Duos Technologies Group, Inc. — Q1 2016 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended March 31, 2016, compared with the three months ended March 31, 2015. The Company develops artificial-intelligence-driven intelligent technology and security systems through Duos Technologies, Inc., including the praesidium and centraco platforms. It also operates an IT asset management services division. The Company completed its reverse merger with duostech effective April 1, 2015.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $1.004 million | $1.102 million | Down $97,852 |
| Gross profit | $517,826 | $553,205 | Down $35,379 |
| Gross margin | 51.6% | 50.2% | Up approximately 1.4 points |
| Operating loss | $(767,382) | $(364,531) | Loss increased $402,851 |
| Operating margin | (76.4%) | (33.1%) | Material deterioration |
| Net loss | $(838,381) | $(752,424) | Loss increased $85,957 |
| Net loss per share | $(0.01) | $(0.01) | No change as reported |
| Cash used in operations | $(91,245) | $(294,815) | Improved by $203,570 |
Revenue consisted of project revenue of $229,123, maintenance and technical support revenue of $607,879, and newly reported IT asset management revenue of $167,241. The Company reported no income tax expense.
At March 31, 2016, cash was $250, total current assets were $981,520, and total current liabilities were $5.346 million, producing a working capital deficit of $4.364 million. Total assets were $1.118 million, versus total liabilities of $5.346 million and stockholders’ deficit of $4.228 million. The accumulated deficit was $21.790 million.
Current obligations included accounts payable of $1.180 million, related-party notes of $495,786, notes payable of $189,108, convertible notes including premiums of $193,950, payroll taxes payable of $456,368, accrued expenses of $1.033 million, deferred revenue of $609,316, and a $550,000 contingent lawsuit payable.
Material changes versus the prior comparable period
- Total revenue declined 8.9%, principally because two anticipated projects were delayed. Project revenue decreased $275,846, partly offset by $10,753 of higher maintenance revenue and $167,241 of IT asset management revenue.
- Gross margin improved modestly because project costs declined proportionately with project revenue, but gross profit decreased $35,379.
- Operating expenses increased 40.0% to $1.285 million. Salaries, wages, and contract labor increased $296,540 as the Company expanded its employee base in anticipation of new projects. Selling and marketing and general and administrative expenses also increased.
- Interest expense decreased to $72,305 from $391,094, primarily because Q1 2015 included a $352,093 debt-premium loss. The reduction in interest expense only partially offset higher operating expenses.
- Weighted-average common shares increased to 65.656 million from 57.738 million, reflecting continued equity issuance and potential dilution from warrants and convertible debt.
- Operating cash burn improved, but investing activities used $19,099 and financing activities used $29,535. Cash declined from $140,129 at December 31, 2015 to $250 at March 31, 2016.
Guidance, outlook, risks, contingencies, and unusual items
Management reported an order backlog of approximately $3.990 million, of which it anticipated recognizing $3.570 million of revenue during 2016. Management also stated that the Company expected to operate at or near annual breakeven, although individual quarters could remain loss-making. No formal earnings guidance was provided.
The Company disclosed substantial doubt about its ability to continue as a going concern. Management stated that additional capital, revenue growth, and profitability are required. It estimated a need for approximately $1 million of additional capital during 2016 and stated that current operations required at least $500,000 of additional capital. Related parties had no legal obligation to continue funding the Company.
On April 1, 2016, after quarter-end, the Company closed a $1.8 million senior secured, non-convertible debt financing. Net proceeds to the Company were $837,891 after the original issue discount, financing expenses, and direct payments to creditors. The note bears 14% annual interest, plus 2% additional interest that compounds monthly, matures in three years, is secured by substantially all Company and subsidiary assets, and includes restrictive covenants. The financing also included warrants for 2.5 million shares at an exercise price of $0.35, and 200,000 additional warrants at $0.40 for the placement agent.
- The financing proceeds were used in part to pay $558,032 to settle the CW Electric litigation, $132,078 to repay a secured shareholder note, $142,000 to a placement agent, and $233,792 toward delinquent payroll taxes.
- The CW Electric litigation was fully settled after quarter-end; the $550,000 liability and related accrued interest were paid.
- Delinquent payroll taxes were $219,470 at March 31, 2016, included in total payroll taxes payable of $456,368. The IRS approved a $25,000 monthly installment plan.
- The Company had $131,000 of monthly lease and other mandatory payments, excluding payroll and ordinary expenses, and reported approximately $65,000 of cash as of May 13, 2016.
- A holder of convertible notes disputed the Company’s rejection of conversion notices. The Company reserved $53,317 for repayment of one note, and discussions were ongoing as of the filing.
- The Company’s disclosure controls were not effective due to insufficient segregation of duties and insufficient technical expertise for public-company financial reporting. Management planned to address the weaknesses by adding accounting personnel when resources permitted.
- The Company identified customer concentration: several customers each represented more than 10% of revenue or accounts receivable. Project revenue recognition depends on percentage-of-completion estimates, creating estimation risk.
Most important facts for investors to verify
- Whether the April 2016 secured financing and subsequent debt service materially improve liquidity, given the very low quarter-end cash balance and substantial mandatory payments.
- Whether the reported backlog converts into the anticipated $3.570 million of 2016 revenue and whether delayed projects commence as expected.
- Whether the Company can raise the additional capital management identified as necessary without excessive dilution or restrictive terms.
- The terms, outstanding balance, and resolution of the disputed convertible-note conversion notices.
- Compliance with the senior secured note’s covenants and the consequences of any default, including potential foreclosure on substantially all assets.
- Progress in remediating the material weaknesses in internal control over financial reporting.
- The status of delinquent payroll taxes and compliance with the IRS installment agreement.
- The effect of customer concentration and percentage-of-completion estimates on revenue, receivables, and future margins.