IWSY ImageWare Systems Incorporated (CE)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. DESCRIPTION OF BUSINESS AND OPERATIONS

Overview

As used in this Report, “we”, “us”, “our”, “Imageware”, “Imageware Systems” or the “Company” refers to Imageware Systems, Inc. and all of its subsidiaries. Imageware Systems, Inc. is incorporated in the state of Delaware. The Company is a pioneer and leader in the emerging market for biometrically enabled software-based identity management solutions. Using those human characteristics that are unique to us all, the Company creates software that provides a highly reliable indication of a person’s identity. The Company’s “flagship” product is our patented Biometric Engine®. The Company’s products are used to manage and issue secure credentials, including national IDs, passports, driver licenses and access control credentials. The Company’s products also provide law enforcement with integrated mug shot, fingerprint LiveScan and investigative capabilities. The Company also provides comprehensive authentication security software using biometrics to secure physical and logical access to facilities or computer networks or internet sites. Biometric technology is now an integral part of all markets the Company addresses, and all the products are integrated into our Biometric Engine. 

The Company's common stock, par value $0.01 per share (the “Common Stock”), trades under the symbol “IWSY" on the OTCQB Marketplace.

Liquidity, Going Concern and Management’s Plans

At March 31, 2022 and December 31, 2021, we had negative working capital of $10,289,000 and $8,046,000, respectively. Included in our negative working capital as of March 31, 2022 are $6,024,000 of derivative liabilities which are not required to be settled in cash except in the event of the consummation of a change of control or at any time after the fourth anniversary of the private placement of our Series D Convertible Preferred Stock, par value $0.01 ("Series D Preferred"), consummated in November and December, 2020 (the “Series D Financing”), at which anniversary the holders of the Series D Preferred may require the Company to redeem in cash any or all of the holder’s outstanding Series D Preferred at an amount equal to the liquidation preference of the Series D Preferred. At March 31, 2022 the liquidation preference totaled $23,469,000.

Historically, our principal sources of cash have included proceeds from the issuance of common and preferred stock and proceeds from the issuance of debt, and, to a lesser extent, customer payments from the sale of our products. Our principal uses of cash have included cash used in operations, product development, and payments relating to purchases of property and equipment. We expect that our principal uses of cash in the future will be for product development, including customization of identity management products for enterprise and consumer applications, further development of intellectual property, development of Software-as-a-Service (“SaaS”) capabilities for existing products as well as general working capital requirements. Management expects that, as our revenue grows, our sales and marketing and research and development expense will continue to grow, albeit at a slower rate and, as a result, we will need to generate significant net revenue to achieve and sustain positive cash flows from operations. Historically, the Company has not been able to generate sufficient net revenue to achieve and sustain positive cash flows from operations. As a result, the Company has been dependent on equity and debt financings to satisfy its working capital requirements and continue as a going concern.

To address our working capital requirements, management is actively seeking additional financing, of which no assurances can be given that we will be successful.  In addition, the Company has instituted several cost cutting measures and has utilized cash proceeds available under the Credit Facility (defined below) with certain funds and separate accounts managed by Nantahala Capital Management, LLC and other lenders (collectively, the “Lenders”), and under the purchase agreement with Lincoln Park Capital Fund, LLC (“Lincoln Park”) to satisfy its working capital requirements (“LPC Purchase Agreement”).

During 2021, the Company retained an investment bank to initiate a review of available alternatives to maximize shareholder value, which may include, among other alternatives, (i) a merger, consolidation, or other business combination or a purchase involving all or a substantial amount of the business, securities or assets of the Company, and/or  (ii) the private placement of securities to meet its working capital requirements or otherwise as necessary in connection with the consummation of any of the above transactions. In the event the Company is unable to consummate one or more of the above transactions, the Company will not be able to continue as a going concern. The Company continues to evaluate indications of interest as well as options to address its projected working capital requirements, and those discussions are ongoing, including discussions with the Company’s largest shareholder with whom the Company has entered a Term Loan and Security Agreement to provide up to $2,500,000 (the “Credit Facility”). As of May 20, 2022 approximately $342,000 remains available under the Credit Facility in such Lender’s discretion, and no assurances can be given that the Lenders will consent to the release of the additional $342,000 under the Credit Facility. The Company is currently negotiating to obtain the remaining funds available under the Credit Facility, including obtaining a waiver of the minimum cash requirement covenant under the Credit Facility.  In this regard, the Company is required to maintain a minimum amount of unrestricted cash and cash equivalents and may fall below the minimum cash requirement given its existing cash balances.  Although we believe we will obtain a waiver of the minimum cash requirement, in the event the Company is unable to obtain a waiver of the minimum cash requirement, the Lenders fail to provide the remaining funds under the Credit Facility, and/or we fail to obtain alternative sources of capital, of which no assurances can be given, such inability may result in an event of default under the terms of the Credit Facility, thereby providing the Lenders with certain rights and remedies under the terms of the Credit Facility, including declaring all advances under the terms of the Credit Facility immediately due and payable.

To date, the Board of Directors (“Board”) has not entered into any financing or other arrangements, other than the Credit Facility and the LPC Purchase Agreement, and no assurances can be given that we will be successful in raising additional capital through the issuance of debt and/or equity securities or entering into any other transaction that addresses our ability to continue as a going concern.  The consummation of a transaction will likely involve substantial dilution to the Company’s stockholders and may result in the loss of your entire investment. 

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying condensed consolidated balance sheet is dependent upon continued operations of the Company, which, in turn, is dependent upon the Company’s ability to continue to raise capital and generate positive cash flows from operations. However, the Company operates in markets that are emerging and highly competitive. There is no assurance that the Company will be able to obtain additional capital, operate at a profit or generate positive cash flows in the future. Therefore, management’s plans do not alleviate the substantial doubt of the Company’s ability to continue as a going concern.

The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

NOTE 2. SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION

Basis of Presentation

The accompanying condensed consolidated balance sheet as of March 31, 2022, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the SEC related to a quarterly report on Form 10-Q. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. The interim financial statements reflect all adjustments, which, in the opinion of management, are necessary for a fair statement of the results for the periods presented. All such adjustments are of a normal and recurring nature. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2021, which are included in the Company’s Annual Report on Form 10-K (the “Annual Report”) for the year ended December 31, 2021 as filed with the SEC on April 15, 2022.

Operating results for the three months ended March 31, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022, or any other future periods.

Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company’s wholly-owned subsidiaries are: XImage Corporation, a California Corporation; Imageware Systems ID Group, Inc., a Delaware corporation (formerly Imaging Technology Corporation); I.W. Systems Canada Company, a Nova Scotia unlimited liability company; Imageware Digital Photography Systems, LLC, a Nevada limited liability company (formerly Castleworks LLC); Digital Imaging International GmbH, a company formed under German laws; and Image Ware Mexico S de RL de CV, a company formed under Mexican laws. All significant intercompany transactions and balances have been eliminated.

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expense during the reporting period. Significant estimates include the evaluation of our ability to continue as a going concern, the allowance for doubtful accounts receivable, assumptions used in the Black-Scholes model to calculate the fair value of share based payments, fair value of financial instruments issued with and affected by the Series D Financing, assumptions used in the application of revenue recognition policies, and assumptions used in the application of fair value methodologies to calculate the fair value of pension assets and obligations. Actual results could differ from estimates.

Accounts Receivable

In the normal course of business, the Company extends credit without collateral requirements to its customers that satisfy pre-defined credit criteria. Accounts receivable are recorded net of an allowance for doubtful accounts. Accounts receivables are considered delinquent when the due date on the invoice has passed. The Company records its allowance for doubtful accounts based upon its assessment of various factors. The Company considers historical experience, the age of the accounts receivable balances, the credit quality of its customers, current economic conditions and other factors that may affect customers’ ability to pay to determine the level of allowance required. Accounts receivables are written off against the allowance for doubtful accounts when all collection efforts by the Company have been unsuccessful.

Inventories

Finished goods inventories are stated at the lower of cost, determined using the average cost method, or net realizable value. See Note 4.

Fair Value of Financial Instruments

For certain of the Company’s financial instruments, including accounts receivable, accounts payable, accrued expense, and deferred revenue, the carrying amounts approximate fair value due to their relatively short maturities.

Lease Liabilities and Operating Lease Right-of-Use Assets

The Company is a party to certain contractual arrangements for office space which meet the definition of leases under Accounting Standards Codification (“ASC”) Topic 842 - Leases (“ASC 842”). In accordance with ASC 842, the Company has determined that such arrangements are operating leases and accordingly the Company has, as of January 1, 2019, initially recorded operating lease right-of-use assets and related lease liability for the present value of the lease payments over the lease terms using the Company’s estimated weighted-average incremental borrowing rate of approximately 14.5% using a capital asset pricing model. The Company has utilized the practical expedient regarding lease and non-lease components and has combined such items into a single combined component. The Company has also utilized the practical expedient regarding leases of twelve months or less and has excluded such leases from its computation of lease liability and related right-of-use assets.

The Company evaluates its operating lease right-of-use assets for impairment. Impairment is based on the excess of the carrying amount over the fair value, based on market value when available, or expected future economic benefits to the company from the operating lease right-of-use asset and is recorded in the period in which the determination is made. The Company recorded no impairment during the three months ended March 31, 2022.

Revenue Recognition

In accordance with ASC Topic 606 – Revenue from Contracts with Customers (“ASC 606”), revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

The core principle of ASC 606 is that we should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve that core principle, we apply the following five step model:

At contract inception, we assess the goods and services promised in a contract with a customer and identify as a performance obligation each promise to transfer to the customer either: (i) a good or service (or a bundle of goods or services) that is distinct, or (ii) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. We recognize revenue only when we satisfy a performance obligation by transferring a promised good or service to a customer.

Determining the timing of the satisfaction of performance obligations as well as the transaction price and the amounts allocated to performance obligations requires judgement.

We disclose disaggregation of our customer revenue by classes of similar products and services as follows:

Software Licensing and Royalties

Software licenses consist of revenue from the sale of software for identity management applications. Our software licenses are functional intellectual property and typically provide customers with the right to use our software in perpetuity as it exists when made available to the customer. We recognize revenue from software licensing at a point in time upon delivery, provided all other revenue recognition criteria are met.

Royalties consist of revenue from usage-based arrangements and guaranteed minimum-based arrangements. We recognize revenue for royalty arrangements at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied.

Computer Hardware and Identification Media

We generate revenue from the sale of computer hardware and identification media. Revenue for these items is recognized upon delivery of these products to the customer, provided all other revenue recognition criteria are met.

Services

Services revenue is comprised primarily of software customization services, software integration services, system installation services and customer training. Revenue is generally recognized upon completion of services and customer acceptance provided all other revenue recognition criteria are met.

Post-Contract Customer Support

Post-contract customer support (“PCS”) consists of maintenance on software and hardware for our identity management solutions. We recognize PCS revenue from periodic maintenance agreements. Revenue is generally recognized ratably over the respective maintenance periods provided no significant obligations remain. Costs related to such contracts are expensed as incurred.

Arrangements with Multiple Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. In addition to selling software licenses, hardware and identification media, services and PCS on a standalone basis, certain contracts include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on our best estimate of the relative standalone selling price. The standalone selling price for a performance obligation is the price at which we would sell a promised good or service separately to a customer. The primary methods used to estimate standalone selling price are as follows: (i) the expected cost-plus margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service; and (ii) the percent discount off of list price approach.

Contract Costs

We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We apply a practical expedient to expense costs as incurred for costs to obtain a contract when the amortization period is one year or less. At March 31, 2022 and December 31, 2021, we had capitalized incremental costs of obtaining a contract with a customer of $0 and recorded no additional contract costs during the three months ended March 31, 2022.

Other Items

We do not offer rights of return for our products and services in the normal course of business.

Sales tax collected from customers is excluded from revenue.

The following table sets forth our disaggregated revenue for the three months ended March 31, 2022 and 2021: 

Customer Concentration

For the three months ended March 31, 2022, two customers accounted for approximately 37% or $314,000 of our total revenue and had trade receivables at March 31, 2022 of $35,000.

For the three months ended March 31, 2021, two customers accounted for approximately 45% or $333,000 of our total revenue and had trade receivables of $249,000 at March 31, 2021.

Recently Issued Accounting Standards

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”), or other standard setting bodies, which are adopted by us as of the specified effective date. Unless otherwise discussed, the Company’s management believes the impact of recently issued standards not yet effective will not have a material impact on the Company’s consolidated financial statements upon adoption.

FASB Accounting Standards Update (“ASU”) No. 2020-06. In August 2020, the FASB issued ASU 2020-06, “Debt-Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” (“ASU 2020-06"). ASU 2020-06 simplifies accounting for convertible instruments by removing major separation models required under current U.S. GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. ASU 2020-06 removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. ASU 2020-06 also simplifies the diluted earnings per share (EPS) calculation in certain areas. ASU 2020-06 is effective for public business entities, excluding entities eligible to be smaller reporting companies, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption will be permitted. The Company is currently evaluating the impact ASU 2020-06 will have on its consolidated financial statements.

NOTE 3. NET LOSS PER COMMON SHARE

Basic loss per common share is calculated by dividing net loss available to common shareholders for the period by the weighted-average number of common shares outstanding during the period. Diluted loss per common share is calculated by dividing net loss available to common shareholders for the period by the weighted-average number of common shares outstanding during the period, adjusted to include, if dilutive, potential dilutive shares consisting of convertible preferred stock, stock options and warrants, calculated using the treasury stock and if-converted methods. For diluted loss per share calculation purposes, the net loss available to common shareholders is adjusted to add back any preferred stock dividends and any interest on convertible debt reflected in the condensed consolidated statement of loss for the respective periods.

The table below presents the computation of basic and diluted loss per share:

The following potential dilutive securities have been excluded from the computations of diluted weighted-average shares outstanding, as their effect would have been antidilutive:

NOTE 4. SELECT BALANCE SHEET DETAILS

Inventory

Inventories of $24,000 as of March 31, 2022 were comprised of work in process of $7,000, representing direct labor costs on in-process projects and finished goods of $17,000 net of reserves for obsolete and slow-moving items of $3,000.

Inventories of $25,000 as of December 31, 2021 were comprised of work in process of $7,000, representing direct labor costs on in-process projects and finished goods of $18,000 net of reserves for obsolete and slow-moving items of $3,000.

Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value and required reserve levels.

Goodwill

The Company annually, or more frequently if events or circumstances indicate a need, tests the carrying amount of goodwill for impairment. The Company performs its annual impairment test in the fourth quarter of each year. In December 2018, the Company adopted the provisions of ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment". The provisions of ASU 2017-04 eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit's carrying amount over its fair value. Entities that have reporting units with zero or negative carrying amounts will no longer be required to perform a qualitative assessment assuming they pass the simplified impairment test. The Company continues to have only one reporting unit, Identity Management, which, at March 31, 2022, had a negative carrying amount of approximately $18,961,000. Based on the results of the Company's impairment testing, the Company determined that its goodwill was not impaired as of March 31, 2022 and December 31, 2021 as the fair value of our Identity Management reporting unit exceeded that reporting unit’s carrying value. However, the Company has experienced decreases in its market capitalization and if our market capitalization continues to decrease, future impairment of goodwill may result.

Other Assets

In conjunction with the LPC Purchase Agreement, the Company issued to Lincoln Park, in May 2021, 1,000,000 shares of Common Stock as consideration for entering into the LPC Purchase Agreement. Pursuant to this issuance, the Company recorded $70,000 as a deferred stock issuance cost. Such deferred stock issuance costs will be recognized as a charge against paid-in capital in proportion to securities sold under the LPC Purchase Agreement. At March 31, 2022, the Company had approximately $70,000 in deferred stock issuance costs included in the caption “Other assets” in its condensed consolidated balance sheets.

NOTE 5. LEASES

The Company is a party to certain contractual arrangements for office space which meet the definition of leases under ASC 842 – Leases (“ASC 842”). In accordance with ASC 842, the Company has determined that such arrangements are operating leases and accordingly the Company has, as of January 1, 2019, initially recorded operating lease right-of-use assets and related lease liability for the present value of the lease payments over the lease terms using the Company’s estimated weighted-average incremental borrowing rate of approximately 14.5%, as the discount rates implicit in the Company’s leases cannot be readily determined. At March 31, 2022, such assets and liabilities aggregated approximately $808,000 and $1,181,000, respectively. At December 31, 2021, such assets and liabilities aggregated approximately $847,000 and $1,298,000, respectively. The Company determined that it had no arrangements representing finance leases.

Our corporate headquarters is located in San Diego, California, where we now occupy approximately 500 square feet of office space at a cost of approximately $2,000 per month. We entered into this facility’s lease in February 2021, with the new lease commencing on March 1, 2021 on a month-to-month basis.

Prior to entering into our current lease agreement in January 2021 and moving our corporate headquarters to a new location, we occupied 8,511 square feet of office space in San Diego, California, at a cost of approximately $28,000 per month. In January 2021, we entered in a subleasing agreement for our previously occupied corporate headquarters located in San Diego, California. The term of the sublease commenced on April 1, 2021 and expires on April 30, 2025, coterminous with the expiration of the Company’s master lease. Sublease payments due to the Company approximate $26,000 per month over the term of the sublease.

The above leases contain no residual value guarantees provided by the Company and there are no options to either extend or terminate the leases.

For the three months ended March 31, 2022 and 2021, the Company recorded approximately $154,000 in lease expense using the straight-line method. Under the provisions of ASC 842, lease expense is comprised of the total lease payments under the lease plus any initial direct costs incurred less any lease incentives received by the lessor amortized ratably using the straight-line method over the lease term. The weighted-average remaining lease term of the Company’s operating leases as of March 31, 2022 is 1.33 years. Cash payments under operating leases are included in operating cash flows and aggregated approximately $162,000 and $166,000 for the three months ended March 31, 2022 and 2021, respectively.

The Company’s lease liability was computed using the present value of future lease payments. The Company has utilized the practical expedient regarding lease and non-lease components and combined such components into a single combined component in the determination of the lease liability. The Company has excluded the lease of its office space in Mexico City, Mexico in the determination of the lease liability as its term is less than 12 months.

At March 31, 2022, future minimum undiscounted lease payments are as follows:

NOTE 6. MEZZANINE EQUITY

Series D Convertible Redeemable Preferred Stock

On November 12, 2020, the Company filed the Certificate of Designations, Preferences and Rights of Series D Convertible Preferred Stock (the “Series D Certificate”) with the Secretary of State for the State of Delaware. Pursuant to the Series D Certificate, the Series D Preferred ranks senior to all Common Stock and all other present and future classes or series of capital stock, except for Series B Preferred (described below in Note 9), and upon liquidation will be entitled to receive the Liquidation Preference Amount (as defined in the Series D Certificate) plus any accrued and unpaid dividends, before the payment or distribution of the Company’s assets or the proceeds thereof is made to the holders of any junior securities. Additionally, dividends on shares of Series D Preferred will be paid prior to any junior securities and are to be paid at the rate of 4% of the Stated Value (as defined in the Series D Certificate) per share per annum in the form of shares of Series D Preferred. Holders of Series D Preferred shall vote together with holders of Common Stock on an as-converted basis, and not as a separate class, except (i) the holders of Series D Preferred, voting as a separate class, shall be entitled to elect two directors, (ii) the holders of Series D Preferred have the right to vote as a separate class regarding the waiver of certain protective provisions set forth in the Series D Certificate, and (iii) as otherwise required by law.

The holders of Series D Preferred may voluntarily convert their shares of Series D Preferred into Common Stock at any time that is at least ninety days following the issuance date, at the conversion price calculated by dividing the Stated Value by the conversion price of $0.0583 per share of Common Stock, subject to adjustments as set forth in Section 5(e) of the Series D Certificate. The shares of Common Stock issuable upon conversion of the Series D Preferred shall be subject to the following registration rights: (i) one demand registration starting three months after the Closing; (ii) two demand registrations starting one year after the Closing; and (iii) unlimited piggy-back and Form S-3 registration rights with reasonable and customary terms.

If, on any date that is at least five (5) years following the Issuance Date (as defined in the Series D Certificate), (i) the Common Stock is registered pursuant to Section 12(b) or (g) under the Exchange Act; (ii) there are sufficient authorized but unissued shares of Common Stock (which have not otherwise been reserved or committed for issuance) to permit the issuance of all Common Stock issuable upon conversion of all outstanding shares of Series D Preferred; (iii) upon issuance, the Common Stock will be either (A) covered by an effective registration statement under the Securities Act of 1933, as amended (the “Securities Act”), which is then available for the immediate resale of such Common Stock by the recipients thereof, and the Board reasonably believes that such effectiveness will continue uninterrupted for the foreseeable future, or (B) freely tradable without restriction pursuant to Rule l44 promulgated under the Securities Act without volume or manner-of-sale restrictions or current public information requirements, as determined by the counsel to the Company as set forth in a written opinion letter to such effect, addressed and acceptable to the Transfer Agent and the affected holders; and (iv) the VWAP of a share of Common Stock is greater than 300% of the Conversion Price (as defined in Section 5(d) below) then in effect for a period of at least twenty (20) Trading Days in any period of thirty (30) consecutive Trading Days, then the Company shall have the right, subject to the terms and conditions, to convert (a “Mandatory Conversion”) all, but not less than all, of the issued and outstanding shares of Series D Preferred into Common Stock.

On the fourth anniversary of the Issuance Date, or in the event of the consummation of a change of control, if any shares of Series D Preferred are outstanding, then each holder of Series D Preferred shall have the right (the “Holder Redemption Right”), at such holder’s option, to require the Company to redeem all or any portion of such holder’s shares of Series D Preferred at the Liquidation Preference Amount per share of Series D Preferred plus an amount equal to all accrued but unpaid dividends, if any, (such price, the “Holder Redemption Price”), which Holder Redemption Price shall be paid in cash.

On November 12, 2020 (“Closing Date”), the Company consummated the Series D Financing, resulting in the sale of 11,560 shares of its Series D Preferred, resulting in gross proceeds to the Company of $11.56 million, less fees and expenses. The gross proceeds include approximately $2.2 million in principal amount due and payable under the terms of certain term loans issued by the Company on September 29, 2020 (“Bridge Note”), which Bridge Notes were converted into Series D Preferred at Closing (the “Conversion”). The issuance and sale of the Series D Preferred was made pursuant to that certain Securities Purchase Agreement, dated September 28, 2020 (the “Purchase Agreement”), by and between the Company and the investors, for the purchase price of $1,000 per share of Series D Preferred. The Conversion and Series D Financing was undertaken pursuant to Section 3(a)(9) and/or Rule 506 promulgated under the Securities Act. On December 23, 2020, the Company sold an additional 500 shares of Series D Preferred resulting in gross proceeds to the Company of $500,000, less fees and expenses.

During the year ended December 31, 2021, the Company issued an aggregate of 999 shares of Series D Preferred as payment of dividends due to the Series D Preferred stockholders. During the year ended December 31, 2021, certain holders of Series D Preferred converted 646 shares of Series D Preferred into 11,149,123 shares of Common Stock which includes 70,221 shares of Common Stock issued for dividends up to the date of conversion.         

During the three months ended March 31, 2022, the Company issued 253 shares of Series D Preferred Stock as payment of dividends due to the Series D Preferred stockholders. There were no conversions of Series D Preferred into Common Stock during the three months ended March 31, 2022.

Guidance for accounting for freestanding financial instruments that contain characteristics of both liabilities and equity are contained in ASC 480, Distinguishing Liabilities From Equity and Accounting Series Release 268 Redeemable Preferred Stocks (“ASR 268”). The Company evaluated the provisions of the Series D Preferred and determined that the provisions of the Series D Preferred grant the holders of the Series D Preferred a redemption right whereby the holders of the Series D Preferred may, at any time after the fourth anniversary of the Series D Preferred issuance, require the Company to redeem in cash any or all of the holder’s outstanding Series D Preferred at an amount equal to the Liquidation Preference Amount (“Liquidation Preference Amount”). The Liquidation Preference Amount is defined as the greater of the stated value of the Series D Preferred plus any accrued unpaid interest or such amount per share as would have been payable had each such share been converted into Common Stock. In the event of a Change of Control (as defined in the Series D Certificate), the holders of Series D Preferred shall have the right to require the Company to redeem in cash all or any portion of such holder’s shares at the Liquidation Preference Amount. The Company has concluded that because the redemption features of the Series D Preferred are outside of the control of the Company, the instrument is to be recorded as temporary or mezzanine equity in accordance with the provisions of ASR 268.

The Company noted that the Series D Preferred instruments were hybrid instruments that contain several embedded features. In November 2014, the FASB issued ASU 2014-16 to amend ASC 815, “Derivatives and Hedging”, (“ASC 815”) and require the use of the whole instrument approach (described below) to determine whether the nature of the host contract in a hybrid instrument issued in the form of a share is more akin to debt or to equity.

The whole instrument approach requires an issuer or investor to consider the economic characteristics and risks of the entire hybrid instrument, including all of its stated and implied substantive terms and features. Under this approach, all stated and implied features, including the embedded feature being evaluated for bifurcation, must be considered. Each term and feature should be weighed based on the relevant facts and circumstances to determine the nature of the host contract. This approach results in a single, consistent determination of the nature of the host contract, which is then used to evaluate each embedded feature for bifurcation. That is, the host contract does not change as each feature is evaluated.

The revised guidance further clarifies that the existence or omission of any single feature, including an investor-held, fixed-price, noncontingent redemption option, does not determine the economic characteristics and risks of the host contract. Instead, an entity must base that determination on an evaluation of the entire hybrid instrument, including all substantive terms and features.

However, an individual term or feature may be weighed more heavily in the evaluation based on facts and circumstances. An evaluation of all relevant terms and features, including the circumstances surrounding the issuance or acquisition of the equity share, as well as the likelihood that an issuer or investor is expected to exercise any options within the host contract, to determine the nature of the host contract, requires judgement.

Using the whole instrument approach, the Company concluded that the host instrument of the Series D Preferred were more akin to debt than equity as the majority of identified features contain more characteristics of debt.

The Company evaluated the identified embedded features of the Series D Preferred host instrument and determined that certain features meet the definition of and contained the characteristics of derivative financial instruments requiring bifurcation at fair value from the host instrument.

The Company has bifurcated from the Series D Preferred host instrument the conversion option, redemption option and participating dividend feature in accordance with the guidance in ASC 815. These bifurcated features aggregated approximately $26,011,000 at issuance and have been recorded as a discount to the Series D Preferred. During the three months ended March 31, 2022 and 2021, the Company recorded the accretion of debt issuance costs and derivative liabilities aggregating approximately $1,531,000 and $1,817,000, respectively, using the effective interest rate method as a deemed dividend.

The following table summarizes the share activity of Series D Preferred for the three months ended March 31, 2022:

The carrying value of the Company’s Series D Preferred was approximately $10,478,000 and $8,759,000 net of discount of approximately $12,991,000 and $14,458,000 as of March 31, 2022 and December 31, 2021, respectively.

NOTE 7. DERIVATIVE LIABILITIES

The Company accounts for its derivative instruments under the provisions of ASC 815, “Derivatives and Hedging”. Under the provisions of ASC 815, the Company identified embedded features within the Series D Preferred host contracts that qualify as derivative instruments and require bifurcation.

The Company determined that the conversion option, redemption option and participating dividend feature contained in the Series D Preferred host instrument required bifurcation. The Company valued these bifurcatable features at fair value. Such liabilities aggregated approximately $6,024,000 and $5,292,000 at March 31, 2022 and December 31, 2021, respectively, and are classified as current liabilities on the Company’s condensed consolidated balance sheets under the caption “Derivative liabilities”. The Company will revalue these features at each balance sheet date and record any change in fair value in the determination of period net income or loss.

The change in fair value of such amounts is recorded in the caption “Change in fair value of derivative liabilities” in the Company’s condensed consolidated statements of operations. For the three months ended March 31, 2022, the Company recorded an increase to its derivative liabilities using fair value methodologies of approximately $667,000. For the three months ended March 31, 2021, the Company recorded a decrease to its derivative liabilities using fair value methodologies of approximately $1,172,000.

NOTE 8. LINE OF CREDIT

December 2021 Credit Facility with Nantahala Capital Management

On December 29, 2021, the Company entered into a Term Loan and Security Agreement with certain funds and separate accounts managed by Nantahala Capital Management, LLC and other lenders (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2,500,000.  Nantahala collectively owns, or otherwise controls, approximately 37.3% of our issued and outstanding voting securities.

On the Closing Date, the Company received in initial draw-down on the Credit Facility of $600,000.  Subsequent to the initial draw-down and through May 20, 2022, the Company received additional draw-downs aggregating $1,450,000. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes. As of May 20, 2022, there is approximately $342,000 outstanding under the Credit Facility in such Lender’s discretion, and no assurances can be given that the Lenders will consent to the release of the additional $342,000 under the LOC.  The Company is currently negotiating to obtain the remaining funds available under the Credit Facility, including obtaining a waiver of the minimum cash requirement covenant under the Credit Facility.  In this regard, the Company is required to maintain a minimum amount of unrestricted cash and cash equivalents and may fall below the minimum cash requirement given its existing cash balances.  Although we believe we will obtain a waiver of the minimum cash requirement, in the event the Company is unable to obtain a waiver of the minimum cash requirement, the Lenders fail to provide the remaining funds under the Credit Facility, and/or we fail to obtain alternative sources of capital, of which no assurances can be given, such inability may result in an event of default under the terms of the Credit Facility, thereby providing the Lenders with certain rights and remedies under the terms of the Credit Facility, including declaring all advances under the terms of the Credit Facility immediately due and payable.

For a more detailed description of this related party credit facility, see Note 12, Related Parties.

NOTE 9. EQUITY

The Company’s Certificate of Incorporation, as amended, authorizes the issuance of two classes of stock to be designated “Common Stock” and “Preferred Stock”. The Preferred Stock may be divided into such number of series and with the rights, preferences, privileges and restrictions as the Board may determine.

On June 9, 2020, the Company amended its Certificate of Incorporation to increase the number of shares of the Company’s Common Stock and the number of shares of the Company’s Preferred Stock authorized thereunder from an aggregate of 179 million to 350 million, consisting of 345 million shares of Common Stock and 5 million shares of Preferred Stock. On September 28, 2020, the Company received executed written consents from the requisite holders of the Company's voting securities, voting on an as-converted basis, approving an increase in the authorized number of shares of Common Stock from 345 million shares to 1.0 billion shares, with no change to the number of authorized shares of Preferred Stock, which action became effective October 13, 2020. On February 16, 2021, the Company received executed written consents from the requisite holders of the Company's voting securities, voting on an as-converted basis, approving an increase in the authorized number of shares of Common Stock from 1.0 billion shares to 2.0 billion shares, with no change to the number of authorized shares of Preferred Stock, which action became effective April 21, 2021.

As of March 31, 2022, we had 347,281,946 and 347,275,242 shares of Common Stock issued and outstanding, respectively. As of December 31, 2021, we had 347,240,045 and 347,233,341 shares of Common Stock issued and outstanding, respectively. Our authorized but unissued shares of Common Stock are available for issuance without action by our shareholders. All shares of Common Stock now outstanding are fully paid and non-assessable.

Our Board has designated five series of Preferred Stock; (i) Series A Preferred, (ii) Series A-1 Preferred, (iii) Series B Preferred, (iv) Series C Preferred and (v) Series D Preferred. As of March 31, 2022, there were no shares of Series A Preferred outstanding, no shares of Series A-1 Preferred outstanding, 239,400 shares of series B Preferred outstanding, no shares of Series C Preferred outstanding, and 23,469 shares of Series D Preferred outstanding.

Series B Convertible Redeemable Preferred Stock

The Company had 239,400 shares of Series B Convertible Preferred Stock (“Series B Preferred”) outstanding as of March 31, 2022 and December 31, 2021. At March 31, 2022 and December 31, 2021, the Company had cumulative undeclared dividends of approximately $21,000 and $8,000, respectively. There were no conversions of Series B Preferred into Common Stock during the three months ended March 31, 2022 and 2021.

Warrants

As of March 31, 2022, warrants to purchase 3,150,000 shares of Common Stock at prices ranging from $0.048 to $0.80 were outstanding. At March 31, 2022, 1,466,680 warrants are exercisable. All warrants expire at various dates between August 5, 2026 and August 5, 2028 with the exception of 150,000 warrants whose expiration date is 3 years from initial vesting, such vesting based on certain events. The intrinsic value of warrants outstanding at March 31, 2022 was $0.

During the three months ended March 31, 2022, there were no warrant issuances, cancellations, expirations or exercises. The weighted-average exercise price of warrants outstanding was $0.10 per share.  The Company recorded approximately $15,000 in share-based payment expense related to warrants for the three months ended March 31, 2022.

NOTE 10. STOCK-BASED COMPENSATION

Stock Options

As of March 31, 2022, the Company had one active stock-based compensation plan: the 2020 Omnibus Stock Incentive Plan (the “2020 Plan”).

2020 Omnibus Stock Incentive Plan

On June 9, 2020, pursuant to authorization obtained from the Company’s stockholders, the Company adopted the 2020 Plan. Such plan had been previously unanimously approved by the Company’s Board. The purposes of our 2020 Plan are to enhance our ability to attract and retain highly qualified officers, non-employee directors, key employees and consultants, and to motivate those service providers to serve the Company and to expend maximum effort to improve our business results by providing to those service providers an opportunity to acquire or increase a direct proprietary interest in our operations and future success. The 2020 Plan also will allow us to promote greater ownership in our Company by the service providers in order to align the service providers’ interests more closely with the interests of our stockholders. Awards granted under the 2020 Plan are designed to qualify for special tax treatment under Section 422 of the Internal Revenue Code.

Pursuant to the adoption of the 2020 Plan, such plan will supersede and replace the Company’s 1999 Stock Award Plan (the “1999 Plan”) and no new awards will be granted under the 1999 Plan thereafter. Any awards outstanding under the 1999 Plan on the date of approval of the 2020 Plan will remain subject to the 1999 Plan. Upon approval of our 2020 Plan, all shares of Common Stock remaining authorized and available for issuance under the 1999 Plan and any shares subject to outstanding awards under the 1999 Plan that subsequently expire, terminate, or are surrendered or forfeited for any reason without issuance of shares will automatically become available for issuance under our 2020 Plan. The Company amended the 2020 Plan to increase the number of shares of Common Stock available for issuance to 145.0 million shares. Such amendment became effective on April 21, 2021. As of March 31, 2022, there were 63,747,077 shares available for issuance under the 2020 Plan.

The Company estimates the fair value of its stock options using a Black-Scholes option-pricing model, consistent with the provisions of ASC 718, “Compensation – Stock Compensation” (“ASC 718”). The fair value of stock options granted is recognized to expense over the requisite service period. Stock-based compensation expense for all share-based payment awards is recognized using the straight-line single-option method. Stock-based compensation expense is reported in operating expense based upon the departments to which substantially all the associated employees report and credited to additional paid-in-capital.

ASC 718 requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The Company is required to make various assumptions in the application of the Black-Scholes option-pricing model. The Company has determined that the best measure of expected volatility is based on the historical weekly volatility of the Company’s Common Stock. The Company has elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin Topic 14.

In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. The Company has adopted the provisions of ASU 2016-09 and will continue to use an estimated annualized forfeiture rate. The Company utilized estimated forfeiture rate of 25% for options granted during the three months ended March 31, 2022. The Company is currently in the process of reviewing the expected forfeiture rate to determine if that percent is still reasonable based on recent historical experience.

A summary of the activity under the Company’s stock option plans is as follows:

There were no options granted during the three months ended March 31, 2022.

During the three months ended March 31, 2022, there were no options that expired unexercised and there were no options exercised.

At March 31, 2022, a total of 4,818,876 options were outstanding, of which 3,633,444 were exercisable at a weighted average price of $0.08 per share with a remaining weighted average contractual term of 3.2 years. The Company expects that, in addition to the 3,633,444 options that were exercisable as of March 31, 2022, another 1,185,432 will ultimately vest resulting in a combined total of 4,818,876. Those 4,818,876 shares have a weighted average exercise price of $0.08 and an aggregate intrinsic value of approximately $0 as of March 31, 2022. Stock-based compensation expense related to equity options was approximately $112,000 for the three months ended March 31, 2022.

The intrinsic value of options exercisable and outstanding at March 31, 2021 was $0. The aggregate intrinsic value for all options outstanding as of March 31, 2021 was $0. There were no issuances of options to purchase Common Stock during the three months ended March 31, 2021. Stock-based compensation expense related to equity options was approximately $32,000 for the three months ended March 31, 2021.

The Company periodically issues Restricted Stock Units (“RSUs”) to certain employees which vest over time. When vested, each RSU represents the right to that number of shares of Common Stock equal to the number of RSUs granted. The grant date fair value for RSU’s is based upon the market price of the Company's Common Stock on the date of the grant. The fair value is then amortized to compensation expense over the requisite service period or vesting term.

A summary of the activity related to RSUs is as follows:

There were no RSUs granted during the three months ended March 31, 2022.

During the three months ended March 31, 2022, the Company recorded compensation expense of approximately $465,000 related to RSUs. During the three months ended March 31, 2021, the Company recorded compensation expense of approximately $15,000 related to RSUs. During the three months ended March 31, 2022 and 2021, the Company issued 41,901 and 161,168 shares of its Common Stock pursuant to the vesting of RSUs.

NOTE 11. FAIR VALUE ACCOUNTING

The Company accounts for fair value measurements in accordance with ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.

ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below:

The following table sets forth the Company’s financial assets and liabilities measured at fair value by level within the fair value hierarchy. As required by ASC 820, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The Company’s German pension plan is funded by insurance contract policies whereby the insurance company guarantees a fixed minimum return. The Company has determined that the pension assets are appropriately classified within Level 3 of the fair value hierarchy because they are valued using actuarial valuation methodologies which approximate cash surrender value that cannot be corroborated with observable market data. All plan assets are managed in a policyholder pool in Germany by outside investment managers. The investment manager is responsible for the investment strategy of the insurance premiums that the Company submits and does not hold individual assets per participating employer. The German Federal Financial Supervisory oversees and supervises the insurance contracts.

As of March 31, 2022 and December 31, 2021, the Company had embedded features contained in the Series D Preferred host instrument (issued in November 2020) that qualified for derivative liability treatment.  The recorded fair market value of these features was approximately $6,024,000 and $5,292,000 at March 31, 2022 and December 31, 2021, respectively, which are classified as a current liability in the consolidated balance sheet as of March 31, 2022 and December 31, 2021. The fair value of the Company’s derivative liabilities are classified within Level 3 of the fair value hierarchy because they are valued using pricing models that incorporate management assumptions that cannot be corroborated with observable market data.  The Company uses Monte-Carlo simulations and other fair value methodologies in the determination of the fair value of derivative liabilities. Considering the various path dependencies for the Series D Preferred Stock, Monte-Carlo simulations were deemed the most appropriate methodology.

Some of the aforementioned fair value methodologies are affected by the Company’s stock price as well as assumptions regarding the expected stock price volatility over the term of the derivative liabilities in addition to the probability of future events. Significant assumptions used in the fair value methodologies during the three months ended March 31, 2022 are a risk-free rate of 2.38%, equity volatility of 127.8%, effective life of 2.76 years and a Preferred Stock dividend rate of 4.0%. These assumptions incorporate management’s estimate of the probability of future financings (Series D Financing) and the timing of potential change of control events. The primary assumptions impacted by Series D Financing were the effective life of 2.76 years and equity volatility.

The Company monitors the activity within each level and any changes with the underlying valuation techniques or inputs utilized to recognize if any transfers between levels are necessary. That determination is made, in part, by working with outside valuation experts for Level 3 instruments and monitoring market related data and other valuation inputs for Level 1 and Level 2 instruments.

The reconciliations of Level 3 pension assets measured at fair value during the three months ended March 31, 2022 and 2021 are presented below:

The reconciliations of Level 3 derivative liabilities measured at fair value for Series D Preferred Stock and for Series C Preferred Stock during the three months ended March 31, 2022 is presented below:

NOTE 12. RELATED PARTY TRANSACTIONS

December 2021 Credit Facility with Nantahala Capital Management

On December 29, 2021 (the “Closing Date”), the Company entered into a Term Loan and Security Agreement (the “Agreement”) with certain funds and separate accounts managed by Nantahala Capital Management, LLC (collectively, “Nantahala”), as lenders, and other lenders set forth on the signature pages thereto (together with Nantahala, the “Lenders”), pursuant to which the Lenders will provide to the Company a secured term loan credit facility in an aggregate amount of up to $2,500,000 (the “Credit Facility”).  Nantahala collectively owns, or otherwise controls, approximately 37.5% of our issued and outstanding voting securities.

All loans (each a “Loan”, and collectively, the “Loans”) under the Credit Facility will bear interest at a rate of 12% for the initial six months after the Closing Date, and at 17% thereafter until the maturity date of 12 months from the Closing Date (the “Maturity Date”).  All amounts borrowed by the Company under the Credit Facility are secured by a first-priority lien on all the assets of the Company.  On the Closing Date, the Company received in initial draw-down on the Credit Facility of $600,000.  As of May 4, 2022, the Company received additional proceeds from draw-downs on the Credit Facility aggregating $1,450,000. The Company expects to use the proceeds from the Credit Facility for working capital requirements and corporate purposes.  As of May 20, 2022, there is approximately $342,000 outstanding under the Credit Facility in such Lender’s discretion, and no assurances can be given that the Lenders will consent to the release of the additional $342,000 under the Credit Facility. The Company is currently negotiating to obtain the remaining funds available under the Credit Facility, including obtaining a waiver of the minimum cash requirement covenant under the Credit Facility.  In this regard, the Company is required to maintain a minimum amount of unrestricted cash and cash equivalents and may fall below the minimum cash requirement given its existing cash balances.  Although we believe we will obtain a waiver of the minimum cash requirement, in the event the Company is unable to obtain a waiver of the minimum cash requirement, the Lenders fail to provide the remaining funds under the Credit Facility, and/or we fail to obtain alternative sources of capital, of which no assurances can be given, such inability may result in an event of default under the terms of the Credit Facility, thereby providing the Lenders with certain rights and remedies under the terms of the Credit Facility, including declaring all advances under the terms of the Credit Facility immediately due and payable.

The Company may prepay amounts borrowed under the Credit Facility in whole or in part, at a price equal to 105% of the principal amount borrowed under the Credit Facility (including any interest capitalized thereon), subject to additional prepayment terms pursuant to the Agreement, a copy of which is filed as an Exhibit to the Company’s Current Report on Form 8-K, filed with the SEC on January 4, 2022. In addition, pursuant to the Agreement, at any time after the Closing Date, each Lender shall have the right, but not the obligation, on mutually agreed upon terms, to exchange each such Lender’s pro rata portion of shares of the Company’s Series D Convertible Preferred Stock, par value $0.01 (“Series D Preferred”) held by such Lender for a mutually agreed upon portion of any subsequent Delayed Draw Loan (as defined in the Agreement) (an “Exchange”). Upon the Company’s receipt by a Lender of a notice stating a Lender’s intent to participate in an Exchange, the Company is required to offer to all holders of Series D Preferred the opportunity, but not the obligation, to exchange each such holder’s pro rata portion of shares of the Company’s Series D Preferred held by such holder for participation in any subsequent Delayed Draw Loan, upon substantially similar terms as those provided in the applicable notice of Exchange by a Lender.

Consulting Agreement

On March 1, 2022, the Company entered into a consulting agreement with a member of the Company’s Board of Directors (the “Consulting Agreement”). The Consulting Agreement provides for the provision of certain strategic financing and corporate development activities . The term of the agreement is for a period of three months and expires June 1, 2022. The maximum consulting fee is $8,000 per month to be accrued throughout the term but with payment deferral until the closing of certain contractually defined milestones. The Company has not made any payments pursuant to the Consulting Agreement during the three months ended March 31, 2022.

NOTE 13. CONTINGENT LIABILITIES

Employment Agreements

The Company has an employment agreement with its Chief Executive Officer, which expires on March 2, 2024 (the “Employment Agreement”). The Company may terminate the Employment Agreement with or without cause. Subject to the conditions and other limitations set forth in the Employment Agreement, the executive will be entitled to the following severance benefits if the Company terminates the executive’s employment without cause or in the event of an involuntary termination (as defined in the Employment Agreement) by the Company or by the executive:

Under the terms of the Employment Agreement, if employment is terminated by the Company without cause or there is a change of control, then the executive shall be entitled to severance payments equal to the executive’s annual salary and shall remain enrolled in the Company’s health, dental, and life insurance plans for the lesser of twelve (12) months or the remaining period prior to expiration of the Employment Period (as defined in the Employment Agreement) plus the executive shall be entitled to any bonus due as of the effective date of such termination.

Litigation

There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of the Company or any of our subsidiaries, threatened against or affecting the Company, our Common Stock, any of our subsidiaries or of the Company’s or our subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.