UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2018

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from _________ to _________

 

Commission file number: 333-150332

 

DRONE AVIATION HOLDING CORP.

(Exact name of registrant as specified in its charter)

 

Nevada   46-5538504
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

11651 Central Parkway #118, Jacksonville, FL 32224

(Address of principal executive offices) (zip code)

 

(904) 834-4400

(Registrant’s telephone number, including area code)

 

Not applicable.

(Former name, former address and former fiscal year, if changed since last report)

  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☐ No ☒

 

Note: The registrant is a voluntary filer but has filed all reports it would have been required to file by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months if it was subject to the filing requirements thereof.

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer
Non-accelerated filer ☐ (Do not check if a smaller reporting company) Smaller reporting company
  Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act and Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

As of October 26, 2018, there were 9,182,470 shares of registrant’s common stock outstanding.

    

 

 

   

 

   

DRONE AVIATION HOLDING CORP.

 

INDEX
       
PART I. FINANCIAL INFORMATION  
       
  ITEM 1 Financial Statements (Unaudited)  
    Consolidated Balance Sheets as of September 30, 2018 (Unaudited) and December 31, 2017 1
    Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017 (Unaudited) 2
    Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 (Unaudited) 3
    Notes to Interim Unaudited Consolidated Financial Statements 4
  ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 13
  ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 20
  ITEM 4. Controls and Procedures 20
       
PART II. OTHER INFORMATION
       
  ITEM 1. Legal Proceedings 21
  ITEM 1A. Risk Factors 21
  ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 21
  ITEM 3. Defaults Upon Senior Securities 22
  ITEM 4. Mine Safety Disclosures 22
  ITEM 5. Other Information 22
  ITEM 6. Exhibits 22
       
  SIGNATURES 23

   

 i 

 

   

DRONE AVIATION HOLDING CORP.

CONSOLIDATED BALANCE SHEETS

 

   September 30,
2018
   December 31,
2017
 
   (Unaudited)     
ASSETS        
         
CURRENT ASSETS:        
Cash  $178,781   $615,375 
Accounts receivable - trade   65,760    110,065 
Inventory, net   1,761,663    991,697 
Prepaid expenses and deposits   99,770    103,008 
           
Total current assets   2,105,974    1,820,145 
           
PROPERTY AND EQUIPMENT, at cost:   176,955    253,444 
Less - accumulated depreciation   (114,979)   (97,507)
           
Net property and equipment   61,976    155,937 
           
OTHER ASSETS:          
Goodwill   99,799    99,799 
Intangible assets, net   778,667    997,667 
           
Total other assets   878,466    1,097,466 
           
TOTAL ASSETS  $3,046,416   $3,073,548 
           
LIABILITIES AND STOCKHOLDERS’ DEFICIT          
           
CURRENT LIABILITIES:          
Accounts payable - trade and accrued liabilities  $653,302   $205,359 
Accounts payable due to related party   183,918    171,981 
Unearned revenue   9,800    - 
Bank Line of Credit   1,900,000    1,000,000 
Related party convertible note payable   1,900,000    1,000,000 
           
Total current liabilities   4,647,020    2,377,340 
           
LONG TERM LIABILITIES:          
Related party convertible note payable   3,000,000    3,000,000 
           
TOTAL LIABILITIES  $7,647,020   $5,377,340 
           
COMMITMENTS AND CONTINGENCIES   -    - 
           
STOCKHOLDERS’ DEFICIT:          
Common stock, $.0001 par value; authorized 300,000,000 shares; 9,182,470 and 9,182,470 shares issued and outstanding, at September 30, 2018 and December 31, 2017, respectively   918    918 
Additional paid-in capital   29,339,511    27,692,067 
Retained Deficit   (33,941,033)   (29,996,777)
           
Total stockholders’ deficit   (4,600,604)   (2,303,792)
           
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT  $3,046,416   $3,073,548 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 1 

 

 

DRONE AVIATION HOLDING CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30,   September 30,   September 30, 
   2018   2017   2018   2017 
                 
Revenues  $84,815   $93,105   $995,838   $474,634 
                     
Cost of good sold   51,587    33,594    537,617    283,590 
                     
Gross profit   33,228    59,511    458,221    191,044 
                     
General and administrative expense   1,127,266    4,544,499    4,158,194    7,432,226 
                     
Loss from operations   (1,094,038)   (4,484,988)   (3,699,973)   (7,241,182)
                     
Other income (expense)                    
Derivative gain   -    779,787    -    1,831,635 
Debt extinguishment   -    (681,988)   -    (681,988)
Interest expense   (95,828)   (376,636)   (244,283)   (1,558,389)
                     
Total other expense   (95,828)   (278,837)   (244,283)   (408,742)
                     
NET LOSS   (1,189,866)   (4,763,825)   (3,944,256)   (7,649,924)
                     
Weighted average number of common shares outstanding - basic and diluted   9,182,470    9,087,361    9,182,470    8,880,168 
                     
Basic and diluted net loss per share  $(0.13)  $(0.52)  $(0.43)  $(0.86)

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 2 

 

 

DRONE AVIATION HOLDING CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

   For the Nine Months Ended 
   September 30,
2018
   September 30,
2017
 
OPERATING ACTIVITIES:          
Net loss  $(3,944,256)  $(7,649,924)
Adjustments to reconcile net loss to net cash used in operating activities:          
Amortization expense of debt discount   -    1,409,790 
Gain on derivative liability   -    (1,831,635)
Loss on debt extinguishment   -    681,988 
Depreciation   29,238    26,350 
Loss on disposal of property and equipment   10,002    - 
Amortization expense of intangible assets   219,000    219,000 
Stock based compensation   1,647,444    4,829,598 
Changes in current assets and liabilities:          
Accounts receivable   44,305    293,251 
Inventory   (769,966)   (275,276)
Prepaid expenses and other current assets   3,238    49,340 
Accounts payable and accrued expense   447,943    (144,000)
Due from related party   11,937    141,368 
Deferred revenue   9,800    - 
           
Net cash used in operating activities   (2,291,315)   (2,250,150)
           
INVESTING ACTIVITIES:          
Cash received from sale of vehicle   60,000    - 
Cash paid on fixed assets   (5,279)   (675)
           
Net cash provided by (used in) investing activities   54,721    (675)
           
FINANCING ACTIVITIES:          
Proceeds from related party convertible note payable   900,000    1,000,000 
Proceeds from bank line of credit   900,000    1,000,000 
    1,800,000    2,000,000 
           
Net cash provided by financing activities   1,800,000    2,000,000 
           
NET DECREASE IN CASH   (436,594)   (250,825)
           
CASH, beginning of period   615,375    2,015,214 
           
CASH, end of period  $178,781   $1,764,389 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:          
Cash paid during the nine months ended September 30:          
Interest  $232,255   $5,875 
           
Noncash investing and financing activities for the nine months ended September 30:          
Conversion of Series A preferred stock to common stock  $-   $25 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 3 

 

  

DRONE AVIATION HOLDING CORP.

NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Period Ended September 30, 2018

 

1. BASIS OF PRESENTATION

 

The following unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, such interim financial statements do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete annual financial statements. The information furnished reflects all adjustments, consisting only of normal recurring items which are, in the opinion of management, necessary in order to make the financial statements not misleading. The balance sheet as of December 31, 2017 has been derived from the Company’s annual financial statements that were audited by an independent registered public accounting firm but does not include all of the information and footnotes required for complete annual financial statements. The consolidated financial statements included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017. 

 

Revenue Recognition

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (Topic 606) “Revenue from Contracts with Customers.” Topic 606 supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605) and requires entities to recognize revenues when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method. We recognized the cumulative effect of adopting this guidance as an adjustment to our opening balance of retained earnings. Prior periods will not be retrospectively adjusted. The adoption of Topic 606 does not have a material impact to our consolidated financial statements, including the presentation of revenues in our Consolidated Statements of Operations.

 

2. GOING CONCERN

 

The accompanying consolidated financial statements and notes have been prepared assuming the Company will continue as a going concern. For the nine months ended September 30, 2018, the Company incurred a net loss of $3,944,256, generated negative cash flow from operations, has an accumulated deficit of $33,941,033 and working capital deficit of $2,541,046. These circumstances raise substantial doubt as to the Company’s ability to continue as a going concern. The Company’s ability to continue as a going concern is dependent upon the Company’s ability to create and market innovative products, raise capital, reduce debt or renegotiate terms, and to sustain adequate working capital to finance its operations. The failure to achieve the necessary levels of profitability and cash flows or obtain additional funding would be detrimental to the Company. The consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

3. RELATED PARTY TRANSACTIONS

 

The Company accounts for related party transactions in accordance with ASC 850 (“Related Party Disclosures”). A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.  

 

 4 

 

 

On November 10, 2017, the Company and Global Security Innovative Strategies, LLC (“GSIS”), a related party, entered in an agreement whereby GSIS will provide business development support and general consulting services for sales opportunities with U.S. government agencies and other identified prospects and consulting support services for the Company’s role and activities as part of the Security Center of Excellence in Orlando, Florida. The agreement was for a period of six months beginning on November 1, 2017. On September 26, 2018, the parties amended the agreement to extend the period of service through September 2019 with monthly auto renew extensions thereafter. The Company also agreed to issue 100,000 options to purchase Company stock which were immediately vested, had a strike price of $1.00 and terminate on September 26, 2022. The Company pays GSIS a fee of $10,000 per month. The Company agreed to pay the expenses of GSIS incurred in connection with the performance of its duties under the agreement. Either party may terminate or renew the agreement at any time, for any reason or no reason, upon at least 30 days’ notice to the other party. David Aguilar, a member of the Company’s board of directors, is a principal at GSIS. 

 

As of September 30, 2018, and December 31, 2017, there was $183,918 and $171,981 accrued interest payable, respectively, to related parties on convertible notes payable.   

 

4. INVENTORY

 

Inventories are stated at the net realizable value, using the first-in first-out method. Cost includes materials, labor and manufacturing overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with our supplies, and the estimated utility of our inventory. If the review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of goods sold. At September 30, 2018, $1,050,740 of the $1,238,331 Work in Process Inventory was related to the WASP multi-mission capable tactical aerostat valued in excess of $1.7 million dollars which was delivered to the Department of Defense on October 9, 2018. Inventory consists of the following at September 30, 2018 and December 31, 2017: 

 

     September 30,
2018
   December 31,
2017
 
  Raw Materials  $115,926   $114,119 
  Work in Progress   1,238,331    482,770 
  Finished Goods   416,978    398,912 
  In Transit   -    5,468 
  Less valuation allowance   (9,572)   (9,572)
  Total  $1,761,663   $991,697 

   

5. PROPERTY AND EQUIPMENT

 

Property and equipment is recorded at cost when acquired.  Depreciation is provided principally on the straight-line method over the estimated useful lives of the related assets, which is 3-7 years for equipment, furniture and fixtures, hardware and software and leasehold improvements.   During the nine months ended September 30, 2018, the Company invested $5,279 in shop machinery and equipment and computers. During that same time period, the company sold a company vehicle for $60,000 cash and wrote off several items of abandoned equipment resulting in a $10,002 loss on disposal of assets. Depreciation expense was $29,238 and $26,350 for the nine months ended September 30, 2018 and 2017, respectively. Property and equipment consists of the following at September 30, 2018 and December 31, 2017:

 

     September 30,
2018
   December 31,
2017
 
  Shop machinery and equipment  $87,534   $87,704 
  Computers and electronics   32,093    35,270 
  Office furniture and fixtures   37,814    37,814 
  Vehicle   -    73,142 
  Leasehold improvements   19,514    19,514 
      176,955    253,444 
  Less - accumulated depreciation   (114,979)   (97,507)
     $61,976   $155,937 

    

 5 

 

 

6. INTANGIBLE ASSETS

 

On July 20, 2015, the Company, through its wholly-owned subsidiary Drone AFS Corp., purchased substantially all the assets of Adaptive Flight, Inc. (“AFI”), a Georgia corporation. The Company purchased assets, including, but not limited to, intellectual property, licenses and permits, including commercial software licenses for the “GUST” (Georgia Tech UAV Simulation Tool) autopilot system and other transferable licenses which include flight simulation and fault tolerant flight control algorithms. The Company paid $100,000 in immediately available funds and $100,000 to be held in escrow. In addition, the Company issued 150,000 shares of unregistered common stock valued at $8.40 per share, on a post-October 29, 2015 reverse stock split basis, on the date of agreement, to be held in escrow. 

  

The Company had a milestone of twelve months to complete a technology integration plan, the non-completion of which could result in the return of the purchased assets and termination of the Company’s obligations to release the escrow cash and shares. Additional milestones included exclusive, no-cost and perpetual licenses to all contributing intellectual property included or related to the purchased assets. As such time as all milestones were met, one-half of the escrow shares were to be released to AFI. Upon termination of the escrow agreement, anticipated to be twelve months from the closing of the asset purchase, if all milestones had been met, the remaining escrow shares would be released to AFI; but if all milestones have not been met, the escrow cash and escrow shares would be released to the Company and the purchased assets would be returned to AFI. According to the terms of the Escrow Agreement, if the escrow share value was less than $1,400,000, the Company must issue an additional number of unregistered shares, not to exceed 50,000 shares. At December 31, 2015, the value of the 150,000 shares was $3.23 per share, or $484,500. The Company recorded $161,500 as an additional liability and expense at December 31, 2015 for the cost of 50,000 shares at $3.23 per share. On June 3, 2016, the Integration Plan was deemed to be completed. At June 3, 2016, the value of the 150,000 shares was $3.01 per share, or $451,150. The additional liability was reduced to $150,500 for the cost of 50,000 shares at $3.01 per share. The Company recorded the $11,000 reduction in the additional liability through the statement of operations at June 3, 2016. The Company began amortizing the $1,460,000 of purchased assets over a sixty-month period on June 3, 2016 in the amount of $24,333 per month. Total amortization expense for the nine months ended September 30, 2018 was $219,000. The remaining unamortized balance of $778,667 is estimated to be amortized in the estimated amounts of $73,000 during 2018 and $292,000 per year for 2019 through 2020 and $121,667 in 2021.

 

The asset acquisition did not qualify as a business combination under ASC 805-10 and has been accounted for as a regular asset purchase. 

 

7. RELATED PARTY CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

 

On September 29, 2016, the Company issued Convertible Promissory Notes Series 2016 due October 1, 2017 in the aggregate principal amount of $3,000,000 in a private placement to the Chairman of the Board and the Chairman of the Strategic Advisory Board of the Company, both of whom are greater than 10% shareholders of the Company. The notes bear interest at a rate of six percent (6%) per annum. The Company may prepay the notes at any time without penalty. If the Company does not prepay a note in full or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at the Company’s discretion. The conversion price of the notes is the lesser of $3.00 per share or eight-five percent (85%) of the lowest per share purchase price of common stock in the next sale of common stock in which the Company receives gross proceeds of an amount greater than or equal to $3,000,000. 

 

 6 

 

 

On August 3, 2017 (the “Effective Date”), the Company entered into amendments (the “Convertible Note Amendments”) with the owners and holders of the following convertible promissory notes issued by the Company (the “Series 2016 Convertible Notes”):

 

  Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Frost Gamma Investments Trust (“Frost Gamma”). Frost Gamma is a trust that is controlled by Dr. Phillip Frost, a substantial shareholder of the Company; and

 

  Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Jay H. Nussbaum, the Company’s Chief Executive Officer and Chairman of the Board of Directors.

 

The Convertible Note Amendments extend the maturity date for each of the Series 2016 Convertible Notes to April 1, 2019 (the “Maturity Date”) and revise the conversion price to mean $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. Accordingly, the notes have been reclassified as long-term debt. Consistent with the original terms of the Series 2016 Convertible Notes, interest accrues at the rate of 6% interest per annum and is payable on the Maturity Date. The accrued interest is payable at the holders’ option in cash or shares of our common stock valued at the $1.00 per share conversion price. The Convertible Note Amendments provide that an event of default in the City National Bank Loan will be treated as an event of default under the Series 2016 Convertible Notes. 

 

On November 9, 2017, the Company entered into amendments (the “November 2017 Convertible Note Amendments”) with the owners and holders of the Series 2016 Convertible Notes to permit the payment of, at the holders’ election, accrued and unpaid interest either in monthly or quarterly payments at any time after the Effective Date. Accrued interest may be paid with: (i) cash; (ii) the issuance and delivery to the holder of shares of common stock of the Company at the conversion price provided for in the Series 2016 Convertible Note; or (iii) any combination of cash and shares of Common Stock, as determined by the holder in its sole discretion.

 

On March 23, 2018, the Company entered into amendments (the “March 2018 Convertible Note Amendments”) with the owners and holders of the Series 2016 Convertible Notes to extend the maturity date from April 1, 2019 until October 1, 2020. The Company evaluated the modification under ASC 470-50 and determined that it does not qualify as an extinguishment of debt.

 

As of September 30, 2018, and December 31, 2017, $165,986 and $166,356 accrued interest has been recorded, respectively.

 

The Company analyzed the conversion option in the notes for derivative accounting treatment under ASC Topic 815, “Derivatives and Hedging,” and determined that the instrument does not qualify for derivative accounting.

 

The Company therefore performed an analysis to determine if the conversion option was subject to a beneficial conversion feature and determined that the instrument does not have a beneficial conversion feature.

 

8. REVOLVING LINE OF CREDIT

 

On August 2, 2017, the Company issued a promissory note to City National Bank of Florida (“CNB”) in the principal amount of $2,000,000, the CNB Note, with a maturity date of August 2, 2018 On September 26, 2018, the Company and CNB agreed to extend the maturity date of the promissory note to August 2, 2019. The Company evaluated the modification under ASC 470-50 and determined that it did not qualify as an extinguishment of debt. The note evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2019 so long as no event of default exists under the note, the Company or Mr. Nussbaum does not cease doing business, Mr. Nussbaum does not seek to revoke or modify his guarantee of the Note, the Company does not misapply the proceeds of this loan or CNB in good faith does not believe itself insecure. The initial CNB Note bore an interest rate at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate payable monthly. At renewal, the variable rate was increased to 1.0 percentage points over the Wall Street Journal Prime Rate. The Company will pay to CNB a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company may prepay the note at any time without penalty. In the event of a default, the interest rate will increase to the highest lawful rate. The Company is obligated to maintain depository accounts with CNB with a minimum average annual balance of $600,000. In the event the Company does not maintain this account balance, CNB may charge the Company a fee equal to 2% of the deficiency as additional interest under the note. The CNB Note is personally guaranteed by Mr. Nussbaum, the Company’s Chief Executive Officer pursuant to written guarantee in favor of CNB (the “CNB Guarantee”). Mr. Nussbaum and the Company are obligated to maintain an unencumbered liquidity of no less than $6,000,000 in the form of cash, repurchase agreements, certificates of deposit or marketable securities acceptable to CNB. In addition, to secure our obligations under the note, we entered into a security agreement in favor of CNB (the “Security Agreement”) encumbering all of our accounts, inventory and equipment along with an assignment of a bank account we maintain at CNB with an approximate balance of $90,000. As of September 30, 2018, $1,900,000 has been drawn against the line of credit, an increase of $900,000 over the balance at December 31, 2017. Accrued interest of $5,558 has been recognized as of September 30, 2018.

 

 7 

 

   

Indemnification Agreement

 

On August 3, 2017, the Company entered into an Indemnification Agreement with Mr. Nussbaum in order to indemnify and defend him to the fullest extent permitted by law for any claim, expense or obligation which might arise as a result of his guarantee of the CNB Note.

  

9. SERIES 2017 SECURED CONVERTIBLE NOTE – RELATED PARTY

 

On August 3, 2017, the Company issued a Secured Convertible Promissory Note Series 2017 due August 2, 2018 in the aggregate principal amount of $2,000,000 (the “Series 2017 Convertible Note”) in a private placement to Frost Nevada Investments Trust (“Frost Nevada”). On September 26, 2018, the Company and Frost Nevada agreed to extend the maturity date of the promissory note to August 2, 2019.  The Company evaluated the modification under ASC 470-50 and determined that it did not qualify as an extinguishment of debt. Frost Nevada is a trust that is controlled by Dr. Frost, a substantial shareholder of the Company. The note evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2019 so long as no event of default exists under the loan. The Company may request advances of principal under this note equal to and at the same time as it requests advances, if any, pursuant to the CNB Note. The note bears interest at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate. The Company may prepay the notes at any time without penalty. If the Company does not prepay the note in full or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at Frost Nevada’s discretion. The conversion price under the note is $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. The Series 2017 Convertible Note is secured by a security interest in all the Company’s assets. This security interest is subordinate to the security interest of CNB discussed in Footnote #8 above. As of September 30, 2018, $1,900,000 has been drawn against the line of credit, an increase of $900,000 over the balance at December 31, 2017. Accrued interest of $17,932 has been recognized as of September 30, 2018.

 

The Company analyzed the conversion option in the notes for derivative accounting treatment under ASC Topic 815, “Derivatives and Hedging,” and determined that the instrument does not qualify for derivative accounting.

 

The Company therefore performed an analysis to determine if the conversion option was subject to a beneficial conversion feature and determined that the instrument does not have a beneficial conversion feature.

 

10. SHAREHOLDERS’ EQUITY

 

On August 3, 2017, the Company entered into an amendment to the August 24, 2014 Independent Contractor Agreements it entered into with Dr. Philip Frost and Steven Rubin who serve as members of the Company’s Strategic Advisory Board (the “SAB Amendments”). The SAB Amendments extend the term of the agreements from May 1, 2017 until April 30, 2018 and provide for the following equity based compensation: (a) for Dr. Frost, a warrant to purchase 2,000,000 shares of the Company’s Common Stock (the “Frost Warrant”) and an award of 150,000 shares of the Company’s unregistered restricted Common Stock and (b) for Mr. Rubin, an award of 100,000 shares of the Company’s unregistered restricted Common Stock. The restricted stock vests upon the occurrence of a change of control (as defined in the SAB Amendments). The Warrant has a term of five years and exercise price of $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. The Company recognized $22,500 expense for the pro rata portion of shares earned by the two members during the nine months ended September 30, 2018, amortizing the expense over the 12 months of the service agreement regardless of the vesting condition.

   

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In September 2016, the Company issued 1,349,000 shares of restricted common stock outside of the 2015 Equity Plan to Jay Nussbaum, Felicia Hess, Daniyel Erdberg, Kendall Carpenter, Mike Silverman and Reginald Brown pursuant to Stock Award Agreements. The shares will vest upon consummation of a significant equity and/or debt financing of at least $5,000,000 provided that the holder remains engaged by the Company through the vesting date. On August 3, 2017, these awards were modified so that the restrictions set forth in the RSA lapse upon the earlier of (i) consummation of a significant equity and/or debt financing from which the Company receives gross proceeds of at least $7,000,000 or (ii) a change in control (as defined in the RSA Amendment), provided that, in either case, the holder remains engaged by the Company through the date of such event. The Company does not believe the modified vesting conditions are probable of being achieved, and as such, no stock-based compensation expense has been recorded. The Company will reassess whether achievement of the vesting conditions is probable at each reporting date. If it is probable, stock-based compensation will be recognized. 

 

On March 28, 2017, these awards were modified in recognition of the Company securing a substantial sales order and recent business development activity and vested on that date. On that date, the awards were determined to be probable for vesting and stock-based compensation was recognized based on the fair market value of the stock on March 28, 2017. The Company recorded $944,300 in stock-based compensation for these awards during the nine months ended September 30, 2018.  

 

On August 28, 2018, the Company filed with the Nevada Secretary of State of a Certificate of Withdrawal to withdraw the Certificates of Designations of the Company’s previously designated Convertible Preferred Stock, Series A, B, B-1, C, D, E, F, G as no shares of these series of preferred stock are issued or outstanding.

 

11. EMPLOYEE STOCK OPTIONS

 

On September 26, 2018, upon approval of the Company’s board of directors, the Company granted outside its 2015 Equity Plan, 6,000,000 options to five management employees and four directors. Jay Nussbaum was issued 2,350,000 options, Felicia Hess was issued 1,000,000 options, Daniyel Erdberg was issued 1,000,000 options, Kendall Carpenter was issued 425,000 options, Reginald Brown, Jr. was issued 1,000,000 options. Director David Aguilar was issued 150,000 options and Directors John Miller, Timothy Hoechst and Robert Guerra were each issued 25,000 options. The options vest upon the Company receiving an aggregate of $4,000,000 in new orders from a prime government contractor or directly from the U.S. government at any time commencing after the date of issuance. The options are exercisable at an exercise price of $.65 per share and expire September 26, 2022. Of these 6,000,000 options, 5,000,000 options have been accounted for as a modification of the August 22, 2018 options. During the nine months ended September 30, 2018, $360,593 compensation expense was recognized on these 6,000,000 options with a remaining balance of $2,238,087 to be recognized over the assumed vesting period.

 

On August 22, 2018, upon approval of the Company’s board of directors, the Company granted outside its 2015 Equity Plan, an aggregate of 5,000,000 options to five management employees and four directors. Included in this award were the following grants to Executive Officers and Directors of the Company: 1,950,000 options to Jay Nussbaum, Chief Executive Officer and Chairman of the Board of Directors, 800,000 options to Felicia Hess, Chief Operating Officer, 800,000 options to Daniyel Erdberg, President, 300,000 options to Kendall Carpenter, Chief Financial Officer and the following directors of the Company: 150,000 options to David Aguilar, 25,000 options to John Miller, 25,000 options to Timothy Hoechst and 25,000 options to Robert Guerra. The options vest upon the Company receiving an aggregate of $4,000,000 in new orders from a prime government contractor or directly from the U.S. government at any time commencing after the date of issuance. The options are exercisable at an exercise price of $1.00 per share and expire August 22, 2022. On September 26, 2018, the Board resolved to cancel the Options to purchase 5,000,000 shares of common stock issued on August 22, 2018 that had not vested.

 

On May 16, 2018, upon approval of the Company’s board of directors, the Company granted outside its 2015 Equity Plan, 460,000 options to four employees. Reginald Brown, Jr. was issued 200,000 options and Kendall Carpenter was issued 130,000 options which were immediately vested, are exercisable at an exercise price of $1.00 per share and expire May 16, 2022. Two engineers received a total of 130,000 shares which vest 50% after one year and the remaining 50% after two years, are exercisable at an exercise price of $1.00 per share and expire May 16, 2022. During the nine months ended September 30, 2018, $165,354 compensation expense was recognized on these 460,000 options with a remaining balance of $36,727 to be recognized over the vesting period.

 

On March 28, 2018, upon approval of the Company’s board of directors, the Company granted outside its 2015 Equity Plan, 100,000 options each to a newly-appointed director, Robert Guerra. These options vest 50% one year after the date of grant and the remaining 50% two years after the date of grant provided the director is still actively involved with the Company. The options are exercisable at an exercise price of $1.00 per share and expire on March 28, 2022. During the nine months ended September 30, 2018, $14,599 compensation expense was recognized on these 100,000 options with a remaining balance of $23,990 to be recognized over the vesting period.

 

On December 13, 2017, upon approval of the Company’s board of directors, the Company issued outside its 2015 Equity Plan, 100,000 options each to two newly-appointed directors, or a total of 200,000 options. These options vest 50% after one year and the remaining 50% after two years provided the director is still actively involved with the Company. The options are exercisable at an exercise price of $1.00 per share and expire on December 13, 2021. During the nine months ended September 30, 2018 and twelve months ended December 31, 2017, $54,638 and $3,593, respectively, compensation expense was recognized on these 200,000 options with a remaining balance of $41,558 to be recognized over the vesting period.

 

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During 2016, the Company granted 10,000 options to an employee with two-year vesting and an exercise price of $3.00 and an expiration date of December 6, 2019. The Company recognized $1,105 in compensation for the nine months ended September 30, 2018. No additional compensation will be recognized on these options which were cancelled due to the termination of the employee. 

 

On June 1, 2015, the Company issued an option award to an employee for 37,500 shares vesting over three years with an exercise price of $10.80 and expiration date of May 4, 2019. During the nine months ended September 30, 2018, $14,369 compensation expense was recognized on these 37,500 options which have been cancelled due to the termination of the employee.

 

On January 9, 2017, the Company issued an option to purchase 100,000 shares of common stock with an exercise price of $2.90 per share to a director. The option vests 50,000 after one year from grant date and another 50,000 two years from grant date with an expiration date of four years from grant date provided that the Director is still providing service to the Company. During the nine months ended September 30, 2018, $33,836 compensation expense was recognized on these 100,000 options with a remaining balance of $11,280 to be recognized over the vesting period.

 

The Company used the Black-Scholes option pricing model to estimate the fair value on the date of grant of the 6,560,000 options granted during the nine months ended September 30, 2018.

    

The following table summarizes the assumptions used to estimate the fair value of the 11,560,000 stock options granted during the nine months ended September 30, 2018 on the date of grant.

 

     2018 
       
  Expected dividend yield   0%
  Expected volatility   80-97%
  Risk-free interest rate   2.48-2.89 %
  Expected life of options   4.00 years

 

 

Under the Black-Scholes option pricing model, the fair value of the 11,560,000 options granted during the nine months ended September 30, 2018 is estimated at $2,839,360 on the date of grant. During the nine months ended September 30, 2018, $540,546 compensation expense was recognized on these 11,560,000 options.

 

The following table represents stock option activity as of and for the nine months ended September 30, 2018:

 

     Number of Options   Weighted
Average
Exercise Price per Share
   Weighted
Average
Contractual
Life in
Years
   Aggregate Intrinsic
Value
 
  Outstanding – December 31, 2017   7,945,000   $1.38    3.50      
  Exercisable – December 31, 2017   7,627,500   $1.35    3.50   $             0 
  Granted   11,560,000   $0.82           
  Cancelled or Expired   (5,425,000)  $1.33           
  Outstanding – September 30, 2018   14,080,000   $0.94    3.39   $0 
  Exercisable – September 30, 2018   7,600,000   $1.15    2.92   $0 

 

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12. WARRANTS

  

As described above in Footnote #3 – Related Party Transactions, on September 26, 2018, the Company issued 100,000 warrants outside its 2015 Equity Plan to Global Security Innovative Strategies, LLC (“GSIS”) with an exercise price of $1.00 per share and an expiration date of September 26, 2022 and which were immediately vested. The Company recognized $36,150 in compensation for the nine months ended September 30, 2018.

 

The following table summarizes the assumptions used to estimate the fair value of the 560,000 stock warrants granted during the nine months ended September 30, 2018 on the date of grant.

 

     2018 
       
  Expected dividend yield   0%
  Expected volatility   91%
  Risk-free interest rate   2.89%
  Expected life of options   4.00 years 

 

Under the Black-Scholes option pricing model, the fair value of the 100,000 warrants granted during the nine months ended September 30, 2018 is estimated at $36,150 on the date of grant. During the nine months ended September 30, 2018, $36,150 compensation expense was recognized on these 100,000 warrants.

 

The following table represents warrant activity as of and for the period ended September 30, 2018: 

 

     Number of Warrants   Weighted
Average
Exercise Price per Share
   Weighted
Average
Contractual
Life in
Years
   Aggregate Intrinsic
Value
 
  Outstanding – December 31, 2017   2,232,500   $1.36    4.34      
  Exercisable – December 31, 2017   2,232,500   $1.36    4.34   $             0 
  Granted   100,000   $1.00           
  Forfeited or Expired   (37,500)  $10.00           
  Outstanding – September 30, 2018   2,295,000   $1.20    3.67   $0 
  Exercisable – September 30, 2018   2,295,000   $1.20    3.67   $0 

 

13. COMMITMENTS AND CONTINGENCIES

 

On November 17, 2014, the Company entered into a 60-month lease for 5,533 square feet of office and manufacturing space at 11651 Central Parkway Suite 118, Jacksonville, Florida, with an anticipated lease commencement date of February 1, 2015. The actual commencement date was July 1, 2015 and the lease was amended to 61 months expiring July 31, 2020. The monthly rent, including operating expenses and sales tax, for each year of the initial lease term is estimated to be $5,915. Anticipated total rent during the term of the lease is as follows:

 

  Year 2018 - $ 18,075
  Year 2019 - $ 77,309
  Year 2020 - $ 45,651

 

Rent expense was $65,995 and $60,425 for the nine months ended September 30, 2018 and 2017, respectively.

 

On May 16, 2016, Banco Popular North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court of the Fourth Judicial Circuit against Aerial Products Corporation d/b/a Southern Balloon Works (“Aerial Products”), Kevin M. Hess, LTAS, and the Company to collect on a delinquent Small Business Administration loan that Banco made in 2007 to Aerial Products with Mr. Hess as the personal guarantor. LTAS and the Company filed an Answer on June 30, 2016 and Responses to Interrogatories on December 16, 2016. The lawsuit is active and discovery is ongoing. It is our position that neither LTAS nor the Company are continuations of Aerial Products, and LTAS and the Company have denied all allegations made by Banco and will vigorously defend that position. The Company has evaluated the probability of loss as possible, but the range of loss is unable to be estimated.

 

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Other than the Banco matter, there are no material claims, actions, suits, proceedings inquiries, labor disputes or investigations pending.

  

14. SUBSEQUENT EVENTS

 

On October 9, 2018, the Company took a draw of $100,000 from the CNB note and a draw of $100,000 from the Series 2017 Convertible Note which are described in Footnotes #8 and #9 above.

 

On October 9, 2018, the Company delivered a WASP multi-mission capable tactical aerostat valued in excess of $1.7 million dollars to a Department of Defense customer. Approximately $1,050,740 of parts, labor and overhead were carried in Work in Process Inventory at September 30, 2018.

 

On October 24, 2018, the Company commenced an offering of up to 10,000,000 shares of its common stock (the “Offered Shares”) in a private placement of up to $5,500,000 to certain accredited investors at a purchase price of $0.55 per share pursuant to a Stock Purchase Agreement (the “SPA”). As of October 26, 2018, the Company has received subscriptions for a total of $3,256,000 (5,920,000 Shares) pursuant to the SPA. Pursuant to the terms of the SPA, any funds received from investors in the offering prior to the closing date will be held by the Company in a segregated bank account until closing. In the event that the SPA is terminated prior to closing or the closing does not occur by December 31, 2018, any funds received by the Company pursuant to the SPA shall be promptly refunded in full to the investors without deduction of any cost or expense. Closing of the offering pursuant to the SPA is conditioned upon certain, limited customary representations and warranties, as well as the Company having received an aggregate of $4,000,000 in new orders from a prime government contractor or directly from the U.S. government at any time commencing after October 9, 2018 (the “Qualifying Sales Order”). As required under the SPA, upon receipt by the Company of a Qualifying Sales Order, the Company will give written notice to the investors notifying them that the Company intends to close on the purchase of the Offered Shares pursuant to the SPA. Within three days after the delivery of the notice to the investors, the Company and the investors will then close under the SPA and at closing, the Company will issue to each purchasing investor the number of shares subscribed for by each Investor.

 

On October 25, 2018, the Board approved Amendment No. 3 to the August 27, 2014 Independent Contractor Agreements it entered into with Dr. Philip Frost and Steven Rubin who serve as members of the Company’s Strategic Advisory Board (the “SAB Amendments”). The SAB Amendments extend the term of the agreements from November 1, 2018 until October 31, 2019 and provide for the following equity-based compensation: (a) for Dr. Frost, an award of 150,000 shares of the Company’s unregistered restricted Common Stock and (b) for Mr. Rubin, an award of 100,000 shares of the Company’s unregistered restricted Common Stock. The restricted stock vests upon the occurrence of a change of control (as defined in the SAB Amendments).

 

On October 25, 2018 the Company borrowed $100,000 from its Chief Executive Officer and Chairman, Jay Nussbaum pursuant to a promissory note. The note bears interest at the rate of 6% per annum and is due on November 30, 2018. The Company plans to use the proceeds from this loan to fund our immediate short-term cash needs  pending settlement of the customer invoice for the WASP shipped October 9, 2018.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  

Certain statements in Management’s Discussion and Analysis (“MD&A”), other than historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements”. Forward-looking statements generally can be identified by the use of forward-looking terminology, such as “may,” “would,” “expect,” “intend,” “could,” “estimate,” “should,” “anticipate,” “believe,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. These statements are subject to a number of risks, uncertainties and developments beyond our control or foresight, including changes in the trends of the advanced aerostats and tethered drone industry, formation of competitors, changes in governmental regulation or taxation, changes in our personnel and other such factors. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers should carefully review the risk factors and related notes included under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission on March 23, 2018.

 

The following MD&A is intended to help readers understand the results of our operations and financial condition and is provided as a supplement to, and should be read in conjunction with, our Unaudited Consolidated Financial Statements and the accompanying Notes to Unaudited Consolidated Financial Statements under Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

Growth and percentage comparisons made herein generally refer to the nine months ended September 30, 2018 compared with the nine months ended September 30, 2017 unless otherwise noted. Unless otherwise indicated or unless the context otherwise requires, all references in this document to “we,” “us,” “our,” the “Company,” and similar expressions refer to Drone Aviation Holding Corp. and, depending on the context, its subsidiaries.

 

Business Overview

 

We design, develop, market and sell lighter-than-air (“LTA”) advanced aerostats and accessories, tethered drones, and land-based intelligence, surveillance and reconnaissance (“ISR”) solutions. We focus primarily on the development of a tethered aerostat known as the Winch Aerostat Small Platform (“WASP”), as well our tethered drone product, the WATT and the FUSE Tether System designed for DJI Matrice 200 (M200) professional drones. Our products are designed for commercial and military applications and provide secure and reliable aerial monitoring for extended durations while being tethered to the ground via a high strength armored tether.

 

Our marketing efforts include submission of proposals and bids to the U.S. Government as well as customer demonstrations at customer identified sites as well as in Jacksonville, Florida. We also showcased our products and technologies at numerous conferences and live demonstrations, including the 2017 Special Operations Forces Industry Conference, 2018 ADS Warrior Expo East, State of Florida HURREX exercise, CyberQuest 2017, and presentations to a variety of federal and state government agencies. We have also increased marketing efforts and announced the following:

 

  On October 16, 2018, we announced delivery of a $1.7 million contract award for enhanced WASP tactical aerostat from the U.S. Department of Defense.

 

  On June 27, 2018, we announced our participation in the ADS Warrior Expo East showcasing the WASP Tactical Aerostat.

 

  On June 1,2018, we announced the livestream of a technology demonstration for Federal and New York State Law Enforcement agencies.

 

  On May 30, 2018, we announced that the FUSE Tether System was employed by Southern Arizona Law Enforcement for enhanced aerial surveillance.

 

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In addition to our plans to organically grow our lighter than air systems through increased marketing and sales, we intend to continue to consider potential strategic transactions, which could involve acquisitions of businesses or assets, joint ventures or investments in businesses, products or technologies that expand, complement or otherwise relate to our current or future business.

 

The Company commenced an offering of up to 10,000,000 shares of its common stock (the “Offered Shares”) in a private placement of up to $5,500,000 to certain accredited investors at a purchase price of $0.55 per share pursuant to a Stock Purchase Agreement (the “SPA”). The Company intends to use the proceeds from this offering for working capital it anticipates it will need in order to finance the costs of production and other costs related to new product orders that are in the final stages of completion. As of October 26, 2018, the Company has received subscriptions for a total of $3,256,000 (5,920,000 Shares) pursuant to the SPA. In addition, on October 25, 2018, the Company borrowed $100,000 from its Chief Executive Officer and Chairman, Jay Nussbaum on a short-term basis to fund its immediate short-term cash needs. See “Liquidity and Capital Resources” for a further discussion on the Company’s working capital requirements.

 

Results of Operations

 

Three Months Ended September 30, 2018 compared to Three Months Ended September 30, 2017 

 

Revenues: Revenues of $84,815 for the quarter ended September 30, 2018 decreased $8,290 or 9% from $93,105 for the same period in 2017. Sources of revenue were derived primarily from aerostat products, FUSE tether systems and accessories. Revenue from FUSE tether systems was $63,000 for the quarter ended September 30, 2018, an increase of $39,000 or 163% from $24,000 for the same period in 2017. We expect increased sales in future periods based on a product pipeline developed following our increased marketing efforts discussed in the Business Overview section above, including the October 2018 delivery of a WASP tactical aerostat valued in excess of $1.7 million dollars.

 

Cost of Goods Sold and Gross Profit: Cost of goods sold of $51,587 for the quarter ended September 30, 2018 increased $17,993 or 54% from $33,594 for the same period in 2017. Costs included materials, parts and labor associated with the sale of aerostat products, FUSE tether systems and accessories. Cost of goods sold from FUSE tether systems was $25,619, an increase of $12,967 or 102% from $12,652 for the same period in 2017. The $33,228 gross profit for the quarter ended September 30, 2018 was a decrease of $26,283 or 44% from the $59,511 in gross profit for the same quarter of 2017. Overall gross profit margins were 39% and 64% for the quarters ended September 30, 2018 and 2017, respectively. Gross profit margins on FUSE tether systems was 59% and 47% for the quarters ended September 30, 2018 and 2017, respectively.

 

General and Administrative Expense: General and administrative expense primarily consists of payroll and related costs, sales and marketing costs, research and development costs, business overhead and costs related to maintaining a public entity. General and administrative expenses decreased $3,417,233 or 75% to $1,127,266 in the quarter ended September 30, 2018 from $4,544,499 for the same period in 2017. Contributing to the decrease was non-cash stock-based compensation of $443,541 which decreased $3,170,390 from $3,613,931 in the same period of 2017. Marketing expenses of $26,353 decreased $70,862 from $97,215, travel expenses of $28,053 decreased $76,287 from $104,340 and research and development of $26,797 decreased $71,182 from $97,979 for the quarter ended September 30, 2018 compared to the same period in 2017. In the third quarter of 2017, the Company conducted a thirty-day demonstration on the US/Mexican border which caused marketing and travel expenses to increase. Research and development costs continue to decrease as the Company’s products are being commercialized.

 

Loss from Operations: Loss from operations for the quarter ended September 30, 2018 decreased $3,390,950 or 76% to $1,094,038 from loss from operations of $4,484,988 for the same period in 2017. The decrease was primarily due to a decrease in gross profit of $26,283 and the decrease of general and administrative expense of $3,417,233 as discussed above.

 

Other Expense: Total other expense of $95,828 for the quarter ended September 30, 2018 was $183,009 less than the total other expense of $278,837 in the same period in 2017. This decrease was primarily due to interest expense on bank and related party notes payable of $95,828 for the quarter ended September 30, 2018, which was $36,490 or 61% greater than the $59,338 interest expense recognized for the same period in 2017 offset by $317,298 amortization of discount to convertible note and $97,799 net result of offsetting derivative gain and debt extinguishment recognized in the third quarter of 2017.

 

Net Loss: Net loss decreased $3,573,959 or 75% to $1,189,866 for the quarter ended September 30, 2018 from net loss of $4,763,825 for the same period in 2017. The decrease in net loss was due to factors discussed above. 

 

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Nine Months Ended September 30, 2018 compared to Nine Months Ended September 30, 2017 

 

Revenues: Revenues of $995,838 for the nine months ended September 30, 2018 increased $521,204 or 110% from $474,634 for the same period in 2017. Sources of revenue were derived primarily from aerostat products, FUSE tether systems and accessories. The increase in sales volume was primarily a result of the delivery of a WASP system valued in excess of $800,000 to the U.S. Army which was ordered in the fourth quarter of 2017 and delivered in the first quarter of 2018. We expect increased sales in future periods based on a product pipeline developed following our increased marketing efforts discussed in the Business Overview section above, including the October 2018 delivery of a WASP tactical aerostat valued in excess of $1.7 million dollars.

 

Cost of Goods Sold and Gross Profit: Cost of goods sold of $537,617 for the nine months ended September 30, 2018 increased $254,027 or 90% from $283,590 for the same period in 2017. Costs included materials, parts and labor associated with the sale of aerostat products, FUSE tether systems and accessories. The $458,221 gross profit for the nine months ended September 30, 2018 was an increase of $267,177 or 140% from the $191,044 in gross profit for the same period in 2017. Gross profit margins were 46% and 40% for the nine months ended September 30, 2018 and 2017, respectively, due to the higher margins built into the pricing of the system delivered in 2018.

 

General and Administrative Expense: General and administrative expense primarily consists of payroll and related costs, sales and marketing costs, research and development costs, business overhead and costs related to maintaining a public entity. General and administrative expenses decreased $3,274,032 or 44% to $4,158,194 in the nine months ended September 30, 2018 from $7,432,226 for the same period in 2017. Contributing to the decrease was non-cash stock-based compensation of $1,647,444 which decreased $3,182,154 from $4,829,598 in the same period of 2017. Marketing expenses of $132,095 decreased $109,834 from $241,929, travel expenses of $169,558 decreased $18,139 from $187,697 and research and development of $94,179 decreased $183,697 from $277,876 for the nine months ended September 30, 2018 compared to the same period in 2017. Payroll expense increased by $288,827 during period to $1,242,895 from $954,068 in the prior year as a result of putting the CEO on salary in the third quarter of 2017 and the bonus effect of payroll taxes paid on the vesting of the September 2016 stock awards. During 2017, the Company conducted a thirty-day demonstration on the US/Mexican border which caused marketing and travel expenses to increase that year. Research and development costs continue to decrease as the Company’s products are being commercialized.

 

Loss from Operations: Loss from operations for the nine months ended September 30, 2018 decreased $3,541,209 or 49% to $3,699,973 from loss from operations of $7,241,182 for the same period in 2017. The decrease was primarily due to an increase in gross profit of $267,177 and by the decrease of general and administrative expense of $3,274,032 as discussed above.

 

Other Expense: Total other expense of $244,283 for the nine months ended September 30, 2018 was $164,459 less than the total other expense of $408,742 in the same period in 2017. This decrease was primarily due to interest expense on bank and related party notes payable of $244,283 for the nine months ended September 30, 2018, which was $95,684 or 64% greater than the $148,599 interest expense recognized for the same period in 2017 offset by $290,143 combined effect of amortization of discount to convertible note, accounting for derivative gain and debt extinguishment recognized in the third quarter of 2017.

 

Net Loss: Net loss decreased $3,705,668 or 48% to $3,944,256 for the nine months ended September 30, 2018 from net loss of $7,649,924 for the same period in 2017. The decrease in net loss was due to factors discussed above. 

  

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Liquidity and Capital Resources

 

Liquidity is the ability of an enterprise to generate adequate amounts of cash to meet its needs for cash requirements. As of September 30, 2018, the Company had $178,781 in cash compared to $615,375 in cash at December 31, 2017, a decrease of $436,594. As of September 30, 2018, the Company had accounts receivable of $65,760 compared to $110,065 at December 31, 2017, a decrease of $44,305 resulting from increased collections in the first nine months of 2018.

 

The Company had total current assets of $2,105,974 and total current liabilities of $4,647,020 or working capital deficit of $2,541,046 at September 30, 2018 compared to total current assets of $1,820,145 and total current liabilities of $2,377,340 or working capital deficit of $557,195 at December 31, 2017.

 

We have historically financed our operations through operating revenues and sales of equity and convertible debt securities. Although as of September 30, 2018 we have cash of $178,781, we have a working capital deficit of $2,541,046 and incurred a net loss of $3,944,256. Furthermore, the Company has a history of negative cash flow from operations, primarily due to historically heavy investment in research and development, stock-based compensation and costs associated with maintaining a public entity. We expect a substantial increase in revenues for the remainder of 2018. To this end, we have delivered a WASP tactical aerostat system to a customer in October 2018 which will increase revenues by more than $1.7 million in the fourth quarter of 2018. In addition, we are conducting a private offering of our common stock of up to $5,500,000 at a purchase price of $0.55 per share pursuant to the SPA. The Company intends to use the proceeds from this offering for working capital it anticipates it will need in order to finance the costs of production and other costs related to new product orders that are in the final stages of completion. As of October 26, 2018, the Company has received subscriptions for a total of $3,256,000 (5,920,000 Shares) pursuant to the SPA. If we are unable to complete a sale of all or a portion of this planned offering and we receive new orders, we will not have sufficient working capital to continue our operations for the next 12 months.

 

On October 25, 2018 we borrowed $100,000 from our Chief Executive Officer and Chairman, Jay Nussbaum pursuant to a promissory note. The note bears interest at the rate of 6% per annum and is due on November 30, 2018. We plan to use the proceeds from this loan to fund our immediate short-term cash needs.

 

 In the event we are unable to complete a sale of all or a substantial portion of the offering of our common stock pursuant to the SPA and refinance our revolving line of credit from City National Bank of Florida and our Series 2017 Secured Convertible Notes on the extended maturity date of August 2, 2019, we will not have sufficient resources to continue our operations for the next 12 months and to effectuate all aspects of our business plan. We will have to raise additional funds to pay for all of our planned expenses. We potentially will have to issue additional debt or equity or enter into a strategic arrangement with a third party to carry out some aspects of our business plan or potentially curtail some aspects of our operations. If we need to raise additional funds through the issuance of equity, equity-related or convertible debt securities in the future, these securities may have rights, preferences or privileges senior to those of the rights of holders of our common stock. We cannot predict whether additional financing will be available to us on favorable terms when required, or at all. The issuance of additional common stock may have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock. Historically, we have financed our cash needs by private placements of our securities and loans, bank financing and revenues from sales of our products. There is no assurance that we will be able to obtain financing on terms consistent with our past financings or satisfactory to us, if at all.

 

Other than the recent loan from Mr. Nussbaum, the commitments we have received for purchases of our common stock pursuant to the SPA or the Revolving Line of Credit from City National Bank of Florida as discussed below, we currently have no agreements, arrangements or understandings with any person to obtain funds through bank loans, lines of credit or any other sources. Consequently, our inability to raise funds to meet our expected working capital requirements will have a severe negative impact on our ability to remain a viable company. We are dependent upon our significant shareholders to provide or loan us funds to meet our working capital needs.

 

We have delivered a WASP tactical aerostat system to a customer in October 2018 which will increase revenues by more than $1.7 million dollars in the fourth quarter. In anticipation of increased sales resulting from our developing product pipeline, we extended financing transactions that provide us with up to $4,000,000 in credit and we extended the maturity date on $3,000,000 of convertible debt until October 2020 providing us with increased liquidity and a strengthened balance sheet. The following is a summary of these completed financing transaction:

 

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Revolving Line of Credit from City National Bank of Florida. On August 2, 2017, the Company issued a promissory note to City National Bank of Florida (“CNB”) in the principal amount of $2,000,000, the CNB Note, with a maturity date of August 2, 2018. On September 26, 2018, the Company and CNB agreed to extend the maturity date of the promissory note to August 2, 2019. The note evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2019 so long as no event of default exists under the note, the Company or Mr. Nussbaum does not cease doing business, Mr. Nussbaum does not seek to revoke or modify his guarantee of the Note, the Company does not misapply the proceeds of this loan or CNB in good faith does not believe itself insecure. The initial CNB Note bore an interest rate at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate payable monthly. At renewal, the variable rate was increased to 1.0 percentage points over the Wall Street Journal Prime Rate. The Company will pay to CNB a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company may prepay the note at any time without penalty. In the event of a default, the interest rate will increase to the highest lawful rate. The Company is obligated to maintain depository accounts with CNB with a minimum average annual balance of $600,000. In the event the Company does not maintain this account balance, CNB may charge the Company a fee equal to 2% of the deficiency as additional interest under the note. The CNB Note is personally guaranteed by Mr. Nussbaum, the Company’s Chief Executive Officer pursuant to written guarantee in favor of CNB (the “CNB Guarantee”). Mr. Nussbaum and the Company are obligated to maintain an unencumbered liquidity of no less than $6,000,000 in the form of cash, repurchase agreements, certificates of deposit or marketable securities acceptable to CNB. In addition, to secure our obligations under the note, we entered into a security agreement in favor of CNB (the “Security Agreement”) encumbering all of our accounts, inventory and equipment along with an assignment of a bank account we maintain at CNB with an approximate balance of $120,000. As of October 26, 2018, we have borrowed a total of $2,000,000 under the CNB Note leaving availability of $0 under such note.

 

Series 2017 Secured Convertible Note. On August 3, 2017, the Company issued a Secured Convertible Promissory Note Series 2017 due August 2, 2018 in the aggregate principal amount of $2,000,000 (the “Series 2017 Convertible Note”) in a private placement to Frost Nevada Investments Trust (“Frost Nevada”). On September 26, 2018, the Company and Frost Nevada agreed to extend the maturity date of the promissory note to August 2, 2019. Frost Nevada is a trust that is controlled by Dr. Frost, a substantial shareholder of the Company. The note evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2019 so long as no event of default exists under the loan. The Company may request advances of principal under this note equal to and at the same time as it requests advances, if any, pursuant to the CNB Note. The note bears interest at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate. The Company may prepay the notes at any time without penalty. If the Company does not prepay the note in full or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at Frost Nevada’s discretion. The conversion price under the note is $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. The Series 2017 Convertible Note is secured by a security interest in all of the Company’s assets. This security interest is subordinate to the security interest of CNB discussed above.  

 

As of October 26, 2018, we have borrowed a total of $2,000,000 under the Series 2017 Secured Convertible Note leaving availability of $0 under such note.

 

Amendments to Related Party Convertible Promissory Notes. On August 3, 2017, the Company entered into amendments (the “Convertible Note Amendments”) with the owners and holders of the following convertible promissory notes issued by the Company (the “Convertible Notes”):

 

  Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Frost Gamma Investments Trust (“Frost Gamma”). Frost Gamma is a trust that is controlled by Dr. Phillip Frost, a substantial shareholder of the Company; and

 

  Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Jay H. Nussbaum, the Company’s Chief Executive Officer and Chairman of the Board of Directors.

 

The Convertible Note Amendments extend the maturity date for each of the Convertible Notes to April 1, 2019 (the “Maturity Date”) and revise the conversion price to mean $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. Consistent with the original terms of the Convertible Notes, interest accrues at the rate of 6% interest per annum and is payable on the Maturity Date. The accrued interest is payable at the holders’ option in cash or shares of our common stock valued at the $1.00 per share conversion price. The Convertible Note Amendments provide that an event of default in the City National Bank Loan will be treated as an event of default under the Convertible Notes. On March 23, 2018, the Company entered into additional amendments further extending the maturity date from April 1, 2019 until October 1, 2020.

 

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On November 9, 2017, the Company entered into amendments (the “November 2017 Convertible Note Amendments”) with the owner and holder of the aggregate principal amount $3,000,000 Series 2016 Convertible Notes (the “Series 2016 Convertible Notes”) issued to our Chairman of the Board and the Chairman of the Strategic Advisory Board and a substantial shareholder of our company on September 29, 2016. The November 2017 Convertible Note Amendments permit the payment of, at the holders’ election, accrued and unpaid interest either in monthly or quarterly payments at any time after the effective date of the amendment. Accrued interest may be paid with: (i) cash; (ii) the issuance and delivery to the holder of shares of common stock of the Company at the conversion price provided for in the Series 2016 Convertible Note; or (iii) any combination of cash and shares of Common Stock, as determined by the holder in its sole discretion.

 

On March 23, 2018, the Company entered into amendments (the “March 2018 Convertible Note Amendments”) with the owners and holders of the Series 2016 Convertible Notes to extend the maturity date from April 1, 2019 until October 1, 2020.

  

As of September 30, 2018, and December 31, 2017, $165,986 and $166,356 accrued interest has been recorded, respectively on the Series 2016 Convertible Notes.

 

The accompanying consolidated financial statements and notes have been prepared assuming the Company will continue as a going concern. For the nine months ended September 30, 2018, the Company incurred a net loss of $3,944,256, generated negative cash flow from operations, has an accumulated deficit of $33,941,033 and working capital deficit of $2,541,046. These circumstances raise substantial doubt as to the Company’s ability to continue as a going concern. The Company’s ability to continue as a going concern is dependent upon the Company’s ability to create and market innovative products, raise capital, reduce debt or renegotiate terms, and to sustain adequate working capital to finance its operations. The failure to achieve the necessary levels of profitability and cash flows or obtain additional funding would be detrimental to the Company. The consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

Sources and Uses of Cash

 

   Nine Months Ended
September 30,
 
   2018   2017 
Cash flows (used in) operating activities  $(2,291,315)  $(2,250,150)
Cash flows provided by (used in) investing activities   54,721    (675)
Cash flows provided by financing activities   1,800,000    2,000,000 
Net (decrease) in cash and cash equivalents  $(436,594)  $(250,825)

 

Operating Activities

 

Net cash used in operating activities during the nine months ended September 30, 2018 was $2,291,315, which was an increase of $41,165, or 2%, from $2,250,150 net cash used in operating activities for the same period in 2017. The net loss of $3,944,256 for the first nine months of 2018 was $3,705,668 less than the same period of 2017, which was a net loss of $7,649,924. In addition to the decreased net loss, the Company recognized $3,182,154 less non-cash stock-based compensation in the first nine months of 2018 than the previous year. The Company experienced a working capital deficit of $2,541,046 in the first nine months of 2018 which was $2,874,480 less than the same period in 2017, which had a working capital balance of $333,434. The Company recognized a non-cash gain on derivative liability of $1,831,635 offset by $1,409,790 amortization of debt discount expense and 681,988 loss on debt extinguishment in the first nine months of 2017. The Company grew inventory by $769,966 and was carrying $447,943 more in accounts payable during the nine months ended September 30, 2018, mostly related to the WASP tactical system that was delivered in October 2018.

 

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Investing Activities

 

Net cash provided by investing activities was $54,721 during the nine months ended September 30, 2018 compared to $675 net cash used in investing activities during the nine months ended September 30, 2017. Net cash provided by investing activities for the nine months ended September 30, 2018 was comprised of $60,000 from the sale of a vehicle partially offset in both periods by purchases of fixed assets that included shop machines and equipment, computers and electronics and furniture and equipment.

 

Financing Activities

 

Financing activities during the first nine months of 2018 included $900,000 proceeds from a bank line of credit and $900,000 proceeds from a related party convertible note payable. Financing activities during 2017 included $1,000,000 proceeds from a bank line of credit and $1,000,000 proceeds from a related party convertible note payable.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that materially effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

  

Critical Accounting Policies and Estimates

 

The Company’s accounting policies are more fully described in Note 1 of the Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission on March 23, 2018. As disclosed therein, the preparation of the Company’s financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. The Company believes that the following discussion addresses the Company’s most critical accounting policies, which are those that are most important to the portrayal of the Company’s financial condition and results of operations and require management’s most difficult, subjective and complex judgments.

 

Accounts Receivable and Credit Policies:

 

Accounts receivable-trade consists of amounts due from the sale of tethered aerostats, accessories, spare parts, and customization and refurbishment of aerostats. Such accounts receivable are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days of receipt of the invoice. We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts based on historical collection experience and a review of the current status of trade accounts receivable. At September 30, 2018 and December 31, 2017, none of the Company’s accounts receivable-trade was deemed uncollectible.

 

Revenue Recognition and Unearned Revenue:

 

The Company accounts for revenue in accordance with Accounting Standards Update No. 2014-09 (Topic 606) and recognizes revenue when obligations under the terms of a contract with our customer are satisfied. Generally, this occurs with the transfer of control of our aerostat products, FUSE tether systems, accessories and services. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Sales, value add, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. Incidental items that are immaterial in the context of the contract are recognized as expense. The expected costs associated with our base warranties and field service actions continue to be recognized as expenses when the products are sold.

 

Derivative Financial Instruments:

 

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. For stock-based derivative financial instruments, the Company uses a Black-Scholes option pricing model, in accordance with ASC 815-15 “Derivative and Hedging” to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

 

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Stock-Based Compensation:

 

We account for stock-based compensation in accordance with ASC 718, “Compensation-Stock Compensation.” ASC 718 requires companies to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period.

 

Recently Issued Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, Leases, which will amend current lease accounting to require lessees to recognize (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the least term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model. This standard will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently reviewing the provisions of this ASU to determine if there will be any impact on our results of operations cash flows or financial condition.

 

Other than those pronouncements, management does not believe that there are any other recently issued, but not effective, accounting standards which, if currently adopted, would have a material effect on the Company’s financial statements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

As a smaller reporting company, as that term is defined in Item 10(f)(1) of Regulation S-K, we are not required to provide information required by this Item.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of disclosure controls and procedures.

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

Management, with the participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2018. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were not effective as of September 30, 2018 for the reasons discussed below. In addition, management identified the following material weaknesses in its assessment of the effectiveness of disclosure controls and procedures as of September 30, 2018:

 

The Company did not effectively segregate certain accounting duties due to the small size of its accounting staff.

  

A material weakness is a deficiency, or a combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected on a timely basis. Notwithstanding the determination that our internal control over financial reporting was not effective, as of December 31, 2017, and that there was a material weakness as identified in this Quarterly Report, we believe that our consolidated financial statements contained in this Quarterly Report fairly present our financial position, results of operations and cash flows for the years covered hereby in all material respects.

 

We expect to be dependent upon our Chief Financial Officer who is knowledgeable and experienced in the application of U.S. Generally Accepted Accounting Principles to maintain our disclosure controls and procedures and the preparation of our financial statements for the foreseeable future. We plan on increasing the size of our accounting staff at the appropriate time for our business and its size to ameliorate our concern that we do not effectively segregate certain accounting duties, which we believe would resolve the material weakness in disclosure controls and procedures, but there can be no assurances as to the timing of any such action or that we will be able to do so. 

 

(b) Changes in internal control over financial reporting.

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. Except as discussed below, we are not currently aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition, or operating results.

 

Banco Popular North America. v Aerial Products Corporation d/b/a Southern Balloon Works, et al. (Fourth Judicial Circuit Court, Duval County Florida-Civil Division) Case No. 16:2016:CA-003343

 

On May 16, 2016, Banco Popular North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court of the Fourth Judicial Circuit against Aerial Products Corporation d/b/a Southern Balloon Works (“Aerial Products”), Kevin M. Hess, LTAS, and the Company to collect on a delinquent Small Business Administration loan that Banco made in 2007 to Aerial Products with Mr. Hess as the personal guarantor. LTAS and the Company filed an Answer on June 30, 2016 and Responses to Interrogatories on December 16, 2016 and we are now in the discovery phase of litigation. The lawsuit is active and discovery is ongoing. It is our position that neither LTAS nor the Company are continuations of Aerial Products, and LTAS and the Company has denied all allegations made by Banco and is vigorously defending itself. The Company has evaluated the probability of loss as possible but the range of loss is unable to be estimated.

 

Other than the Banco matter, there are no material claims, actions, suits, proceedings inquiries, labor disputes or investigations pending. 

 

Item 1A. Risk Factors

 

Smaller reporting companies are not required to provide the information required by this Item.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable. 

 

ITEM 5. OTHER INFORMATION

 

On October 24, 2018, the Company commenced an offering of up to 10,000,000 shares of its common stock (the “Offered Shares”) in a private placement of up to $5,500,000 to certain accredited investors at a purchase price of $0.55 per share pursuant to a Stock Purchase Agreement (the “SPA”). As of October 26, 2018, the Company has received subscriptions for a total of $3,256,000 (5,920,000 Shares) pursuant to the SPA. Pursuant to the terms of the SPA, any funds received from investors in the offering prior to the closing date will be held by the Company in a segregated bank account until closing. In the event that the SPA is terminated prior to closing or the closing does not occur by December 31, 2018, any funds received by the Company pursuant to the SPA shall be promptly refunded in full to the investors without deduction of any cost or expense. Closing of the offering pursuant to the SPA is conditioned upon certain, limited customary representations and warranties, as well as the Company having received an aggregate of $4,000,000 in new orders from a prime government contractor or directly from the U.S. government at any time commencing after October 9, 2018 (the “Qualifying Sales Order”). As required under the SPA, upon receipt by the Company of a Qualifying Sales Order, the Company will give written notice to the investors notifying them that the Company intends to close on the purchase of the Offered Shares pursuant to the SPA. Within three days after the delivery of the notice to the investors, the Company and the investors will then close under the SPA and at closing, the Company will issue to each purchasing investor the number of shares subscribed for by each Investor. 

 

On October 25, 2018, the Company entered into Amendment No. 3 to the August 27, 2014 Independent Contractor Agreements it entered into with Dr. Philip Frost and Steven Rubin who serve as members of the Company’s Strategic Advisory Board (the “SAB Amendments”). The SAB Amendments extend the term of the agreements from November 1, 2018 until October 31, 2019 and provide for the following equity-based compensation: (a) for Dr. Frost, an award of 150,000 shares of the Company’s unregistered restricted Common Stock and (b) for Mr. Rubin, an award of 100,000 shares of the Company’s unregistered restricted Common Stock. The restricted stock vests upon the occurrence of a change of control (as defined in the SAB Amendments).

 

On October 25, 2018 we borrowed $100,000 from our Chief Executive Officer and Chairman, Jay Nussbaum pursuant to a promissory note. The note bears interest at the rate of 6% per annum and is due on November 30, 2018. We plan to use the proceeds from this loan to fund our immediate short-term cash needs pending settlement of the customer invoice for the WASP shipped October 9, 2018.

 

Item 6. EXHIBITS

 

The Exhibits listed in the accompanying Exhibit Index are filed, furnished herewith, or incorporated by reference as part of this Quarterly Report on Form 10-Q, in each case as set forth in the Exhibit Index.

  

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  DRONE AVIATION HOLDING CORP.
     
Date: October 26, 2018 By: /s/ JAY H. NUSSBAUM
    Jay H. Nussbaum
    Chief Executive Officer
(Principal Executive Officer)
     
Date: October 26, 2018 By: /s/ KENDALL CARPENTER
    Kendall Carpenter
    Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)

  

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EXHIBIT INDEX

  

        Incorporation by Reference        
Exhibit Number   Exhibit Description   Form   Filing Date   Exhibit Number   SEC File
No.
  Filed Herewith
2.1   Agreement and Plan of Merger, dated April 30, 2014, between Drone Aviation Holding Corp. and MacroSolve, Inc.   8-K   5/5/14   2.1   333-150332    
2.2   Plan of Merger, effective March 26, 2015, between Drone Aviation Holding Corp. and Drone Aviation Corp.   10-K   3/31/15   10.14   333-150332    
2.3   Asset Purchase Agreement, dated July 20, 2015, between Drone AFS Corp. Drone Aviation Holding Corp., Adaptive Flight, Inc., and the shareholders of Adaptive Flight, Inc.   8-K   7/21/15   10.1   333-150332    
3.1   Articles of Incorporation of Drone Aviation Holding Corp., dated April 17, 2014   8-K   5/5/14   3.1   333-150332    
3.2   Certificate of Amendment to Articles of Incorporation of Drone Aviation Holding Corp., dated October 29, 2015   8-K   10/30/15   3.1   333-150332    
3.3   Bylaws of Drone Aviation Holding Corp.   8-K   5/5/14   3.6   333-150332    
3.4   Certificate of Designation of Preferences, Rights and Limitations of Series A Convertible Preferred Stock   8-K   5/5/14   3.2   333-105332    
3.5   Certificate of Designation of Preferences, Rights and Limitations of Series B Convertible Preferred Stock   8-K   5/5/14   3.3   333-105332    
3.6   Certificate of Designation of Preferences, Rights and Limitations of Series B-1 Convertible Preferred Stock   8-K   5/5/14   3.4   333-105332    
3.7   Certificate of Designation of Preferences, Rights and Limitations of Series C Convertible Preferred Stock   8-K   5/5/14   3.5   333-105332    
3.8   Certificate of Designation of Preferences, Rights and Limitations of Series D Convertible Preferred Stock   8-K   6/5/14   3.1   333-105332    
3.9   Certificate of Designation of Preferences, Rights and Limitations of Series E Convertible Preferred Stock   8-K   6/5/14   3.2   333-105332    
3.10   Certificate of Amendment to Certificate of Designation of Preferences, Rights and Limitations of Series E Convertible Preferred Stock   8-K   6/3/15   3.3   333-105332    
3.11   Certificate of Designation of Preferences, Rights and Limitations of Series F Convertible Preferred Stock   8-K   8/28/14   3.1   333-105332    
3.12   Certificate of Amendment to Certificate of Designation of Preferences, Rights and Limitations of Series F Convertible Preferred Stock   8-K   6/3/15   3.4   333-105332    
3.13   Certificate of Designation of Preferences, Rights and Limitations of Series G Convertible Preferred Stock   8-K   6/3/15   3.1   333-105332    
3.14   Certificate of Correction to the Certificate of Designation of Preferences, rights and Limitations of Series G Convertible Preferred Stock   8-K   6/3/15   3.2   333-105332    
3.15   Form of Certificate of Withdrawal to be filed with Nevada Secretary of State.   8-K   8/24/2018   3.1   333-105332    

   

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        Incorporation by Reference        
Exhibit Number   Exhibit Description   Form   Filing Date   Exhibit Number   SEC File
No.
  Filed Herewith
4.1   Form of Convertible Promissory Note Series 2016 due October 1, 2017   8-K   9/30/16   4.1   333-105332    
4.1(a)   (a) Form of Amendment to Convertible Promissory Note Series 2016   10-Q    8/4/17   4.1(a)   333-150332     
4.1(b)   (b) Form of November 2017 Amendment to Convertible Promissory Note Series 2016   10-Q   11/13/17   4.1(b)    333-150332     
4.1(c)   (c) Form of March 2018 Amendment to Convertible Promissory Note Series 2016    10-K    3/23/18    4.1(c)   333-150332    
4.2   Form of Secured Convertible Promissory Note Series 2017-08 due August 2, 2018   10-Q    8/4/17   4.2   333-150332     
10.1*   Form of Common Stock Purchase Agreement.           X
10.2*   Form of Amendment No. 3 to Independent Contractor Agreement dated August 3, 2017           X
10.24   Amendment to promissory between Drone Aviation Holding Corp. and City National Bank of Florida dated September 26, 2018.   8-K   9/28/2018   10.1   333-105332    
10.25   Amendment to Secured Convertible Promissory Note issued by Drone Aviation Holding Corp. to Frost Nevada Investment Trust dated September 26, 2018.   8-K   9/28/2018   10.2   333-105332    
10.26   Form of Promissory Note between Drone Aviation Holding Corp and Jay Nussbaum dated October 25, 2018                   X
31.1   Certification of the Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002           X
31.2   Certification of the Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002           X
32**   Certifications of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002           X
101 INS***   XBRL Instance Document           X
101 SCH***   XBRL Taxonomy Extension Schema Document           X
101 CAL***   XBRL Taxonomy Calculation Linkbase Document           X
101 LAB***   XBRL Taxonomy Labels Linkbase Document           X
101 PRE***   XBRL Taxonomy Presentation Linkbase Document           X
101 DEF***   XBRL Taxonomy Extension Definition Linkbase Document           X

 

*Indicates management contract or compensatory plan or arrangement.

 

**Furnished herewith

 

***These documents formatted in XBRL (Extensible Business Reporting Language) have been attached as Exhibit 101 to this report

 

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