# Apyx Medical Corp: Form 10-Q for the period ended Sep 30, 2019

- Company: [Apyx Medical Corp](/companies/apyx.md) (CIK 719135)
- Form: 10-Q
- Filed: 2019-11-15
- Accepted by EDGAR: Nov 15, 2019, 16:05 ET
- Period: 2019-09-30
- Accession: 0000719135-19-000060
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/719135/000071913519000060/a2019q310-q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/719135/000071913519000060/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2019-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2019-07-01 to 2019-09-30 | $7.6m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 9 months, 2019-01-01 to 2019-09-30 | $19.8m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2019-07-01 to 2019-09-30 | $2.6m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 9 months, 2019-01-01 to 2019-09-30 | $6.8m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2019-07-01 to 2019-09-30 | $5.0m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2019-01-01 to 2019-09-30 | $13.0m | us-gaap:GrossProfit |
| Research and development | 3 months, 2019-07-01 to 2019-09-30 | $936.0k | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 9 months, 2019-01-01 to 2019-09-30 | $2.6m | us-gaap:ResearchAndDevelopmentExpense |
| Selling, general and administrative | 3 months, 2019-07-01 to 2019-09-30 | $3.8m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 9 months, 2019-01-01 to 2019-09-30 | $9.9m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2019-07-01 to 2019-09-30 | −$4.7m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2019-01-01 to 2019-09-30 | −$14.9m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2019-07-01 to 2019-09-30 | $0 | us-gaap:InterestExpense |
| Interest expense | 9 months, 2019-01-01 to 2019-09-30 | $0 | us-gaap:InterestExpense |
| Income tax | 3 months, 2019-07-01 to 2019-09-30 | $171.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2019-01-01 to 2019-09-30 | $123.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2019-07-01 to 2019-09-30 | −$4.3m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2019-01-01 to 2019-09-30 | −$13.9m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2019-07-01 to 2019-09-30 | −$0.13 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2019-01-01 to 2019-09-30 | −$0.41 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2019-07-01 to 2019-09-30 | −$0.13 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2019-01-01 to 2019-09-30 | −$0.41 | us-gaap:EarningsPerShareBasic |
| Operating cash flow | 9 months, 2019-01-01 to 2019-09-30 | −$15.1m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2019-01-01 to 2019-09-30 | $1.1m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2019-09-30 | $62.3m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2019-09-30 | $78.9m | us-gaap:AssetsCurrent |
| Total assets | at 2019-09-30 | $86.9m | us-gaap:Assets |
| Current liabilities | at 2019-09-30 | $9.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2019-09-30 | $10.2m | us-gaap:Liabilities |
| Shareholders' equity | at 2019-09-30 | $76.7m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 26,912 characters.

You should read the following discussion and analysis in conjunction with our financial statements and related notes contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors discussed in this report and those discussed in other documents we file with the SEC. In light of these risks, uncertainties and assumptions, readers are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements represent beliefs and assumptions as of the date of this report. While we may elect to update forward-looking statements and at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. Past performance does not guarantee future results.

### Executive Level Overview

We are a medical technology company and the developer of J-Plasma® (marketed and sold under the Renuvion® Cosmetic Technology brand in the cosmetic surgery market), a patented plasma-based surgical product for cutting, coagulation and ablation of soft tissue. J-Plasma technology utilizes a helium ionization process to produce a stable, focused beam of plasma that provides surgeons with greater precision and minimal invasiveness. We also leverage our expertise through original equipment manufacturing (OEM) agreements with other medical device manufacturers.

During 2019, we continue our full-scale commercialization efforts for Renuvion®. As of September 30, 2019, we had a direct sales force of 29 field-based selling professionals and a network of 6 independent sales agencies. We also had 4 sales managers. This selling organization is focused on the use of Renuvion in the cosmetic surgery market. In addition, we have invested in training programs and marketing-related activities to support accelerated adoption of Renuvion.

International sales represented approximately 26.7% of total revenues for the three months ended September 30, 2019, as compared with 24.8% of total revenues in the prior year. International sales represented approximately 29.2% of total revenues for the nine months ended September 30, 2019, as compared with 21.2% of total revenues in the prior year. Management estimates our products have been sold in more than 40 countries through local dealers coordinated by sales and marketing personnel at the Clearwater, Florida facility.

As previously disclosed with the Commission on Form 8-K filed on April 4, 2019, we announced on April 1, 2019, that we voluntarily withdrew our application for premarket notification 510(k) regulatory clearance of our J-Plasma®/Renuvion® technology for use in dermal resurfacing procedures. While this is a delay in our commercialization efforts, we remain committed to working with the U.S. Food and Drug Administration relative to the development of a new 510(k) submission for use in dermal resurfacing procedures.

During October 2019, the Company initiated subject enrollment in an FDA approved U.S. Investigational Device Exemption clinical study evaluating the use of its Renuvion technology in skin laxity procedures in the neck and submental region. Also during October 2019, the Company received U.S. Food and Drug Administration 510(k) clearance to market and sell the Apyx Plasma/RF Handpiece, a new addition to the Renuvion product family.

On August 30, 2018, we closed on a definitive asset purchase agreement ("the Asset Purchase Agreement") with Specialty Surgical Instrumentation Inc., a Tennessee Corporation and wholly-owned subsidiary of Symmetry Surgical Inc. (“Symmetry”), pursuant to which we divested and sold our electrosurgical "Core" business segment and related intellectual property, including the Bovie® brand and trademarks, to Symmetry for gross proceeds of $97 million in cash. The divestiture and sale of our Core business segment to Symmetry allows us to further focus on our strategic objective of commercializing our J-Plasma technology, including the Renuvion® brand in the cosmetic surgery market. We also entered into a Transition Services Agreement, Patent Licensing Agreement, a Disposables Supply Agreement, and a Generator Manufacturing and Supply Agreement, the latter of which will establish us as an OEM-provider of generators to Symmetry for a period of at least 10 years.

In connection with the Asset Purchase Agreement, we entered into an Electro Surgical Disposables and Accessories, Cauteries and Other Products Supply Agreement with Symmetry for up to a four-year term, whereby we will manufacture certain Core products and sell them to Symmetry at agreed upon prices. Any revenue, costs and expenses resulting from this agreement are netted and reported in our Consolidated Statements of Operations as Other gains or losses.

In connection with the Asset Purchase Agreement, we entered into a Manufacture and Supply Agreement with Symmetry for a ten-year term, whereby we will manufacture certain products and sell them to Symmetry at agreed upon prices. Revenue, costs and expenses resulting from this agreement are reported in our Consolidated Statements as income or loss from operations of our OEM reporting segment.

Operating segments are aggregated into reportable segments only if they exhibit similar economic characteristics. In addition to similar economic characteristics, we also consider the following factors in determining the reportable segments: the nature of business activities, the management structure directly accountable to our chief operating decision maker for operating and administrative activities, availability of discrete financial information and information presented to the Board of Directors and investors.

Our reportable segments are disclosed as principally organized and managed as two operating segments: Advanced Energy and OEM. "Corporate & Other" includes certain unallocated corporate and administrative costs which are not specifically attributed to any reportable segment. Net assets are shared, therefore, not allocated to the reportable segments. The OEM segment is primarily development and manufacturing contract and product driven, all related expenses are recorded as cost of sales, therefore no segment specific operating expenses are incurred.

We reclassified the financial results of the Core business to discontinued operations and from segment results for all periods presented. We strongly encourage investors to visit our website: www.apyxmedical.com to view the most current news and to review our filings with the Securities and Exchange Commission.

### Results of Operations

#### Sales

*(In thousands)*

| Sales by Reportable Segment | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 |  | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Advanced Energy | $6,094 | $2,985 | 104.2% | $15,734 | $8,727 | 7,007,000 | 80.3% |
| OEM | 1,481 | 687 | 115.6% | 4,038 | 2,033 | 2,005,000 | 98.6% |
| Total | $7,575 | $3,672 | 106.3% | $19,772 | $10,760 |  | 83.8% |
|  |  |  |  |  | 9,012,000 |  |  |
| **Sales by Domestic and International** |  |  |  |  |  |  |  |
| Domestic | $5,552 | $2,763 | 100.9% | $14,002 | $8,481 |  | 65.1% |
| International | 2,023 | 909 | 122.6% | 5,770 | 2,279 |  | 153.2% |
| Total | $7,575 | $3,672 | 106.3% | $19,772 | $10,760 |  | 83.8% |

Total revenue from continuing operations for the three months ended September 30, 2019, increased $3.9 million, or 106.3%, to $7.6 million, compared to $3.7 million in the prior year. Sales of the Company’s Advanced Energy generators and handpieces drove the increase in total revenue in the third quarter of 2019, with OEM segment sales contributing modestly to the year-over-year increase in total revenue from continuing operations during the third quarter 2019 period. Advanced Energy segment sales increased approximately $3.1 million, or 104.2% year-over-year, to $6.1 million, compared to approximately $3.0 million last year, as a result of additional sales force in the U.S. and new international distributors. This increase in selling infrastructure has resulted in increases of generator and handpiece sales, both domestically and in international markets. OEM segment sales increased $0.8 million, or 115.6% year-over-year, to $1.5 million, compared to $0.7 million last year, primarily attributable to sales to Symmetry under our Manufacture and Supply Agreement.

Total revenue from continuing operations for the nine months ended September 30, 2019, increased $9.0 million, or 83.8%, to $19.8 million, compared to $10.8 million in the prior year. Advanced Energy segment sales increased approximately $7.0 million, or 80.3% year-over-year, to $15.7 million, compared to approximately $8.7 million last year, as a result of additional sales force in the U.S. and new international distributors. This increase in selling infrastructure has resulted in increases of generator and handpiece sales, both domestically and in international markets. OEM segment sales increased $2.0 million, or 98.6% year-over-year, to $4.0 mil lion, compared to $2.0 million last year, resulting mainly from sales to Symmetry under our Manufacture and Supply Agreement.

#### Gross Profit

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Cost of sales | $2,558 | $1,151 | 122.2% | $6,757 | $3,490 | 93.6% |
| Percentage of sales | 33.8% | 31.3% |  | 34.2% | 32.4% |  |

|  |  |  |  |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Gross profit | $5,017 | $2,521 | 99.0% | $13,015 | $7,270 | 79.0% |
| Percentage of sales | 66.2% | 68.7% |  | 65.8% | 67.6% | 574,500,000.0% |

Gross profit for the three months ended September 30, 2019, increased approximately $2.5 million, or 99.0% year-over-year, to $5.0 million, compared to $2.5 million in the prior year. Gross margin for the three months ended September 30, 2019 was 66.2%, compared to 68.7% for the same period. The primary drivers of the decrease in gross profit margin were reallocations of overhead expenses in Bulgaria for manufactured inventory, revenue related to our new Product, Manufacturing, and Supply agreements with Symmetry and increases in Advanced Energy sales outside of the U.S., which have lower margins than U.S. sales and represented a higher mix of total sales in three months ended September 30, 2019.

Gross profit for the nine months ended September 30, 2019, increased approximately $5.7 million, or 79.0% year-over-year, to $13.0 million, compared to $7.3 million in the prior year. Gross margin for the nine months ended September 30, 2019, was 65.8%, compared to 67.6% for the same period. The primary drivers of the decrease in gross profit margin were increases in Advanced Energy sales outside the U.S., which have lower margins than U.S. sales and represented a higher mix of total sales in 2019 compared to last year, revenue related to our new Product, Manufacturing, and Supply agreements with Symmetry, which did not contribute to revenue results significantly during the first three quarters of 2018, and additional allocations of overhead expenses in Bulgaria for manufactured inventory. These decreases were also partially offset by an increase in margins due to reclassification of regulatory salaries from cost of goods sold in 2018.

#### Other Costs and Expenses

#### Research and development

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Research and Development expense | $936 | $613 | 52.7% | $2,634 | $1,890 | 39.4% |
| Percentage of sales | 12.4% | 16.7% |  | 13.3% | 17.6% |  |

Research and development expenses increased 52.7% and 39.4% for the three and nine months ended September 30, 2019, respectively, primarily due to focused spending on clinical studies and research projects related to the cosmetic surgery market.

#### Professional services

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Professional services expense | $1,996 | $628 | 217.8% | $5,756 | $1,815 | 217.1% |
| Percentage of sales | 26.3% | 17.1% |  | 29.1% | 16.7% |  |

Professional services expense increased 217.8% and 217.1% for the three and nine months ended September 30, 2019, respectively, primarily attributable to expense increases for training-related physician consulting, medical advisory board stock option grants, marketing expenses, and legal and audit fees.

#### Salaries and related costs

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries and related expenses | $3,020 | $2,119 | 42.5% | $9,691 | $5,734 | 69.0% |
| Percentage of sales | 39.9% | 57.7% |  | 49.0% | 53.3% |  |

During the three and nine months ended September 30, 2019, salaries and related expenses increased approximately 42.5% and 69.0%, respectively, primarily driven by an increase in employee stock option expense, increase in sales force by approximately a dozen, increase in administrative headcount, and reclassification of regulatory salaries from cost of goods sold in 2018.

#### Selling, general and administrative expenses

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| SG&A Expense | $3,762 | $1,957 | 92.2% | $9,869 | $6,280 | 57.1% |
| Percentage of sales | 49.7% | 53.3% |  | 49.9% | 58.4% |  |

During the three and nine months ended September 30, 2019, selling, general and administrative expense increased by 92.2% and 57.1%, respectively, primarily driven by higher sales commissions and regulatory expense.

#### Other Income (Expense)

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest income | $327 | $135 | 142.2% | $1,153 | $135 | 754.1% |
| Percentage of sales | 4.3% | 3.7% |  | 5.8% | 1.3% |  |
| Interest expense | $— | $(30) | (100.0)% | —% | $(102) | (100.0)% |
| Percentage of sales | —% | (0.8)% |  | —% | (0.9)% |  |
| Other income (losses), net | $230 | $(155) | (248.4)% | $5 | $(155) | (103.2)% |
| Percentage of sales | 3.0% | (4.2)% |  | —% | (1.4)% |  |
| Change in fair value of derivative liabilities, net | $— | $— | —% | $— | $20 | (100.0)% |
| Percentage of sales | —% | —% |  | —% | 0.2% |  |

#### Interest income

Total interest income was higher for the three and nine months ended September 30, 2019, as compared with the prior year. This increase is primarily related to short term investments in U.S. Treasury Securities which we purchased with the proceeds received from the sale of the Core business in September 2018.

#### Income Taxes

*(In thousands)*

|  | Three Months Ended September 30, 2019 | 2018 | Change | Nine Months Ended September 30, 2019 | 2018 | Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Income tax expense (benefit | $171 | $(2,408) | (107.1)% | $123 | $(2,384) | (105.2)% |
| Effective tax rate | (4.1)% | 84.6% |  | (0.9)% | 27.9% |  |

The Company’s income tax expense was $171,000 and $123,000 with an effective tax rate of (4.1)% and (0.9)% for the three and nine months ended September 30, 2019 respectively, as compared to an expense of $2,400,000, and $2,400,000 with an effective tax rate of 84.6% and 27.9%, for the three and nine months ended September 30, 2018, respectively. The effective rate differs from the statutory rate primarily due to the change in the valuation allowance on the Company’s net deferred tax assets.

### Product Development

We have developed most of our products and product improvements internally. Funds for this development have come primarily from our internal cash flow and equity issuances. We maintain close working relationships with physicians and medical personnel who assist in product research and development. New and improved products play a critical role in our sales growth. We continue to emphasize the development of proprietary products and product improvements to complement and expand our existing product lines. Our research and development team members are based in our Clearwater, Florida office and our facility in Sofia, Bulgaria.

### Reliance on Collaborative, Manufacturing and Selling Arrangements

We manufacture the majority of our products on our premises in Clearwater, Florida and in Sofia, Bulgaria. Labor-intensive sub-assemblies and labor-intensive products may be outsourced to our specification.

We also perform development services for OEM customers who have no legal obligation to purchase products from us. Should such customers fail to give us purchase orders for the product after development, our future business and value of related assets could be negatively affected. Furthermore, no assurance can be given that such customers will give sufficient high priority to our products. Additionally, we will function as an OEM-provider of generators to Symmetry for a period of at least 10 years from the date of the Generator Manufacturing and Supply Agreement.

We also have collaborative arrangements with two key foreign suppliers of certain items and components, and we purchase them pursuant to purchase orders. Our purchase order commitments are never more than one year in duration and are supported by our sales forecasts. The majority of our raw materials are purchased from sole-source suppliers. While we believe we could ultimately procure other sources for these components, should we experience any significant disruptions in this key supply chain, there are no assurances that we could do so in a timely manner which could render us unable to meet the demands of our customers, resulting in a material and adverse effect on our business and operating results.

### Liquidity and Capital Resources

Our working capital at September 30, 2019 was approximately $69.9 million compared with $81.9 (as revised) million at December 31, 2018.

On August 30, 2018, we sold our Core business segment and other related assets for $97 million in cash. At December 31, 2018, we had approximately $78 million in Cash, Cash Equivalents and Short-Term Investments, after making estimated Federal and State tax payments of $13.3 million.

For the nine months ended September 30, 2019, net cash used in operating activities is approximately $15.1 million, which principally funded our operating loss of $(13.9) million, compared with net cash used in operating activities of approximately $2.8 million in the same period for 2018.

Net cash from investing activities is $60.8 million, primarily related to the maturity of short term investments and reinvestment in cash equivalents.

Cash from financing activities of approximately $0.2 million primarily relates to cash collected for stock options during the nine months ended September 30, 2019. Cash used in 2018 financing activities in 2018 was $2.6 million and primarily related to the repayment of our mortgage at the Clearwater, FL, facility.

At September 30, 2019, we had purchase commitments totaling approximately $4.6 million, substantially all of which is expected to be purchased within the next six months.

### Critical Accounting Estimates

In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), we have adopted various accounting policies. Our most significant accounting policies are disclosed in Note 2 to the consolidated financial statements included in our Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on March 14, 2019.

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to inventories, intangible assets, property, plant and equipment, legal proceedings, research and development, warranty obligations, product liability, fair valued liabilities, sales returns and discounts, stock-based compensation and income taxes are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, or various assumptions that are believed to be reasonable under the circumstances and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may materially differ from these estimates.

Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Our critical accounting estimates include the following:

### Inventory reserves

We maintain a reserve for excess and obsolete inventory resulting from the potential inability to sell our products at prices in excess of current carrying costs and costs to sell. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an ongoing basis. Such marketplace changes may cause our products to become obsolete. We make estimates regarding the future recoverability of the costs of these products and record a provision for excess and obsolete inventories based on historical experience and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required, which would unfavorably affect future operating results.

### Long-lived assets

We review long-lived assets which are held and used, including property and equipment, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors that are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. To date, no reporting units are at risk of failing an impairment test.

### Stock-based Compensation

Under our stock option plan, options to purchase common shares of the Company may be granted to key employees, officers and directors of the Company by the Board of Directors. The Company accounts for stock options in accordance with FASB ASC Topic 718-10, *Compensation-Stock Compensation*, with compensation expense amortized over the vesting period based on the trinomial lattice option-pricing model fair value on the grant date, which includes a number of estimates that affect the amount of our expense.

### Litigation Contingencies

In accordance with authoritative guidance, we accrue a liability in our consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is recorded. If a loss is reasonably possible, but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded, actual results may differ from these estimates.

### Income Taxes

The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using enacted marginal tax rates. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.

As a result of historical losses exclusive of discontinued operations and the Company’s expectation to continue to generate losses in the near future, the Company recorded a valuation allowance on the net deferred tax asset and does not anticipate recording an income tax benefit related to these deferred tax assets. The Company will reassess the realization of deferred tax assets each reporting period and will be able to reduce the valuation allowance to the extent the financial results of continuing operations improve and it becomes more likely than not that the deferred tax assets will be realizable.

We assess the financial statement impact of an uncertain tax position taken or expected to be taken on an income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized in the financial statements unless it is more likely than not of being sustained.

The Company is subject to U.S. federal and state income tax examination. The Company’s 2015 through 2018 U.S. federal income tax returns are subject to examination by the Internal Revenue Service. The Company’s state income tax returns are subject to examination for the tax years 2014 through 2018.

### Inflation

Inflation has not materially impacted the operations of our Company.

### Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements at this time.

### Recent Accounting Pronouncements

See Note 4 of the Notes to Consolidated Financial Statements.

## Controls and procedures

As filed, 7,860 characters.

### Evaluation of Disclosure Controls and Procedures

Our management has established and maintains disclosure controls and procedures that are designed to ensure that the information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2019, the Company's disclosure controls and procedures were not effective because of the material weaknesses in our internal control over financial reporting as discussed below.

Notwithstanding such material weaknesses, which is described below in Management’s Report on Internal Control over Financial Reporting, our management has concluded that the consolidated financial statements included in this Form 10-Q present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.

### Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. 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.

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management carried out an evaluation of the effectiveness of the Company's internal control over financial reporting as of December 31, 2018, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013). Based on that evaluation, management concluded that, as of December 31, 2018, the Company's internal control over financial reporting was not effective as a result of the material weaknesses described below.

The effectiveness of our internal control over financial reporting as of December 31, 2018 was audited by Frazier & Deeter, LLC, an independent registered public accounting firm, as stated in their report included in Part II, Item 8 of our most recent Form 10-K for the period ended December 31, 2018, contains an adverse opinion on the effectiveness of our internal control over financial reporting.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that material misstatements of the Company's annual or interim financial statements will not be prevented or detected on a timely basis.

We have identified three material weaknesses: (i) an ineffective control environment due to a lack of sufficient qualified accounting personnel with an appropriate level of knowledge and experience with generally accepted accounting principles, (ii) ineffective control activities due to the lack of documentation and timeliness in executing business process controls, and (iii) ineffective monitoring controls to ascertain whether the components of internal control were present and functioning.

As of September 30, 2019, we continue our remediation efforts related to these deficiencies.

### Remediation Efforts to Address Material Weaknesses

To date, we have implemented and are continuing to implement a number of measures to address the material weaknesses identified. We are also designing additional controls around the identification, documentation and application of technical accounting guidance with particular emphasis on events outside the ordinary course of business. These controls are expected to include the implementation of additional supervision and review activities by qualified personnel, the preparation of formal accounting memoranda to support our conclusions on technical accounting matters, and the development and use of checklists and research tools to assist in compliance with GAAP reporting requirements.

Included in the remediation efforts are investments in new personnel that have expertise in a broad array of accounting topics. As a result of these investments, the Company reevaluated its accounting on a variety of topics. While reevaluating the accounting for stock-based compensation expense during the three months ended September 30, 2019, the Company discovered immaterial errors in its accounting for certain items included in stock-based compensation expense. These errors related to its accounting for forfeitures, the vesting periods over which the expense was recognized, modifications, fair value measurements, and other minor miscellaneous items, all of which relate to the prior year. Additionally, the Company identified an issue relating to grants in the first quarter of 2019, whereby compensation was not recognized over the correct vesting period.

During the three months ended September 30, 2019, the Company re-evaluated its accounting for pre-development activities on certain OEM contracts. In performing the review, the Company determined that the it has not completed its performance obligations on its pre-development activities in these contracts. Accordingly, the Company determined that it had prematurely recognized revenues during the first quarter relating to these activities and did not defer the accompanying costs.

The Company has determined that the effects of the corrections are not material to the consolidated financial statements as of December 31, 2018, March 31, 2019 or June 30, 2019, but has elected to correct the consolidated financial statements for the three and nine months ended September 30, 2019. Accordingly, the Company has corrected the errors in the periods to which they relate.

We have also fully engaged a third-party specialist to help us assess and improve our internal controls and to assist in the process of designing and implementing a financial reporting system that is adequate to satisfy our reporting obligations. This has included the establishment of our overall internal control framework and the redesign of controls deemed to be defective in our most recently filed 10-K. As we continue to evaluate and take actions to improve our internal controls over financial reporting, we may find it necessary to take additional actions to address control deficiencies and modify our remediation measures.

### Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13(a)-15(f) and 15(d)-15(f)) during the nine months ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 167 characters.

There have been no material changes to the Risk Factors described in Part I, Item1A-Risk Factors in our annual report on Form10-K for the year ended December 31, 2018.

Filed Nov 15, 2019.
Source: SEC EDGAR, the filing index for accession 0000719135-19-000060. Last ingested by Listed: Nov 5, 2026, 13:09 ET. No prices; not investment advice.