COMSovereign (COMS) - 2018 Q4 - Annual Report

Part I Business Drone Aviation Holding Corp. develops and sells tethered aerial platforms, primarily WASP systems, for national defense and security ISR and communications - The company's primary business is designing and selling tethered aerial platforms, including the WASP aerostat and other tethered drones, for military and security ISR and communications applications[18] - The core product focus is the Winch Aerostat Small Platform (WASP), a mobile, tactical aerostat system capable of carrying payloads up to 90 pounds to an altitude of up to 1,500 feet[19][21] - The company's primary customers are U.S. Government entities, including the Department of Defense (DoD) and Department of Homeland Security (DHS), with significant future revenue expected from these sources[21][47][57] - In December 2018, the company was awarded a subcontract valued at $3.8 million for six WASP aerostat systems for U.S. southern border deployment by Customs and Border Protection (CBP)[58] - The company holds a key patent (No. 9,446,858) for its electric tethered aerial platform (ETAP) technologies, a core competitive differentiator[35][43] Research & Development Expenses | Year | Amount Spent ($) | | :--- | :--- | | 2018 | $107,015 | | 2017 | $351,768 | Risk Factors The company faces substantial risks from reliance on government contracts, intense competition, funding needs, supply chain vulnerabilities, and limited stock liquidity as a penny stock - The company is heavily dependent on U.S. Government contracts, which are subject to congressional appropriations and shifting political priorities, posing a risk to revenue stability[65][66] - The company competes with large, well-funded defense contractors such as TCOM, Raytheon, and Lockheed Martin, possessing significantly greater financial, technical, and marketing resources[36][69][70] - The company has significant debt, including a $2 million revolving line of credit maturing in August 2019, and may require additional funding to continue operations, which could lead to shareholder dilution[93][97] - The company's common stock is quoted on the OTCQB market and is subject to SEC 'penny stock' rules, creating limited liquidity and potentially cumbersome transactions for investors[106][110][111] - There is a risk of supply chain disruption as the company relies on a limited number of suppliers for critical components and raw materials, such as helium gas for its aerostats[87] Unresolved Staff Comments The company reports no unresolved staff comments from the SEC - There are no unresolved staff comments[117] Properties The company's principal executive office and manufacturing space is a 5,533 square foot leased facility in Jacksonville, Florida, with an additional 2,390 square foot lease in Holly Hill, Florida, for aerostat manufacturing - The main office and manufacturing facility is a 5,533 sq. ft. leased space in Jacksonville, FL under a 60-month lease that commenced in 2015[118] - A new 36-month operating lease for 2,390 sq. ft. in Holly Hill, FL was signed on March 1, 2019, to expand aerostat manufacturing[118] Legal Proceedings The company is involved in a lawsuit with Banco Popular North America regarding a delinquent loan to a third party, denying liability and deeming the probability of loss possible but unestimable - The company is involved in a lawsuit with Banco Popular North America regarding a delinquent loan made to Aerial Products Corporation, denying liability and defending the case[119] - Management has evaluated the probability of loss as possible but is unable to estimate the range of potential loss[119] Mine Safety Disclosures This item is not applicable to the company - Not applicable[122] Part II Market for Common Equity and Related Matters The company's common stock trades on OTCQB, has never paid dividends, and recently converted $5.1 million in debt to equity while selling $2 million in stock - The company's common stock trades on the OTCQB under the symbol 'DRNE'[126] Quarterly Stock Price (Bid Price) | Quarter Ended | 2018 High ($) | 2018 Low ($) | 2017 High ($) | 2017 Low ($) | | :--- | :--- | :--- | :--- | :--- | | March 31 | $1.20 | $0.70 | $2.99 | $2.17 | | June 30 | $0.90 | $0.68 | $2.27 | $1.35 | | September 30 | $0.75 | $0.61 | $1.45 | $0.71 | | December 31 | $0.69 | $0.47 | $1.65 | $0.89 | - The company has never declared or paid cash dividends and does not plan to in the foreseeable future[129] - In December 2018, approximately $5.1 million of debt and accrued interest was converted into 10,208,151 shares of common stock at $0.50 per share[130] Management's Discussion and Analysis (MD&A) In 2018, net revenues increased by 384% to $2.72 million, while gross margin declined due to a $565,000 inventory write-off, but the company significantly improved its liquidity and mitigated going concern doubts through debt conversion and capital raises Results of Operations (2018 vs. 2017) | Metric | 2018 ($) | 2017 ($) | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Net Revenues | $2,722,713 | $562,078 | +$2,160,635 | +384% | | Gross Profit | $508,547 | $223,499 | +$285,048 | +128% | | Gross Margin | 19% | 40% | -21 pts | -52.5% | | Loss from Operations | ($8,130,817) | ($9,846,342) | +$1,715,525 | -17% | | Net Loss | ($8,475,313) | ($10,323,992) | +$1,848,679 | -18% | - The 2018 gross margin was negatively impacted by a $565,000 inventory write-off of slow-moving items, including FUSE tether systems and powered drone inventory, as the company shifted focus to aerostat products[137] Cash Flow Summary (2018 vs. 2017) | Activity | 2018 ($) | 2017 ($) | | :--- | :--- | :--- | | Cash from Operations | ($2,387,731) | ($3,326,022) | | Cash from Investing | $54,721 | ($73,817) | | Cash from Financing | $4,000,000 | $2,000,000 | - The company's liquidity position improved significantly, with working capital turning positive to $212,879 at year-end 2018 from a deficit of $557,195 at year-end 2017[144] - Management states that actions taken in 2018, including raising capital and converting debt, have mitigated the substantial doubt about the company's ability to continue as a going concern that was present in 2017[154][365][366] Changes in and Disagreements with Accountants The company reports no disagreements with its accountants on accounting and financial disclosure - None[179] Controls and Procedures Management concluded that disclosure controls were ineffective as of December 31, 2018, due to a material weakness in internal control over financial reporting caused by insufficient segregation of accounting duties - Management concluded that disclosure controls and procedures were not effective as of December 31, 2018[183] - A material weakness was identified in internal control over financial reporting: the company did not effectively segregate certain accounting duties due to the small size of its accounting staff[187] - Despite the material weakness, management believes the consolidated financial statements in the report are fairly presented in all material respects[188] Part III Directors, Executive Officers and Corporate Governance This section details the company's executive officers and board of directors, highlighting key leadership, experienced members from government and technology, and the board's independent composition and committees - The executive team includes Jay H. Nussbaum (CEO), Daniyel Erdberg (President), Kendall Carpenter (CFO), Kevin Hess (CTO), and Felicia Hess (Chief Operating Officer)[195] - The Board of Directors includes members with extensive government and defense industry experience, such as David Aguilar (former U.S. CBP), John E. Miller (LTG, Ret. U.S. Army), and Robert Guerra[195][203][205][206] - The Board has determined that directors John Miller, David Aguilar, Robert Guerra, and Timothy Hoechst are independent[210] - The company has adopted a Code of Ethics and Business Conduct applicable to all directors, officers, and employees[216] Executive Compensation This section details executive and non-employee director compensation for 2017-2018, including salaries, bonuses, and significant stock and option awards, with CEO Jay Nussbaum's 2018 total compensation at $1.66 million 2018 Summary Compensation Table | Name and Principal Position | Salary ($) | Bonus ($) | Stock Awards ($) | Option Awards ($) | Total ($) | | :--- | :--- | :--- | :--- | :--- | :--- | | Jay Nussbaum, CEO & Chairman | 245,000 | 225,000 | 315,000 | 848,017 | 1,662,113 | | Felicia Hess, COO | 150,833 | 25,000 | 302,050 | 347,904 | 848,531 | | Daniyel Erdberg, President | 165,833 | 175,000 | 232,750 | 347,904 | 939,012 | - Employment agreements are in place for key executives, with base salaries for 2019 set at $300,000 for the CEO, $175,000 for the President, and $160,000 for the Chief Quality Officer[228][231][234] - In March 2019, CTO Kevin Hess transitioned from an employee to an independent contractor, providing services through a corporation owned by his spouse, Felicia Hess (the company's Chief Quality Officer)[229] 2018 Director Compensation | Name | Fees Earned or Paid in Cash ($) | Stock Awards ($) | Total ($) | | :--- | :--- | :--- | :--- | | Robert Guerra | 20,500 | 32,611 | 53,111 | | David Aguilar | 26,500 | 120,073 | 146,573 | | Timothy Hoechst | 26,500 | 46,096 | 72,596 | | LTG John E. Miller (Ret.) | 38,500 | 46,009 | 84,509 | | Total | 112,000 | 244,786 | 356,789 | Security Ownership This section details beneficial ownership as of March 21, 2019, showing Dr. Phillip Frost as the largest shareholder at 46.1%, and executive officers and directors collectively owning 63.5%, indicating high ownership concentration Beneficial Ownership (as of March 21, 2019) | Name of Beneficial Owner | Percentage of Class (%) | | :--- | :--- | | Dr. Phillip Frost | 46.1% | | Jay Nussbaum (CEO) | 33.0% | | Felicia Hess (COO) | 12.2% | | Daniyel Erdberg (President) | 11.1% | | Executive Officers and Directors as a Group (9 persons) | 63.5% | - Ownership is highly concentrated, with Dr. Phillip Frost and the executive officers/directors group controlling a majority of the company's stock[254] Related Party Transactions The company engaged in significant related-party transactions, including the conversion of $5 million in convertible notes from major shareholders and CEO to common stock, a consulting agreement with a director's firm, and a restructured employment agreement for the CTO with his spouse's company - In December 2018, $3.0 million of Series 2016 Convertible Notes held by Frost Gamma and CEO Jay Nussbaum were converted into common stock at $0.50 per share[264] - In December 2018, a $2.0 million Series 2017 Convertible Note held by Frost Nevada Investments Trust was converted into common stock at $0.50 per share[266][267] - The company has a consulting agreement with Global Security Innovative Strategies, LLC (GSIS), paying $10,000 per month for business development services, where Director David Aguilar is a principal[269] - CTO Kevin Hess is married to Chief Quality Officer Felicia Hess; in March 2019, his employment was converted to an independent contractor agreement with Cognitive Carbon Corporation, a company wholly owned by Felicia Hess[208][271] Principal Accounting Fees and Services This section discloses fees billed by MaloneBailey, LLP, totaling $63,000 in 2018 and $61,000 in 2017, exclusively for audit services with no other fees incurred Accountant Fees | Fee Type | 2018 ($) | 2017 ($) | | :--- | :--- | :--- | | Audit Fees | $63,000 | $61,000 | | Audit-Related Fees | - | - | | Tax Fees | - | - | | All Other Fees | - | - | | Total | $63,000 | $61,000 | - All fees paid to the independent auditor in 2018 and 2017 were for audit services[277][278][279] Part IV Exhibits and Financial Statement Schedules This section provides an index to the consolidated financial statements and a comprehensive list of all exhibits filed with the 10-K, including governance documents, material contracts, and certifications - This section provides an index to the Consolidated Financial Statements, which begin on page F-1[283][284] - A detailed list of exhibits is provided, including articles of incorporation, bylaws, material contracts, and employment agreements[285][287][288][290][292] Financial Statements Auditor's Report MaloneBailey, LLP issued an unqualified opinion on the consolidated financial statements for 2018 and 2017, affirming fair presentation in conformity with U.S. GAAP and PCAOB standards - The auditor, MaloneBailey, LLP, provided an unqualified opinion on the consolidated financial statements[305] - The company was not required to have, nor was the auditor engaged to perform, an audit of its internal control over financial reporting[307] Consolidated Financial Statements The 2018 consolidated financial statements show total assets at $3.56 million, a dramatic decrease in liabilities to $2.49 million due to debt conversion, resulting in positive stockholders' equity of $1.07 million, and a net loss of $8.48 million Consolidated Balance Sheet Data (at Dec 31) | Account | 2018 ($) | 2017 ($) | | :--- | :--- | :--- | | Cash | $2,282,365 | $615,375 | | Total Current Assets | $2,697,903 | $1,820,145 | | Total Assets | $3,556,599 | $3,073,548 | | Total Current Liabilities | $2,485,024 | $2,377,340 | | Total Liabilities | $2,485,024 | $5,377,340 | | Total Stockholders' Equity (Deficit) | $1,071,575 | ($2,303,792) | Consolidated Statement of Operations Data (Year Ended Dec 31) | Account | 2018 ($) | 2017 ($) | | :--- | :--- | :--- | | Revenues | $2,722,713 | $562,078 | | Gross Profit | $508,547 | $223,499 | | Loss from Operations | ($8,130,817) | ($9,846,342) | | Net Loss | ($8,475,313) | ($10,323,992) | | Basic and Diluted Net Loss per Share | ($0.89) | ($1.15) | Notes to Consolidated Financial Statements The notes detail accounting policies and financial results, including management's liquidity plan mitigating going concern doubts, $5 million in related-party debt conversion, a $2 million credit facility, high customer concentration, and $2 million in subsequent capital raises - Management concluded that its 2018 actions, including raising over $4 million in capital and converting $5 million in debt to equity, mitigated the substantial doubt about its ability to continue as a going concern that existed in 2017 (Note 2)[365][366] - In December 2018, $5,000,000 in principal of convertible notes held by related parties (Frost entities and CEO Jay Nussbaum) plus accrued interest were converted into common stock, significantly deleveraging the balance sheet (Note 6 & 8)[381][389] - The company has a $2,000,000 revolving line of credit with City National Bank of Florida, fully drawn as of Dec 31, 2018, maturing in August 2019, and personally guaranteed by CEO Jay Nussbaum (Note 7)[385] - The company has a high customer concentration, with one customer accounting for 95% of total revenues in 2018 (Note 15)[440] - Subsequent to year-end, in January 2019, the company raised an additional $2,007,750 through the sale of common stock at $0.50 per share (Note 16)[441]