to the terms and conditions specified in
these facilities. There can be no assurance that the Company will
in fact be able to raise additional capital through these
facilities or even from other sources on commercially acceptable
terms if at all.
The Notes under 2007 and 2014 NPA and subordinated promissory notes
to related parties mature in November of 2020 and the Comerica LSA
matures in June of 2020. The Company management is actively
negotiating extension of maturity on the 2007 and 2014 NPAs
and subordinated promissory notes with related parties by at
least two years and refinancing of Comerica LSA by extending its
maturity. As such, there is substantial doubt
about the Company's ability to continue as a going
concern.
Certain prior period amounts have been reclassified for consistency
with the current period presentation. These reclassifications had
no effect on the reported results of
operations.
2.
SIGNIFICANT
ACCOUNTING POLICIES
Use of Estimates
The preparation of
financial statements in conformity with accounting principles
generally accepted in the United States (“US GAAP”)
requires management to make estimates and assumptions in the
Company’s financial statements and notes thereto. Significant
estimates and assumptions made by management include the
determination of performance obligations and the allocation of
consideration among performance obligations, and the determination
of when the Company has met the requirements to recognize revenue
related to the performance obligations, share-based compensation,
allowance for accounts receivable, estimated useful lives of
property and equipment, recoverability of capitalized software
asset and other long lived assets. Actual results could differ from
those estimates.
Cash and Cash Equivalents
All highly liquid
investments with an original maturity of three months or less are
considered to be cash equivalents. The Federal Deposit
Insurance Corporation ("FDIC") covers $250,000 for substantially
all depository accounts. The Company from time to time may have
amounts on deposit in excess of the insured limits.
Revenue Recognition: General Overview and Performance Obligations
to Customers
The
Company derives revenue primarily from contracts for subscription
to the suite of e-health mobile solutions and, to a much lesser
degree, ancillary services provided in connection with subscription
services.
The
Company’s contracts include the following performance
obligations:
●
Access
to the content available on the App Blueprint Catalog, including
hosting of the deployed apps;
●
App
Build and Managed Services; and
●
Custom
development work.
The
majority of the Company’s contracts are for a subscription to
a catalog of mobile App Blueprints, and hosting of the deployed
apps and related services. Custom work for specific deliverables is
documented in statements of work or separate contracts. Customers
may enter into subscription and various statements of work
concurrently or consecutively. Most of the Company’s
performance obligations are not considered to be distinct from the
subscription to Blueprints, hosting of deployed apps and related
services and are combined into a single performance obligation
except for certain custom development work which is capable of
being distinct. New statements of work and modifications of
contracts are reviewed each reporting period and significant
judgment is applied as to nature and characteristics of the new or
modified performance obligations on a contract by contract
basis.
Revenue Recognition: Transaction Price of the Contract and
Satisfaction of Performance Obligations
The
transaction price of the contract is an aggregate amount of
consideration payable by customer for delivery of contracted
services. The transaction price is impacted by the terms of a
contracted agreement with the customer. Such terms range from one
to three years. The transaction price excludes any
marketing or sales discounts or any future renewal periods,
unless the renewal periods represent a material right given to
customer to extend the agreement. The transaction price may include
a significant financing component in instances where the Company
offers discounts for accelerated payments on the long-term
contracts. Significant financing components are recorded in
other assets and amortized as interest expense in the
Company’s Statement of Operations over the term of the
contract.
The
transaction price is predominantly allocated to a single
performance obligation of access to the Blueprints, hosting and
related services and, to a lesser degree, allocated between the
access and other distinct performance obligations based on the
stand-alone selling price. The subscription revenue is then
recognized over time over the term of the contract, using the
output method of time elapsed. Other performance obligations
identified are evaluated based on the specific terms of the
agreement are usually recognized at a point in time upon delivery
of a specific documented output. Management believes that such
chosen methods faithfully depict satisfaction of the Company
performance obligations and transfer of benefit to the
customers.
The full
transaction price of the contract may be billed in its entirety or
in agreed upon installments. Billed transaction price in
excess of revenue recognized results in the recording of a contract
liability. The unbilled portion of transaction price related
to revenue earned represents contracted consideration receivable by
the Company that was not yet billed.
Incremental Costs of Obtaining a Contract
The
Company’s incremental costs of obtaining a contract include
sales commissions. Sales commissions are recognized as other
assets on the balance sheet for the contracts with a term exceeding
12 months. These costs are amortized through the term of the
contract and are recorded as sales and marketing expense. As of
December 31, 2019 the Company’s other assets include
approximately $25,000 of such costs.
Contract Liabilities
A
new contract liability is created every time the Company records
receivables due from its customers. The contract liability
represents the Company’s obligation to transfer services for
which the Company has already invoiced. Most of the contract
liabilities will be recognized in revenue over a period of 12 to 36
months.
Customer Credit Risk
Most of the
Company's receivables (billings) are collected within 30-45
days. The majority of the Company's customers are healthcare
organizations, which historically have had low credit
risk.
Use of practical expedients in application of the Topic
606
The newly adopted
recognition standard prescribes the application of accounting
standards to individual contracts with customers, but allows for
the application of the guidance to a portfolio of contracts (or
performance obligations) with similar characteristics if the effect
of such application is immaterial. The Company applies
practical expedients in following instances:
●
The
Company does not adjust the promised amount of consideration for
the effects of a significant financing component if, at contract
inception, the period between when the Company transfers its
services to a customer and when the customer pays services will be
one year or less.
●
The Company
recognizes incremental costs of obtaining a contract as expenses
when incurred if the amortization period of the asset that the
Company otherwise would have recognized is one year or
less.
●
In instances where
a customer had been granted a material option which in essence is a
right to renew under the terms of the original contract, the
Company uses a practical alternative to estimating the standalone
selling price of the option: the alternative includes allocation of
the transaction price to the optional goods or services by
reference to the goods or services expected to be provided and the
corresponding expected consideration
Cost of Revenues
Cost of revenues
includes salaries of customer support teams, costs of
infrastructure, expenses for outsourced work to fulfill the
contracted work, and amortization charges for capitalized
software.
Allowance for Doubtful Accounts
The Company
maintains an allowance for doubtful accounts for estimated losses
resulting from the inability or failure of its customers to make
required payments. The need for an allowance for doubtful accounts
is evaluated based on specifically identified amounts that
management believes to be potentially uncollectible. If actual
collections experience changes, revisions to the allowance may be
required.
Property and Equipment
The Company records
property and equipment at cost and provides for depreciation and
amortization using the straight-line method for financial reporting
purposes over the estimated useful lives. The estimated useful
lives by asset classification are as follows:
Computer hardware
and office equipment
|
5
years
|
Computer
software
|
5
years
|
Furniture and
fixtures
|
5
years
|
Leasehold
improvements
|
Shorter of the
estimated useful life or the lease term
|
Software Development Costs
The Company
capitalized certain costs of development and subsequent enhancement
of our platform that supports the deployment of mobile apps created
from Blueprints (the "Platform") through the middle of 2013. The
Company started capitalizing software development costs when
technological feasibility of the Platform or its enhancements had
been established. The Company expensed costs associated with the
preliminary project stage and research activities. The
Company’s policy provided for the capitalization of certain
payroll, benefits, and other payroll-related costs for employees
who were directly associated with development.
During 2012, the
Platform was substantially completed. During 2013, the
Company’s development efforts became more driven by market
requirements and rapidly changing customers’ needs. As a
result, the Company’s development team adopted iterative
approach to software development (the "agile methodology"). Due to
agile methodology short development cycles and focus on rapid
production, the Company ceased capitalizing software development
costs mid-way through 2013 as the documentation produced under the
agile methodology did not meet requirements necessary to establish
technological feasibility. No development costs were capitalized in
2019 or 2018 and the Company does not expect to capitalize
substantial development costs in the future.
Impairment of Long-Lived Assets
The Company
evaluates the recoverability of its long-lived assets every
reporting period or whenever events and circumstances indicate that
the value may be impaired.
Advertising Costs
Advertising costs
consist primarily of industry related tradeshows and marketing
campaigns. Advertising costs are expensed as incurred, or the first
time the advertising takes place, applied consistently based on the
nature of the advertising activity. The amounts related to
advertising during the years ended December 31, 2019 and 2018 were
$234,203 and $404,882, respectively.
Share-Based Compensation
The Company
measures share-based compensation cost at the grant date based on
the fair value of the award. The Company recognizes compensation
cost on a straight-line basis over the requisite service period.
The requisite service period is generally three years. The
Company accounts for forfeitures as they occur.
The Company uses
the simplified method allowed by SAB 107 for estimating
expected term of the options in
calculating the fair value of the awards that have a term of more
than 7 years because the Company does not have reliable historical
data on exercise of its options. The simplified method was
used for options granted in 2018 and 2019.
The fair value of
option grants under the Company’s equity compensation plan
during the years ended December 31, 2019 and 2018 was estimated
using Black-Scholes pricing
model using the following weighted-average assumptions
:
|
|
|
Dividend
yield
|
0.00%
|
0.00%
|
Expected
volatility
|
112%
|
108.48%
|
Risk-free interest
rate
|
2.12%
|
2.75%
|
Expected lives
(years)
|
6
|
6.5
|
Net Loss Per Share
Basic net loss per
share is computed by dividing net loss by the weighted average
number of shares of common stock outstanding during the periods.
Diluted net loss per share is computed using the weighted average
number of common and dilutive common equivalent shares outstanding
during the periods. Shares of common stock issuable upon conversion
of Convertible Subordinated Promissory Notes (the
“Notes”) and exercise of share-based awards are
excluded from the calculation of the weighted average number,
because the effect of the conversion and exercise would be
anti-dilutive.
Recently Issued Accounting Pronouncements
In
June 2018, the Financial Accounting Standards Board ("FASB")
announced Accounting Standards Update ("ASU") 2018-07
Compensation-Stock Compensation ("Topic 718"): Improvements to
Nonemployee Share-Based Payment Accounting. ASU 2018-07 expands the
scope of Topic 718, Compensation—Stock Compensation (which
currently only includes share-based payments to employees) to
include share-based payments issued to nonemployees for goods or
services. Consequently, the accounting for share-based payments to
nonemployees and employees will be substantially aligned. The ASU
supersedes Subtopic 505-50, Equity—Equity-Based Payments to
Non-Employees. ASU 2018-07 is effective for public companies for
fiscal years beginning after December 15, 2018, including interim
periods within that fiscal year. Early adoption is permitted, but
no earlier than a company’s adoption date of Topic 606,
Revenue from Contracts with Customers. The Company elected to adopt
ASU 2018-07 as of January 1, 2018.
In August 2018, the FASB announced ASU
2018-13 Fair Value Measurement (Topic 820): Disclosure
Framework—Changes to the Disclosure Requirements for Fair
Value Measurement. This amendment removes, modifies or adds
certain disclosure requirements for Fair Value Measurements.
For all entities, amendments are effective for fiscal years, and
interim periods within those fiscal years, beginning after December
15, 2019. The Company doesn't expect that the ASU will have
material impact on its financial statements.
In
February 2016, the FASB established Topic 842, Leases, by
issuing ASU 2016-02, which requires companies to recognize leases
the balance sheet and disclose key information about leasing
arrangements. The new standard establishes a right-of-use model
("ROU") that requires a lessee to recognize a ROU asset and lease
liability on the balance sheet for all leases with a term longer
than 12 months. Leases are to be classified as finance or
operating, with classification affecting the pattern and
classification of expense recognition in the statement of
operations.
The
new standard was effective and adopted by us on January 1, 2019. A
modified retrospective transition approach is required, applying
the new standard to all leases existing at the date of initial
application.
As
a result we did not restate the prior period presented in the
Financial Statements.
The new standard provides a number of
optional practical expedients in transition. We elected the
‘package of practical expedients’, which permits us not
to reassess under the new standard our prior conclusions about
lease identification, lease classification and initial direct
costs.
The most significant judgments and impacts upon adoption of the
standard include the following:
●
We
recognized right-of-use asset and operating lease liability for our
corporate office operating lease that have not previously been
recorded. The lease liability for operating lease is based on the
net present value of future minimum lease payments.
●
Financing lease
right-of-use assets (formerly capital lease assets) have been and
will continue to be included within Property and Equipment.
Capital lease liabilities previously included in Short-term
capital lease obligations and Long-term capital lease
obligations were reclassified to Other Liabilities and Accrued
Expenses in our Balance Sheet.
●
The
right-of-use asset for operating lease is based on the lease
liability adjusted for the reclassification of deferred rent, which
we remeasured at adoption due to the application of hindsight to
our lease term estimates. Deferred rent will no longer be presented
separately.
●
Certain
line items in the Statements of Cash Flows and have been
renamed to align with the new terminology presented in the new
standard; “Repayment of capital lease obligations” is
now presenting as “Repayments of financing lease
obligations”. In the “Operating Activities”
section of the Statements of Cash Flows we have added
“Operating lease right-of-use asset” and
“Operating lease liability” which represent the change
in the operating lease asset and liability, respectively.
Additionally, in the “Supplemental disclosure of cash flow
information” section of the Statements of Cash Flows we
have added “Operating lease payments,” and in the
“Noncash investing and financing activities” section we
have added “Operating lease right-of-use assets obtained in
exchange for lease obligations.”
●
In
determining the discount rate used to measure the right-of-use
asset and lease liability, we use rates implicit in the lease, or
if not readily available, we use our incremental borrowing rate.
Our incremental borrowing rate of 8% is based on the rate on our
debt.
The
following tables summarize the current period impacts of adopting
Topic 842 on our Financial Statements as of January 1,
2019:
|
Beginning
Balance
|
Cumulative Effect
Adjustment
|
Beginning Balance, As
Adjusted
|
Assets
|
|
|
|
Operating
Lease Right-of-Use Asset
|
$-
|
$883,634
|
$883,634
|
|
|
|
|
Liabilities and Stockholders' Deficit
|
|
|
|
Operating
Lease Liabilities
|
-
|
881,585
|
881,585
|
Accumulated
Deficit
|
$(158,771,112)
|
$2,173
|
$(158,768,939)
|
Fair Value Measurements
Fair value is
defined as the price that would be received to sell an asset or
paid to transfer a liability (an exit price) in the principal or
most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date.
The fair value hierarchy prescribed by the accounting literature
contains three levels as follows:
Level 1 –
Quoted prices in active markets for identical assets or
liabilities.
Level 2 –
Observable inputs other than Level 1 prices such as quoted prices
for similar assets or liabilities; quoted prices in markets that
are not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full
term of the assets or liabilities.
Level 3 –
Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets
or liabilities. Level 3 assets and liabilities include financial
instruments whose value is determined using pricing models,
discounted cash flow methodologies, or similar techniques, as well
as instruments for which the determination of fair value requires
significant management judgment or estimations.
As of December 31, 2019 and 2018, we believe that
the fair value of our financial instruments other than cash and
cash equivalents, such as, accounts receivable, our bank loan,
notes payable, and accounts payable approximate their carrying
amounts.
3.
PROPERTY AND EQUIPMENT AND CAPITALIZED SOFTWARE
Property and
equipment:
|
December 31,
2019
|
December 31,
2018
|
|
|
|
Equipment
|
$124,915
|
$162,799
|
Furniture
and fixtures
|
89,580
|
89,580
|
Leasehold
improvements
|
34,162
|
34,162
|
|
248,657
|
286,541
|
Less
accumulated depreciation
|
(219,289)
|
(241,529)
|
Property
and equipment, net
|
$29,368
|
$45,012
|
Capitalized
software:
|
December 31,
2019
|
December 31,
2018
|
|
|
|
Capitalized
software
|
$736,678
|
$736,678
|
Less
accumulated amortization
|
(731,208)
|
(672,326)
|
Capitalized
software, net
|
$5,470
|
$64,352
|
During the years
ended December 31, 2019 and 2018, the Company recorded depreciation
and amortization expense related to its property and equipment and
capitalized software of $74,526 and $161,424,
respectively.
4. DEBT
The table below summarizes the Company’s debt at December 31,
2019 and December 31, 2018:
Debt Description
|
December 31,
|
December 31,
|
|
|
|
2019
|
2018
|
Maturity
|
Rate
|
|
|
|
|
|
Bank Loan
|
$5,000,000
|
$5,000,000
|
June
2020
|
6.10%
|
Convertible
Notes - Related Parties, net of discount of $1,193,799 and
$1,527,146, respectively
|
39,230,432
|
35,740,085
|
November
2020
|
8.00%
|
Convertible
notes, net of discount of $45,029
|
610,740
|
610,740
|
November
2020
|
8.00%
|
Subordinated
Promissory Notes, Related Parties
|
3,518,250
|
525,000
|
November
2020
|
8.00%
|
Total
debt
|
48,359,422
|
41,875,825
|
|
|
|
|
|
|
|
Less:
current portion of long term debt
|
48,359,422
|
-
|
|
|
|
|
|
|
|
Debt
- long term
|
$-
|
$41,875,825
|
|
|
Bank Loan
The Company has an outstanding Loan and
Security Agreement with Comerica Bank ("Comerica") dated June 9,
2014 (the "LSA") in the amount of $5,000,000, with original
maturity of June 9, 2016. On June 8, 2018, the Company
and Comerica Bank entered into Second Amendment to the LSA, which
extended the maturity of the LSA to June 9, 2020. The LSA is
secured by an irrevocable letter of credit ("SBLC") issued by UBS
AG (Geneva, Switzerland) ("UBS AG") with a renewed term expiring on
May 31, 2020, which term is renewable for one year periods, unless
notice of non-renewal is given by UBS AG at least 45 days prior to
the then current expiration date.
The LSA with Comerica has the following additional
terms:
●
a
variable interest rate at prime plus 0.6% payable
quarterly;
●
secured
by substantially all of the assets of the Company, including the
Company’s intellectual property;
●
acceleration of
payment of all amounts due thereunder upon the occurrence and
continuation of certain events of default, including but not
limited to, failure by the Company to perform its obligations,
observe the covenants made by it under the LSA, failure to renew
the UBS AG SBLC, and insolvency of the Company.
Convertible Notes Overview
Since November 14,
2007 and through December 10, 2014, the Company financed its
working capital deficiency primarily through the issuance of its
notes of up to $33,300,000 in principal (the “2007 NPA
Notes”) under the Convertible Secured Subordinated Note
Purchase Agreement, dated November 14, 2007, as amended (the
“2007 NPA”). On December 11, 2014 the Company
entered into an unsecured Convertible Subordinated Note Purchase
Agreement, as amended (the “2014 NPA”) with Union
Bancaire Privée, UBP SA ("UBP") a related party, for the sum
of notes up to $40,000,000 in principal ("2014 NPA Notes").
At the request of the noteholder any amounts borrowed under the
2007 NPA and the 2014 NPA allow the principal amount to be
converted to common shares at a conversion price of $1.43 per
share.
On
May 25, 2018, the Company and the holders of the majority of
the aggregate outstanding principal amount of the 2014 NPA
Notes and holders of the majority of the aggregate outstanding
principal amount of the 2007 NPA Notes agreed to
extend the maturity dates of these notes to November 14,
2020. All other terms relating to the outstanding 2007 NPA
Notes and the 2014 NPA Notes were not modified. The Company is
entitled to utilize the amounts available for future borrowing
under each of the 2007 NPA and the 2014 NPA through November 14,
2020.
As
a result of the modification, any unamortized discount will be
amortized into interest expense through the new maturity date of
November 14, 2020.
During
2019, the Company borrowed an additional $3,160,000 under the 2014
NPA from UBP. The market value of the Company’s
common stock on the date of each issuance of the 2014 NPA Notes to
UBP was higher than the conversion price, which resulted in a
beneficial conversion feature totaling an aggregate $877,413 and a
corresponding debt discount, which is being amortized into interest
expense through the maturity date of the Notes.
During
the year ended December 31, 2018 a total of $5,075,000 of notes
were converted into 3,548,951 shares of Company's common stock at
the stated conversion price of $1.43 per share. Related party
debt was $5,000,000 of the converted amount.
On
October 30, 2018 following request from UBP, the Company
simultaneously repaid $2,000,000 of 2014 NPA Notes and
borrowed $2,000,000 by issuing 2007 NPA Notes in a cashless
note exchange with UBP.
During
2019 the Company sold $2,993,250 of unsecured subordinated short
term notes to related parties. The notes mature in November
of 2020 and have an interest rate of 8%.
In
September of 2018 the Company changed the frequency of interest
payments on its 2007 NPA Notes, 2014 NPA Notes and other
subordinated related party notes payable from quarterly to twice
per year in January and July of each year until
maturity.
Convertible notes issued under 2014 NPA
The aggregate principal amount of 2014 NPA Notes that may be
issued under the 2014 NPA is $40 million, of which $20,600,000 had
been borrowed as of December 31, 2019. The 2014 NPA
Notes are convertible into shares of the Company’s common
stock, par value $0.001 per share, and are subordinated to the $5
million outstanding under the LSA with Comerica and to any
promissory notes outstanding under the 2007
NPA.
The 2014 NPA Notes
have the following terms:
●
a
maturity date of the earlier of (i) November 14, 2020, (ii) a
Change of Control (as defined in the 2014 NPA), or (iii) when, upon
or after the occurrence of an Event of Default (as defined in the
2014 NPA), other than for a bankruptcy related, such amounts are
declared due and payable by at least two-thirds of the aggregate
outstanding principal amount of the 2014 NPA Notes;
●
an
interest rate of 8% per year, with accrued interest payable in cash
in semi-annual installments with the final installment payable on
the maturity date of the note;
●
a
conversion price per share that is fixed at $1.43 per
share;
●
optional conversion
upon noteholder request; provided that, if at the time of any such
request, the Company does not have a sufficient number of shares of
common stock authorized to allow for such conversion, the
noteholder may only convert that portion of their Notes outstanding
for which the Company has a sufficient number of authorized shares
of common stock. To the extent multiple noteholders under the 2014
NPA, the 2007 NPA, or both, request conversion of its notes on the
same date, any limitations on conversion shall be applied on a pro
rata basis. In such case, the noteholder may request that the
Company call a special meeting of its stockholders specifically for
the purpose of increasing the number of shares of common stock
authorized to cover conversions of the remaining portion of the
notes outstanding as well as the maximum issuances contemplated
pursuant to the Company’s 2004 Equity Compensation Plan,
within 90 calendar days after the Company’s receipt of such
request; and
●
may not
be prepaid without the consent of holders of at least two-thirds of
the aggregate outstanding principal amount of 2014 NPA
Notes.
Convertible
notes issued under 2007 NPA
The aggregate principal amount of 2007 NPA Notes that may be
issued under the 2007 NPA is $33,300,000, of which
$20,480,000
had
been borrowed as of December 31, 2019. The 2007 NPA
Notes are convertible into shares of the Company’s common
stock, par value $0.001 per share, and are subordinated to the $5
million outstanding under the LSA with Comerica.
As amended, the
2007 NPA Notes have the following terms:
●
a
maturity date of the earlier of (i) November 14, 2020, (ii) a
Change of Control (as defined in the amended 2007 NPA), or (iii)
when, upon or after the occurrence of an Event of Default (as
defined in the amended 2007 NPA) such amounts are declared due and
payable by a 2007 NPA Noteholder or made automatically due and
payable in accordance with the terms of the 2007 NPA;
●
an
interest rate of 8% per year, with accrued interest payable in cash
in semi-annual installments with the final installment payable on
the maturity date of the note;
●
a
conversion price that is fixed at $1.43 per share; and
●
optional conversion
upon 2007 NPA Noteholder request, provided that, if at the time of
any such request, the Company does not have a sufficient number of
shares of common stock authorized to allow for such conversion, as
well as the issuance of the maximum amount of common stock
permitted under the Company’s 2004 Equity Compensation Plan,
the 2007 NPA Noteholder may request that the Company call a special
meeting of its stockholders specifically for the purpose of
increasing the number of shares of common stock authorized to cover
the remaining portion of the Notes outstanding as well as the
maximum issuances permitted under the 2004 Equity Compensation
Plan.
The table
below summarizes convertible notes issued as of December 31,
2019 and 2018 by type:
|
|
|
2007
NPA notes, net of discount
|
$20,405,588
|
$20,374,668
|
2014
NPA notes, net of discount
|
19,435,584
|
15,976,157
|
Total
convertible notes, net of discount
|
$39,841,172
|
$36,350,825
|
Related Party Convertible Notes under 2007 and 2014
NPAs
Grasford
Investments, Ltd. ("Grasford"), the Company’s largest
stockholder, owns $12,076,282 in face value amount of 2007 NPA
Notes as of December 31, 2019. Grasford is controlled by Avy
Lugassy, one of the Company’s principal
shareholders.
UBP owns
$27,617,180 in combined face value of 2007 and 2014 NPA Notes as of
December 31, 2019 and is considered a significant beneficial
owner.
Crystal Management
owns $730,769 in face value of 2007 NPA Notes as of December 31,
2019. Crystal Management is controlled by Doron Rotler, the third
largest shareholder of the Company.
Subordinated Promissory Notes, Related
Parties
The Company has
issued subordinated notes to related parties to finance its
shortfall in working capital. The subordinated notes carry
interest rate of 8% per year, which is paid twice a year. The
subordinated notes are unsecured and are subordinated to all other
Company debt.
The
subordinated notes mature in November of 2020.
Avy Lugassy, one
of the Company's principal shareholders is a beneficial owner of
the related parties holding the subordinated
notes.
Interest
Interest expense
for the year ended December 31, 2019 for convertible notes was
$4,576,896, including amortization of discount of
$1,207,759.
Interest expense
for the year ended December 31, 2018 convertible notes was
$3,818,657, including amortization of discount of
$773,877.
Interest expense
for subordinated promissory notes to related parties was $155,627
and $31,194 for the years ended December 31, 2019 and
December 31, 2018, respectively.
5.
COMMITMENTS AND CONTINGENCIES
Legal Proceedings
From
time to time, the Company may be subject to routine litigation,
claims or disputes in the ordinary course of business. The Company
defends itself vigorously in all such matters. In the opinion of
management, no pending or known threatened claims, actions or
proceedings against the Company are expected to have a material
adverse effect on its financial position, results of operations or
cash flows. However, the Company cannot predict with certainty the
outcome or effect of any such litigation or investigatory matters
or any other pending litigations or claims. There can be no
assurance as to the ultimate outcome of any such lawsuits and
investigations. The Company will record a liability when it
believes that it is both probable that a loss has been incurred and
the amount can be reasonably estimated. The Company
periodically evaluates developments in its legal matters that could
affect the amount of liability that it has previously accrued, if
any, and makes adjustments as appropriate. Significant judgment is
required to determine both the likelihood of there being, and the
estimated amount of, a loss related to such matters, and the
Company’s judgment may be incorrect. The outcome of any
proceeding is not determinable in advance. Until the final
resolution of any such matters that the Company may be required to
accrue for, there may be an exposure to loss in excess of the
amount accrued, and such amounts could be material.
6.
STOCKHOLDERS’
DEFICIT
Common Stock
The Company is
authorized to issue 100,000,000 shares of common stock, $0.001 par
value per share. As of December 31, 2019, the Company had
28,271,598 shares of common stock outstanding. Holders of the
Company’s shares of common stock are entitled to one vote for
each share held.
Preferred Stock
The Board of
Directors is authorized, without further stockholder approval, to
issue up to 5,000,000 shares of $0.001 par value preferred stock in
one or more series and to fix the rights, preferences, privileges,
and restrictions applicable to such shares, including dividend
rights, conversion rights, terms of redemption, and liquidation
preferences, and to fix the number of shares constituting any
series and the designations of such series. There were no shares of
preferred stock outstanding at December 31, 2019 and
2018.
Equity Compensation Plans
2004 Equity Compensation Plan
The Company adopted
its 2004 Equity Compensation Plan (the “2004 Plan”) as
of March 31, 2004. The 2004 Plan provides for the grant of
incentive stock options, non-statutory stock options, restricted
stock, and other direct stock awards to employees (including
officers) and directors of the Company as well as to certain
consultants and advisors. The total number of shares of common
stock reserved for issuance under the 2004 Plan is 5,000,000
shares, subject to adjustment in the event of a stock split, stock
dividend, recapitalization, or similar capital change. The Company
can’t make any new grants under the plan.
2016 Equity Compensation
Plan
In May 2016, the Company’s shareholders
authorized adoption of the approved MobileSmith Inc. 2016
Equity Compensation Plan for officers,
directors, employees and consultants, initially reserving for
issuance thereunder 15,000,000 shares of Common
Stock.
The exercise price
for incentive stock options granted under the above plans is
required to be no less than the fair market value of the common
stock on the date the option is granted, except for options granted
to 10% stockholders, which are required to have an exercise price
of not less than 110% of the fair market value of the common stock
on the date the option is granted. Incentive stock options
typically have a maximum term of 10 years, except for option grants
to 10% stockholders, which are subject to a maximum term of five
years. Non-statutory stock options have a term determined by either
the Board of Directors or the Compensation Committee of the Board
of Directors. Options granted under the plans are not transferable,
except by will and the laws of descent and
distribution.
A summary of the status of the stock
option issuances as of December 31, 2019 and 2018, and changes
during the periods ended on these dates is as
follows:
|
Number of Shares
|
Weighted Average Exercise
Price
|
Weighted Average Remaining
Contractual Term
|
Aggregate Intrinsic
Value
|
Outstanding,
December 31, 2017
|
2,658,247
|
$1.54
|
4.29
|
$654,701
|
Cancelled
|
(1,011,289)
|
1.70
|
|
|
Issued
|
5,057,758
|
1.95
|
|
|
Outstanding,
December 31, 2018
|
6,704,716
|
$1.83
|
7.41
|
$765,927
|
Cancelled
|
(1,892,900)
|
1.52
|
|
|
Issued
|
7,533,980
|
1.66
|
|
|
Outstanding,
December 31, 2019
|
12,345,796
|
1.73
|
8.3
|
$13,823,410
|
Vested
and exercisable, December 31, 2019
|
4,120,173
|
$1.69
|
6.6
|
$4,776,994
|
Weighted-average
grant-date fair values of options issued during 2019 and 2018 were
$1.42 and $1.95, respectively.
At December 31,
2019, $12,318,525 of expense remains to be recorded related to all
options outstanding.
Exercise prices for
options outstanding as of December 31, 2019 ranged between $.90 and
$2.00.
7.
INCOME
TAXES
The
Company accounts for income taxes under the asset and liability
method in accordance with the requirements of US GAAP. Under the
asset and liability method, deferred income taxes are recognized
for the tax consequences of “temporary differences” by
applying enacted statutory tax rates applicable to future years to
differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities.
The
balances of deferred tax assets and liabilities are as
follows:
|
December 31,
2019
|
December 31,
2018
|
Net current deferred income tax assets related
to:
|
Allowance
for doubtful accounts
|
$1,000
|
$59,000
|
Depreciation
and amortization
|
104,000
|
114,000
|
Deferred
revenue
|
41,000
|
99,000
|
Stock-based
compensation
|
53,000
|
60,000
|
Other
|
9,325
|
9,325
|
Net
operating loss carryforwards
|
22,719,000
|
23,022,000
|
Total
|
22,927,325
|
23,333,325
|
Less
valuation allowance
|
(22,927,325)
|
(23,333,325)
|
Net
current deferred income tax
|
$-
|
$-
|
Under
US GAAP, a valuation allowance is provided when it is more likely
than not that the deferred tax asset will not be
realized.
Total income tax
expense differs from expected income tax expense (computed by
applying the U.S. federal corporate income tax rate of 21% in 2019
and 2018) to loss before taxes as follows:
Tax
benefit computed at statutory rate of 21%
|
$(2,311,162)
|
$(1,750,297)
|
State
income tax benefit, net of federal effect
|
(132,066)
|
(100,017)
|
Permanent
differences
|
|
Stock
based compensation
|
770,688
|
304,339
|
Debt
discount amortization
|
268,123
|
181,464
|
Other
|
(52,583)
|
2,323
|
Impact of change in state tax
rate
|
3,317,028
|
Expiration
of NOLs
|
1,863,000
|
|
Change
in valuation allowance
|
(406,000)
|
(1,954,535)
|
Totals
|
$-
|
$-
|
As
of December 31, 2019, the Company had U.S. federal net operating
loss (“NOL”) carryforwards of approximately $104.7
million, of which $12.2 million will never expire and approximately
$89.5 million will expire between 2020 and 2039. For state tax
purposes, the NOL carryforwards expire between 2020 and 2034. In
accordance with Section 382 of the Internal Revenue Code of 1986,
as amended, a change in equity ownership of greater than 50% of the
Company within a three-year period can result in an annual
limitation on the Company’s ability to utilize its NOL
carryforwards that were created during tax periods prior to the
change in ownership.
The
Company has reviewed its tax positions and has determined that it
has no significant uncertain tax positions at December 31,
2019.
8.
MAJOR CUSTOMERS AND CONCENTRATIONS
A customer that
individually generates more than 10% of revenue is considered a
major customer.
For the year ended December 31, 2019, one customer
accounted for 16% of the Company’s revenue. Three customers
accounted for 81% of the net accounts receivable balance as of
December 31, 2019. One vendor accounted for 30% of the
accounts payable balance as of December 31,
2019.
For the year ended December 31, 2018, no customer
accounted for more than 10% of the Company’s revenue. Four
customers accounted for 76% of the net accounts receivable balance
as of December 31, 2018. Two vendors accounted for 22% of the
accounts payable balance as of December 31,
2018.
9.
EMPLOYEE BENEFIT PLAN
All full-time employees who meet certain age and
length of service requirements are eligible to participate in the
Company’s 401(k) Plan. The plan provides for contributions by
the Company in such amounts as the Board of Directors may annually
determine, as well as a 401(k) option under which eligible
participants may defer a portion of their salaries. The Company
contributed a total of approximately $36,453 and $41,477 to the
plan during 2019 and 2018, respectively.
10. DISAGGREGATED PRESENTATION OF REVENUE AND
OTHER RELEVANT INFORMATION
The
tables below depict how the nature, amount, timing, and uncertainty
of revenue and cash flows are affected by economic factors, such as
type of customer and type of contract.
Customer size
impact on billings and revenue:
|
Year Ended
December 31, 2019
|
Year Ended
December 31, 2018
|
|
Billings
|
GAAP Revenue
|
Billings
|
GAAP Revenue
|
Top
5 Customers (Measured By Amounts Billed)
|
$877,030
|
$787,386
|
$815,691
|
$356,871
|
All
Other Customers
|
$1,344,054
|
$2,014,322
|
$1,790,387
|
$1,966,250
|
|
$2,221,084
|
$2,801,708
|
$2,606,078
|
$2,323,121
|
As of December 31,
2019 the aggregate amount of the transaction price allocated to
unsatisfied (or partially satisfied) performance obligations was
$2,400,326 of which $1,079,371 had been billed to the customers and
recorded as a contract liability and $1,320,955 remained unbilled
as of December 31, 2019. The following table describes
the timing of when the Company expects to recognize the revenue
from the unsatisfied performance obligations.
|
Billed (Contract Liability as of
December 31, 2019)
|
Unbilled
|
Total
|
2020
|
$1,051,271
|
$731,044
|
$1,782,315
|
2021
|
28,100
|
469,709
|
497,809
|
2022
|
-
|
120,202
|
120,202
|
|
$1,079,371
|
$1,320,955
|
$2,400,326
|
At January 1, 2019
the total contract liability balance was $1,673,521 (net of the
Topic 606 adoption adjustment), of which $1,487,907 was recognized
in revenue during the twelve months ended December 31,
2019.
11.
LEASES
Leases (Topic 842)
Disclosures
We are a lessee for a non-cancellable operating lease for our
corporate office in Raleigh, North Carolina. We are also a lessee
for a non-cancellable finance lease for a corporate vehicle and
office furniture. See Note 4 for disclosures regarding
financing leases. The operating lease for the corporate
office expires on April 30, 2024.
The following table
summarizes the information about operating
lease:
|
Year Ended December 31,
2019
|
The
following table summarizes the information about operating
lease:
|
|
Operating
lease expense
|
$203,974
|
Weighted
Average Remaining Lease Term
(Years)
|
4.25 years
|
Weighted
Average Discount Rate
|
8%
|
Future maturities
of operating lease liability as of December 31, 2019, were as
follows:
Years Ended
December 31,
|
Operating Lease
Expense
|
Variable Lease
Expense
|
Total Lease
Expense
|
2020
|
190,365
|
13,238
|
203,603
|
2021
|
189,994
|
13,609
|
203,603
|
2020
|
189,615
|
13,988
|
203,603
|
2023
|
189,225
|
14,378
|
203,603
|
2024
|
63,074
|
4,793
|
67,867
|
Total
lease payments
|
$822,273
|
$60,006
|
882,279
|
Less
imputed interest
|
|
|
(138,760)
|
Total
|
|
|
$743,519
|
12.
SUBSEQUENT
EVENTS
Subsequent to December 31, 2019, the Company
issued two 2014 NPA Notes for a total amount of $2,000,000 on the
same terms as the currently outstanding 2014 NPA Notes. The notes
mature on November 14, 2020. In addition, the Company
borrowed $1,045,000 through related party subordinated promissory
notes on the same terms and with similar entities as the currently
outstanding subordinated promissory notes from related parties
described in Note 4.