Business Context and Reporting Period
Duos Technologies Group, Inc. filed a Form 10-K for the fiscal year ended December 31, 2016; the filing is annual rather than a standalone fourth-quarter report. Through its wholly owned subsidiary, Duos Technologies, Inc., the company develops artificial-intelligence, video-analytics, security and inspection systems, primarily for rail transportation and other critical infrastructure markets. Its two principal platforms are Praesidium and Centraco. It also operates an IT asset management services division.
Financial Performance and Liquidity
| Metric | 2016 | 2015 |
|---|---|---|
| Revenue | $6.105 million | $6.768 million |
| Gross profit | $3.372 million | $3.572 million |
| Approximate gross margin | 55.2% | 52.8% |
| Operating loss | $1.744 million | $2.227 million |
| Net loss | $2.562 million | $2.326 million |
| Net loss applicable to common stock | $2.568 million | $2.326 million |
| Basic and diluted loss per share | $0.04 loss | $0.04 loss |
| Cash used in operating activities | $1.840 million | $2.116 million |
| Cash provided by financing activities | $1.910 million | $2.246 million |
| Cash at year-end | $174,376 | $140,129 |
- Total assets were $1.162 million and total liabilities were $6.383 million at December 31, 2016.
- Working capital deficit was $4.133 million; stockholders’ deficit was $5.523 million; accumulated deficit was $23.519 million.
- Debt included $1.207 million of non-current notes payable, $577,716 of related-party notes, $193,950 of convertible notes including premiums, and a $793,099 warrant derivative liability.
- The company reported no income tax benefit because its deferred tax assets were fully offset by a valuation allowance. Net operating loss carryforwards were approximately $13.941 million.
Material Changes Versus the Prior Comparable Period
- Revenue declined 10% to $6.105 million, principally because a one-time project of approximately $2.4 million was cancelled after related federal funding was withdrawn. The decline was partially offset by new project revenue and a 27% increase in IT asset management revenue to $674,078.
- Maintenance and technical support revenue declined by approximately $250,000 following expiration of a service contract.
- Gross profit declined 6%, but the reported gross margin improved based on the stated revenue and cost figures. Management attributed margin pressure in part to aggressive pricing on a large contract.
- Operating expenses decreased because 2015 included a $1.579 million non-cash impairment charge. Excluding that charge, 2016 operating expenses increased by approximately $896,000 due to added personnel, public-company professional fees and research and development resources.
- Operating loss improved from $2.227 million to $1.744 million, but net loss increased because 2015 included $861,650 of other income from settlement of a contingent lawsuit liability, while 2016 included a $264,099 warrant derivative loss.
- Common shares outstanding increased from 64.778 million to 66.221 million. The company also issued 29,600 Series A redeemable convertible preferred shares for $296,000 and repurchased 114,793 common shares for $148,000.
Guidance, Outlook, Risks and Unusual Items
- Management planned to continue expanding rail, retail, healthcare, utilities, petrochemical and government applications, subject to available capital. It expected additional development and pilot activity, including CSX and Ferromex live testing, a Kohl’s distribution-center pilot, and a New York City Transit platform-intrusion pilot.
- The company expected to require approximately $3 million of additional capital during 2017 and was pursuing a registered offering expected to raise approximately $10 million. It also entered into a JMJ bridge financing arrangement with up to $2.5 million available, subject to milestones, with warrants and potential conversion rights upon default.
- The independent auditor stated that substantial doubt exists regarding the company’s ability to continue as a going concern. Management identified additional debt or equity financing, increased revenue and eventual profitability as necessary to fund operations. The filing states that bankruptcy protection could be sought if adequate financing and revenue are not obtained.
- Liquidity was highly constrained: cash was $174,376 at year-end, while management reported approximately $131,000 of monthly lease and other mandatory payments before payroll and ordinary expenses. The company also had delinquent payroll taxes of $400,076 within total payroll taxes payable of $444,476 and an IRS installment agreement requiring $25,000 monthly payments.
- Customer concentration was significant. The five largest customers represented approximately 75% of 2016 revenue, and three customers represented 50%, 26% and 14% of accounts receivable.
- The company remained dependent on related-party financing and had $577,716 of related-party notes payable at year-end. The CEO had deferred compensation of $681,381, including accrued interest.
- Post-year-end, the company paid $150,194 to settle the Greentree convertible-note litigation and paid the final FacilityTeam settlement amount. It also drew additional JMJ financing, issued additional warrants, filed an S-1 for a proposed $10 million offering and pursued a potential 1-for-35 reverse split.
- Management reported effective disclosure controls and effective internal control over financial reporting as of year-end, although the filing notes the risks associated with the company’s small accounting staff and limited segregation of duties.
Important Facts for Investors to Verify
- Whether the planned registered offering and additional financing were completed, on what terms, and whether proceeds were sufficient to address the going-concern uncertainty.
- Current cash, monthly cash burn, payroll-tax obligations, debt maturities, default status and collateral associated with secured borrowings.
- The effect of JMJ warrants, Series A preferred conversion rights, potential note conversions and any reverse split on future dilution.
- Whether CSX, Ferromex, Kohl’s and New York City Transit pilots converted into recurring commercial contracts and revenue.
- The sustainability of revenue given the cancellation of the approximately $2.4 million project and concentration among a small number of customers.
- The status and commercial adoption of the company’s rail inspection, mechanical inspection and artificial-intelligence platforms.