ITEM 1. BUSINESS
Overview
We are a single-source provider of end-to-end IT and next-generation network solutions to the telecommunications service provider (carrier) and corporate enterprise markets through cloud platforms and professional services. We offer cloud and managed services, professional consulting and staffing services, and voice, data and optical solutions to assist our customers in meeting their changing technology demands. Our cloud and managed services group offers enterprise and service-provider customers the opportunity to adopt an operational expense model by outsourcing to us rather than the capital expense model that has dominated in recent decades in IT infrastructure management. Our professional services group offers a broad range of solutions to enterprise and service provider customers, including application development teams, analytics, project management, program management, unified communications, network management and field support services on a short and long-term basis. Our applications and infrastructure division offers enterprise and service provider customers specialty contracting services, including engineering, design, installation and maintenance services, that support the build-out and operation of some of the most advanced small cell, Wi-Fi and distributed antenna system (DAS) networks. We believe the migration of these complex networks from proprietary hardware-based solutions to software-defined networks (SDN) and cloud-based solutions provides our company a significant opportunity as we are one of only a few industry competitors that can span across both the legacy and next-generation networks that are actively being designed and deployed in the marketplace. We also believe we are in a position to assist our customers by offering competitive cloud and SDN solutions from a single source, while also maintaining our customers’ legacy hardware-based solutions.
We provide the following categories of offerings to our customers:
●Cloud and Managed Services. Our cloud-based service offerings include platform as a service (PaaS), infrastructure as a service (IaaS), database as a service (DbaaS), and software as a service (SaaS). Our cloud services encompass public, private and hybrid cloud offerings within compute, network and storage. In addition, our easy-to-use, intuitive portal assists customers in migrating through an extensive app store and allows customers quickly to add or subtract applications and services. Our experience in system integration and solutions-centric services helps our customers quickly to integrate and adopt cloud-based services. In addition, our managed-services offerings include network management, 24x7x365 monitoring, security monitoring, storage and backup services.
●Applications and Infrastructure. We provide an array of applications and services throughout North America and internationally, including unified communications, interactive voice response (IVR) and SIP-based call centers. We also offer structured cabling and other field installations. In addition, we design, engineer, install and maintain various types of Wi-Fi and wide-area networks, DAS networks, and small cell distribution networks for incumbent local exchange carriers (ILECs), telecommunications original equipment manufacturers (OEMs), cable broadband multiple system operators (MSOs) and enterprise customers. Our services and applications teams support the deployment of new networks and technologies, as well as expand and maintain existing networks. We also design, install and maintain hardware solutions for the leading OEMs that support voice, data and optical networks.
●Professional Services. We provide consulting and professional staffing solutions to the service-provider and enterprise market in support of all facets of IT and next-generation networks, including project management, network implementation, network installation, network upgrades, rebuilds, maintenance and consulting services. We leverage our international recruiting database, which includes more than 70,000 professionals, for the rapid deployment of our professional services. On a weekly basis, we deploy hundreds of telecommunications professionals in support of our worldwide customers.
Our Recent Acquisitions
We continue to grow and expand our service offerings and geographic reach through strategic acquisitions. Since January 1, 2013, we have completed the following acquisitions:
● AW Solutions, Inc. In April 2013, we acquired AW Solutions, Inc. and AW Solutions Puerto Rico, LLC, or collectively AW Solutions, a professional, multi-service line, telecommunications infrastructure company that provides outsourced services to the wireless and wireline industry. AW Solution’s services include network systems design, architectural and engineering services, program management and other technical services. The acquisition of AW Solutions broadened our suite of services and added new customers to which we can cross-sell our other services.
● Integration Partners-NY Corporation. In January 2014, we acquired Integration Partners-NY Corporation, IPC, a full-service voice and data network engineering firm based in New York. IPC serves both corporate enterprises and telecommunications service providers. We believe the acquisition of IPC will support the cloud and managed services aspect of our business, as well as improve our systems integration and applications capabilities.
● RentVM, Inc. In February 2014, we acquired RentVM, Inc., or RentVM, a New Jersey-based provider of infrastructure-as-a-service IaaS, Platform as a service, PaaS and SaaS technology to SMB, enterprise, and carrier customers across all major verticals. IaaS, PaaS and SaaS allow customers to run their applications on RentVM equipment without the customer purchasing capital equipment. In a private, public, or hybrid cloud environment. RentVM expands our cloud and managed services capabilities by providing us a software defined data center (SDDC) platform to offer enterprise-grade cloud computing solutions.
● VaultLogix, LLC. In October 2014, we acquired VaultLogix, LLC, Data Protection Services, LLC and U.S. Data Security Acquisition, LLC, or collectively VaultLogix, leading providers of cloud backup services to nearly 10,000 businesses around the world. VaultLogix safeguards a wide range of enterprise-class operating systems and applications through its unique combination of encryption, block-level data duplication and compression. In addition, through its partner program, VaultLogix offers software branding, a robust partner portal and dedicated account management. We believe the acquisition of VaultLogix will broaden our suite of cloud service offerings by adding VaultLogix’s cloud backup services to our wide range of cloud services, including IaaS, virtual desktop, hosted exchange, disaster recovery in the cloud and file sharing, and will add new customers and resellers to which we can cross-sell our other services.
Our Industry
Advances in technology architectures have supported the rise of cloud computing, which enables the delivery of a wide variety of cloud-based services, such as platform as a service (PaaS), infrastructure as a service (IaaS), database as a service (DbaaS), and software as a service (SaaS). Today, mission-critical applications can be delivered reliably, securely and cost-effectively to our customers over the internet without the need to purchase supporting hardware, software or ongoing maintenance. The lower total cost of ownership, better functionality and flexibility of cloud applications represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting cloud services to rapidly deploy and integrate applications without building out their own expensive infrastructure and to minimize the growth of their own IT departments and create business agility by taking advantage of accelerated time-to-market dynamics. Gartner, Inc. a leading IT research and advisory company, expects total cloud spending to increase from $132 billion worldwide in 2013 to $244 billion in 2017.
According to the U.S. National Institute of Standards and Technology, or the NIST, cloud computing is on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management and effort and service provider interaction. The NIST has identified five essential characteristics of cloud computing:
●on-demand service;
●broad network access;
●resource pooling;
●rapid elasticity; and
●measured service
Cloud computing can generally be offered across the following four different deployment or service models:
●Platform as a Service. PaaS allows users to develop their own web-based applications or to customize existing applications using one or more programming languages and development tools.
●Infrastructure as a Service. IaaS allows customers to access the equipment and hardware needed to perform computing operations, including storage, processing and networking components.
●Database as a Service. DbaaS consists of a service that is managed by a cloud operator (public or private) that supports applications, without the application team assuming responsibility for traditional database administration functions. With a DBaaS, the application developers need not be database experts, nor should they have to hire a database administrator to maintain the database.
●Software as a Service. SaaS consists of firms offering the capability to use software applications that are housed off of the user’s premises. This software is differentiated from the traditional software programs that are resident on and used in stand-alone computing environments.
Generally, there are three deployment models through which cloud services are provided:
●Private Clouds - exclusive to a single user.
●Public or Community Clouds - available to the general public or shared by large, diverse groups of customers.
●Hybrid Clouds - combined public and private elements in the same data center.
Cloud services enable the transition from Infrastructure 1.0 (mainframe computing to client-server computing) to Infrastructure 2.0. Current trends, such as cloud computing, software defined networks (meta orchestration), big data analytics, mobile, and social networks, are increasingly defining IT infrastructure needs and spending. Converged infrastructures, policy-based automation and other innovative technologies are providing the solutions enterprises will need to manage the exponential increase in the number of devices and data. The increasing demand for cloud services is fueling the growth of our managed services offerings, which are specifically designed to accelerate the adoption of cloud services by our two primary customer segments: enterprise and service providers.
The increased movement by enterprise businesses of their information technology services, applications and infrastructure to a cloud-based architecture will cause market revenue in this segment to surge by a factor of three from 2011 to 2017, according to a January 2014 IHS Technology report entitled “Cloud & Big Data Report - A Paradigm Shift in the ICT Industry 2013.” According to that same report, global business spending for infrastructure and services related to the cloud will reach an estimated $174.2 billion this year, up 20% from $145.2 billion in 2013. In a sign of the market’s strength, strong spending growth will continue during the next few years as enterprises race to come up with their own cloud-storage solutions. By 2017, enterprise spending on the cloud will amount to a projected $235.1 billion.
The Cisco® Internet Business Solutions Group, or IBSG, believes that there is a significant opportunity for service providers as well. IBSG projects a more than $60 billion direct mobile cloud service opportunity worldwide by 2016, with an additional cloud pull-through market of $335 billion.
Cloud spending is expected to rise across United States federal agencies as well. A report by International Data Corporation, or IDC, titled Government Insight (September 2013) projects a rise in cloud government spending after fiscal year 2014. According to such report, Infrastructure as a service (IaaS) and private cloud in particular will lead government investment. Federal private cloud services spending is expected to reach $1.7 billion in fiscal year 2014, reaching $7.7 billion by 2017.
Increased functionality and proliferation of data through the usage of smart phones, tablets and other mobile devices has resulted in the significant adoption of such devices within corporate enterprises. According to IDC, there were 1.4 billion mobile internet users worldwide in 2013, and there will be 2.3 billion in 2017. According to Forrester Research, Inc. (2013 Mobility Workforce Adoption Trends) the number of “anytime, anywhere information workers”- those who use three or more devices, work from multiple locations, and use many apps - has risen from 23% of the global workforce in 2011 to 29% in 2012. According to Gartner, the number of tablets sold has grown at a compound annual growth rate of 97% between 2010 and 2014 worldwide, and is expected to surpass personal computers by annual number of units sold in 2016.
The rapid increase in data traffic, usage of wireless networks and evolution of services and technology are also driving telecommunications providers to undertake a number of initiatives to increase coverage, capacity and performance of their existing networks, including adding and upgrading cell sites nationwide.
To remain competitive and meet the rapidly-growing demand for state-of-the-art mobile data services, telecommunications and cable companies rely on outsourcing to provide a wide range of network and infrastructure services, as well as project staffing services, to help build out and maintain their networks. OEMs supplying equipment to those telecommunications and cable service providers also frequently rely on outsourced solutions for project management and network deployment. Demand for these “professional services”, whether utilizing a cloud platform or more traditional network solutions, is expected to continue to grow. According to the Telecommunications Industry Association 2012 ICT Market Review, the wireless telecommunications and network infrastructure outsourcing market has grown 9.5% per year since 2004 and is expected to continue to grow at a 5.9% rate through 2014, becoming a $21.6 billion market in 2014.
Our Competitive Strengths
We believe our market advantages center around our cloud-based applications and services portfolio and positioning. As a true infrastructure 2.0 provider, we add value by enabling applications and services while helping to contain costs. Customers now demand a partner that can provide end-to-end IT solutions, that offers a solution that allows the customer to move IT expenditures from capital costs to operating costs, and that offers the customer greater elasticity and the ability to rapidly deploy enterprise applications. We believe our strengths described below will enable us to continue to compete effectively and to take advantage of anticipated growth in our target markets:
●Single-Source Provider of Cloud and Managed Services Applications and Infrastructure to Enterprise and Service Providers.
●Customizable Cloud Integration Services. We offer a wide spectrum of flexible and customizable cloud solutions for our customers. We differentiate our services by our ability to plan and customize a wide variety of cloud solutions for each customer.
●Totally Secure Private and Hybrid Cloud Architectures. While many cloud companies only offer public cloud services, leaving great risks of security challenges within a network, our ability to customize private and hybrid cloud architecture, with multiple levels of security, mitigates these risks.
●Licensed and Open Source SaaS Portfolio. Our software as a service (SaaS) business utilizes top licensed software in the marketplace, including offerings from Microsoft, Hewlett Packard and Citrix. In addition, we utilize open source platforms that our skilled applications team can customize to fit our customers’ requirements.
●Established Customer Relationships
●Vertical Market Compliance. Our customer list includes relationships in many vertical markets, such as healthcare, finance and retail, which are specifically sensitive to industry compliance. Proficiency with standards such as HIPAA, PCI and Ssae16 are essential. In addition, our applications specialists support customer requirements for unified communication competencies, call center, interactive voice response (IVR) and video applications.
●Service Provider Relationships. We have established relationships with many leading wireless and wireline telecommunications providers, cable broadband MSOs, OEMs and others. Our current customers include Ericsson Inc., Verizon Communications Inc., Alcatel-Lucent USA Inc., Century Link, Inc., AT&T Inc. and Hotwire Communications.
●Long-Term Master Service Agreements. We have over 30 master service agreements with service providers and OEMs. Our relationships with our customers and existing master service agreements position us to continue to capture existing and emerging opportunities, both domestically and internationally. We believe the barriers are extremely high for new entrants to obtain master service agreements with service providers and OEMs unless there are established relationships and a proven ability to execute.
●Global Professional Services
●Engineering talents. Our geographical reach and vast engineering talents enable our customers to take advantage of our end-to-end solutions and one-stop shopping.
●Proven Ability to Recruit, Manage and Retain High-Quality Personnel. Our ability to recruit, manage and retain skilled labor is a critical advantage in an industry in which a shortage of skilled labor is often a key limitation for our customers and competitors alike. We own and operate an actively-maintained database of more than 70,000 telecom and IT personnel. We also employ highly-skilled recruiters and utilize an electronic hiring process that we believe expedites deployment of personnel and reduces costs. We believe this access to a skilled labor pool gives us a competitive edge over our competitors as we continue to expand.
●Strong Senior Management Team with Proven Ability to Execute. Our highly-experienced management team has deep industry knowledge and brings an average of over 25 years of individual experience across a broad range of disciplines. We believe our senior management team is a key driver of our success and is well-positioned to execute our strategy.
Our Growth Strategy
Under the leadership of our senior management team, we intend to build our sales, marketing and operations groups to support our rapid growth while focusing on increasing operating margins. While organic growth will be a main focus in driving our business forward, acquisitions will play a strategic role in augmenting existing product and service lines and cross-selling opportunities. We are pursuing several strategies, including:
●Expand Our Cloud-Based Service Offerings. The IT and telecommunications industries have been undergoing a massive shift in recent years from proprietary hardware solutions to software-defined networking (SDN), network function virtualization (NFV), and delivered with a meta orchestrated cloud-based solution. This shift is being driven by many converging issues, including the ‘consumerization’ of IT, BYOD (bring your own device), meta orchestration of complex networks, video growth and the acceptance of open source network architecture. We are building a company that can manage the existing network infrastructures of the largest domestic and international corporations and service providers while also delivering a broad range of enterprise-grade cloud solutions. We believe the ability to provide such services is a critical differentiator as we already have relationships with many potential customers by offering services through our three operating divisions -- applications and infrastructure, professional services, and cloud and managed services. Each of our three operating divisions intends to continue to expand by offering additional cloud services, such as cloud management of Wi-Fi and DAS networks, on a virtualized wireless controller running on our cloud rather than installed throughout a corporate network, allowing better controls and cost savings for clients. We expect to expand the service offerings of our professional services division to include services to support the roll-out of SDN and cloud solutions teams and to market such services to both the service provider and enterprise markets. These new service offerings are expected to create a new market for professional services as customers in those markets typically do not have next-generation network professionals on staff. We expect these new service offerings to be a significant growth opportunity in each of those multi-billion-dollar global markets. Industry experts project that cloud-based IT and telecom solutions will outpace traditional hardware sales by 2016, which supports our strategy and growth plans.
●Grow Revenues and Market Share through Selective Acquisitions. We plan to continue to acquire private companies that enhance our earnings and offer complementary services or expand our geographic reach. We believe such acquisitions will help us to accelerate our revenue growth, leverage our existing strengths, and capture and retain more work in-house as a prime contractor for our clients, thereby contributing to our profitability. We also believe that increased scale will enable us to bid and take on larger contracts. We believe there are many potential acquisition candidates in the high-growth cloud computing space, the fragmented professional services markets, and in the applications and infrastructure arena.
●Aggressively Expand Our Organic Growth Initiatives. Our customers include many leading wireless and wireline telecommunications providers, cable broadband MSOs, OEMs and enterprise customers. As we have expanded the breadth of our service offerings through both organic growth and selective acquisitions, we believe we have opportunities to expand revenues with our existing clients by marketing additional cloud and SDN service offerings to them, as well as by extending services to existing customers in new geographies.
●Expand Our Relationships with New Service Providers. We plan to expand new relationships with cable broadband providers, competitive local exchange carriers (CLECs), integrated communication providers (ICs), competitive access providers (CAPs), network access point providers (NAPs) and integrated communications providers (ICPs). We believe that the business model for the expansion of these relationships, leveraging our core strength and array of service solutions, will support our business model for organic growth.
●Increase Operating Margins by Leveraging Operating Efficiencies. We believe that by centralizing administrative functions, consolidating insurance coverage and eliminating redundancies across our newly-acquired businesses, we will be positioned to offer more integrated end-to-end solutions and improve operating margins.
Our Services
We provide cloud- and managed-service-based platforms, professional services, applications and infrastructure to both the telecommunications industry and corporate enterprises. Our cloud-based and managed services and our engineering, design, construction, installation, maintenance and project staffing services support the build-out, maintenance, upgrade and operation of some of the most advanced fiber optic, Ethernet, copper, wireless and satellite networks. Our breadth of services enables our customers to selectively augment existing services or to outsource entire projects or operational functions. We divide our service offerings into the following categories of services:
●Cloud and Managed Services. We provide integrated cloud-based solutions that allow organizations around the globe to migrate and integrate their applications into a public, private or hybrid cloud environment. We combine engineering expertise with white glove service and support to maintain and support these complex global networks. We provide traditional hardware solutions and applications, cloud-based solutions and professional staffing services, which work as a seamless extension of a telecommunications service provider or enterprise end user.
●Applications and Infrastructure. We provide an array of applications and services, including unified communications, voice recognition and call centers, as well as structured cabling, field installations and other IT and telecom infrastructure solutions. Our design, engineering, installation and maintenance of various types of local and wide-area networks, DAS systems, and other broadband installation and maintenance services augment ILECs, telecommunications OEMs, cable broadband MSOs and large end-users. Our services and applications support the deployment of new networks and technologies, as well as expand and maintain existing networks. We also sell hardware and applications for the leading OEMs that support voice, data and optical networks.
●Applications. We apply our expertise in networking, converged communications, security, data center solutions and other technologies utilizing our skills in consulting, integration and managed services to create customized solutions for our enterprise customers. We provide applications for managed data, converged services (single and multiple site), voice recognition, session initiation protocol (SIP trunking-Voice Over IP, streaming media and unified communication (UC)) collocation services and others. These applications can be serviced at our customers’ premises or in our cloud solutions.
●Professional Services. Our global professional services organization offers on customer premise or off-premise IT and Cloud solutions consulting, design, engineering, integration, implementation and ongoing support of all solutions offered at InterCloud. Our global footprint is a differentiating factor for national and international based customers needing a broad range of IT/Cloud technical expertise for management of their legacy and next generation IT networks.
Customers
Our customers include many Fortune 1000 enterprises, wireless and wireline service providers, cable broadband MSOs and telecommunications OEMs. Our current service provider and OEM customers include leading telecommunications companies, such as Ericsson, Inc., Verizon Communications, Sprint Nextel Corporation and AT&T.
Our top four customers, Ericsson, Inc., Crown Castle, Andrew Solutions, and Dell, accounted for approximately 33% of our total revenues in the year ended December 31, 2014. Our top four customers, Ericsson, Inc., Crown Castle, NX Utilities and Uline, accounted for approximately 57% of our total revenues in the year ended December 31, 2013. Ericsson, Inc. and its affiliates, as an OEM provider for seven different carrier projects, accounted for approximately 15% and 41% of our total revenues in the years ended December 31, 2014 and 2013, respectively.
A substantial portion of our revenue is derived from work performed under multi-year master service agreements and multi-year service contracts. We have entered into master service agreements MSAs, with numerous service providers and OEMs, and generally have multiple agreements with each of our customers. MSAs are awarded primarily through a competitive bidding process based on the depth of our service offerings, experience and capacity. MSAs generally contain customer-specified service requirements, such as discrete pricing for individual tasks, but do not require our customers to purchase a minimum amount of services. To the extent that such contracts specify exclusivity, there are often a number of exceptions, including the ability of the customer to issue work orders valued above a specified dollar amount to other service providers, perform work with the customer’s own employees and use other service providers. Most of our MSAs may be cancelled by our customers upon minimum notice (typically 60 days), regardless of whether we are then in default. In addition, many of these contracts permit cancellation of particular purchase orders or statements of work without any prior notice. Our cloud-managed service offerings have multi-year agreements and provide the customers with service level commitments. This is one of the fastest growing portions of our business.
Suppliers and Vendors
We have supply agreements with major technology vendors, such as Ericsson, Avaya, Aruba, Juniper,, Microsoft, Ciena, Citrix and Cisco Systems. However, for a majority of the professional services we perform, our customers supply the necessary materials. We expect to continue to further develop our relationships with our technology vendors and to broaden our scope of work with each of our partners. In many cases, our relationships with our partners have extended for over a decade, which we attribute to our commitment to excellence. It is our objective to selectively expand our partnerships moving forward in order to expand our service offerings.
Competition
We provide cloud and managed services, professional services, and infrastructure and applications to the enterprise and service provider markets globally. Our markets are highly fragmented and the business is characterized by a large number of participants, including several large companies, as well as a significant number of small, privately-held, local competitors.
Our current and potential larger competitors include Amazon.com, Inc., Arrow Electronics, Inc., Black Box Corporation, CenturyLink Technology Solutions (formerly Savvis), Dimension Data, Dycom Industries, Inc., Goodman Networks, Inc., Hewlett Packard Company, Rackspace Hosting, Inc., SoftLayer Technologies, Inc., Tech Mahindra Limited, TeleTech Holdings, Inc. and Volt Information Sciences, Inc. A significant portion of our services revenue is currently derived from MSAs and price is often an important factor in awarding such agreements. Accordingly, our competitors may underbid us if they elect to price their services aggressively to procure such business. Our competitors may also develop the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services, and we may not be able to maintain or enhance our competitive position. The principal competitive factors for our professional services include geographic presence, breadth of service offerings, technical skills, licensing price, quality of service and industry reputation. We believe we compete favorably with our competitors on the basis of these factors.
Safety and Risk Management
We require our employees to participate in internal training and service programs from time to time relevant to their employment and to complete any training programs required by law. We review accidents and claims from our operations, examine trends and implement changes in procedures to address safety issues. Claims arising in our business generally include workers’ compensation claims, various general liability and damage claims, and claims related to vehicle accidents, including personal injury and property damage. We insure against the risk of loss arising from our operations up to certain deductible limits in substantially all of the states in which we operate. In addition, we retain risk of loss, up to certain limits, under our employee group health plan. We evaluate our insurance requirements on an ongoing basis to help ensure we maintain adequate levels of coverage.
We carefully monitor claims and actively participate with our insurers in determining claims estimates and adjustments. The estimated costs of claims are accrued as liabilities, and include estimates for claims incurred but not reported. Due to fluctuations in our loss experience from year to year, insurance accruals have varied and can affect the consistency of our operating margins. If we experience insurance claims in excess of our umbrella coverage limit, our business could be materially and adversely affected.
Employees
As of December 31, 2014, we had 479 full-time employees and four part-time employees, of whom 79 were in administration and corporate management, 14 were accounting personnel, 31 were sales personnel and 359 were technical and project managerial personnel.
In general, the number of our employees varies according to the level of our work in progress. We maintain a core of technical and managerial personnel to supervise all projects and add employees as needed to complete specific projects. Because we also provide project staffing, we are well-positioned to respond to changes in our staffing needs.
Environmental Matters
A portion of the work we perform is associated with the underground networks of our customers. As a result, we are potentially subject to material liabilities related to encountering underground objects that may cause the release of hazardous materials or substances. We are subject to federal, state and local environmental laws and regulations, including those regarding the removal and remediation of hazardous substances and waste. These laws and regulations can impose significant fines and criminal sanctions for violations. Costs associated with the discharge of hazardous substances may include clean-up costs and related damages or liabilities. These costs could be significant and could adversely affect our results of operations and cash flows.
Regulation
Our operations are subject to various federal, state, local and international laws and regulations, including licensing, permitting and inspection requirements applicable to electricians and engineers; building codes; permitting and inspection requirements applicable to construction projects; regulations relating to worker safety and environmental protection; telecommunication regulations affecting our fiber optic licensing business; labor and employment laws; and laws governing advertising.
ITEM 1A.
ITEM 1A. RISK FACTORS
Investing in our securities involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this report before purchasing our securities. If any of the following risks occur, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that case, the market price of our common stock could decline, and you could lose some or all of your investment.
Risks Related to Our Business
A failure to successfully execute our strategy of acquiring other businesses to grow our company could adversely affect our business, financial condition, results of operations and prospects.
We intend to continue pursuing growth through the acquisition of companies or assets to expand our product offerings, project skill-sets and capabilities, enlarge our geographic markets, add experienced management and increase critical mass to enable us to bid on larger contracts. However, we may be unable to find suitable acquisition candidates or to complete acquisitions on favorable terms, if at all. Moreover, any completed acquisition may not result in the intended benefits. For example, while the historical financial and operating performance of an acquisition target are among the criteria we evaluate in determining which acquisition targets we will pursue, there can be no assurance that any business or assets we acquire will continue to perform in accordance with past practices or will achieve financial or operating results that are consistent with or exceed past results. Any such failure could adversely affect our business, financial condition or results of operations. In addition, any completed acquisition may not result in the intended benefits for other reasons and our acquisitions will involve a number of other risks, including:
●We may have difficulty integrating the acquired companies;
●Our ongoing business and management’s attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically or culturally diverse enterprises;
●We may not realize the anticipated cost savings or other financial benefits we anticipated;
●We may have difficulty applying our expertise in one market to another market;
●We may have difficulty retaining or hiring key personnel, customers and suppliers to maintain expanded operations;
●Our internal resources may not be adequate to support our operations as we expand, particularly if we are awarded a significant number of contracts in a short time period;
●We may have difficulty retaining and obtaining required regulatory approvals, licenses and permits;
●We may not be able to obtain additional equity or debt financing on terms acceptable to us or at all, and any such financing could result in dilution to our stockholders, impact our ability to service our debt within the scheduled repayment terms and include covenants or other restrictions that would impede our ability to manage our operations;
●We may have failed to, or be unable to, discover liabilities of the acquired companies during the course of performing our due diligence; and
●We may be required to record additional goodwill as a result of an acquisition, which will reduce our tangible net worth.
Any of these risks could prevent us from executing our acquisition growth strategy, which could adversely affect our business, financial condition, results of operations and prospects.
We may be unable to successfully integrate our recent and future acquisitions, which could adversely affect our business, financial condition, results of operations and prospects.
We acquired several companies over the past 24 months, including AW Solutions in April 2013, IPC in January 2014, RentVM in February 2014 and VaultLogix in October 2014. The operation and management of recent acquisitions, or any of our future acquisitions, may adversely affect our existing income and operations or we may not be able to effectively manage any growth resulting from these transactions. Before we acquired these companies, each of these companies operated independently of one another. Until we establish centralized financial, management information and other administrative systems, we will rely on the separate systems of these companies, including their financial reporting systems.
Our success will depend, in part, on the extent to which we are able to merge these functions, eliminate the unnecessary duplication of other functions and otherwise integrate these companies (and any additional businesses with which we may combine in the future) into a cohesive, efficient enterprise. This integration process may entail significant costs and delays could occur. Our failure to integrate the operations of these companies successfully could adversely affect our business, financial condition, results of operations and prospects. To the extent that any acquisition results in additional goodwill, it will reduce our tangible net worth, which might adversely affect our business, financial condition, results of operations and prospects, as well as our credit and bonding capacity.
We derive a significant portion of our revenue from master service agreements that may be cancelled by customers on short notice, or which we may be unable to renew on favorable terms or at all.
During the years ended December 31, 2014 and 2013, we derived approximately 36% and 65%, respectively, of our revenues from master service agreements and long-term contracts, none of which require our customers to purchase a minimum amount of services. The majority of these contracts may be cancelled by our customers upon minimal notice (typically 60 days), regardless of whether or not we are in default. In addition, many of these contracts permit cancellation of particular purchase orders or statements of work without any notice.
These agreements typically do not require our customers to assign a specific amount of work to us until a purchase order or statement of work is signed. Consequently, projected expenditures by customers are not assured until a definitive purchase order or statement of work is placed with us and the work is completed. Furthermore, our customers generally require competitive bidding of these contracts. As a result, we could be underbid by our competitors or be required to lower the prices charged under a contract being rebid. The loss of work obtained through master service agreements and long-term contracts or the reduced profitability of such work could adversely affect our business or results of operations.
If we do not accurately estimate the overall costs when we bid on a contract that is awarded to us, we may achieve a lower than anticipated profit or incur a loss on the contract.
A significant portion of our revenues from our engineering and professional services offerings are derived from fixed unit price contracts that require us to perform the contract for a fixed unit price irrespective of our actual costs. We bid for these contracts based on our estimates of overall costs, but cost overruns may cause us to incur losses. The costs incurred and any net profit realized on such contracts can vary, sometimes substantially, from the original projections due to a variety of factors, including, but not limited to:
●onsite conditions that differ from those assumed in the original bid;
●delays in project starts or completion;
●fluctuations in the cost of materials to perform under a contract;
●contract modifications creating unanticipated costs not covered by change orders;
●availability and skill level of workers in the geographic location of a project;
●our suppliers’ or subcontractors’ failure to perform due to various reasons, including bankruptcy;
●fraud or theft committed by our employees;
●citations or fines issued by any governmental authority;
●difficulties in obtaining required governmental permits or approvals or performance bonds;
●changes in applicable laws and regulations; and
●claims or demands from third parties alleging damages arising from our work or from the project of which our work is a part.
These factors may cause actual reduced profitability or losses on projects, which could adversely affect our business, financial condition, results of operations and prospects.
Our contracts may require us to perform extra or change order work, which can result in disputes and adversely affect our business, financial condition, results of operations and prospects.
Our contracts generally require us to perform extra or change order work as directed by the customer, even if the customer has not agreed in advance on the scope or price of the extra work to be performed. This process may result in disputes over whether the work performed is beyond the scope of the work included in the original project plans and specifications or, if the customer agrees that the work performed qualifies as extra work, the price that the customer is willing to pay for the extra work. Even when the customer agrees to pay for the extra work, we may be required to fund the cost of such work for a lengthy period of time until the change order is approved by the customer and we are paid by the customer.
To the extent that actual recoveries with respect to change orders or amounts subject to contract disputes or claims are less than the estimates used in our financial statements, the amount of any shortfall will reduce our future revenues and profits, and this could adversely affect our reported working capital and results of operations. In addition, any delay caused by the extra work may adversely impact the timely scheduling of other project work and our ability to meet specified contract milestone dates.
We derive a significant portion of our revenue from a few customers and the loss of one of these customers, or a reduction in their demand for our services, could adversely affect our business, financial condition, results of operations and prospects.
Our customer base is highly concentrated. Due to the size and nature of our contracts, one or a few customers have represented a substantial portion of our consolidated revenues and gross profits in any one year or over a period of several consecutive years. Ericsson Inc. and its affiliates accounted for approximately 15% of our total revenues in the year ended December 31, 2014 and 41% of our total revenues in the year ended December 31, 2013. Our top four customers, Ericsson, Crown Castle, Andrew Solutions, and Dell, accounted for approximately 33% of our total revenues in the year ended December 31, 2014. Our top four customers, Ericsson, Inc., Crown Castle, NX Utilities and Uline, accounted for approximately 57% of our total revenues in the year ended December 31, 2013. Revenues under our contracts with significant customers may continue to vary from period to period depending on the timing or volume of work that those customers order or perform with their in-house service organizations. A limited number of customers may continue to comprise a substantial portion of our revenue for the foreseeable future. Because we do not maintain any reserves for payment defaults, a default or delay in payment on a significant scale could adversely affect our business, financial condition, results of operations and prospects. We could lose business from a significant customer for a variety of reasons, including:
●the consolidation, merger or acquisition of an existing customer, resulting in a change in procurement strategies employed by the surviving entity that could reduce the amount of work we receive;
●our performance on individual contracts or relationships with one or more significant customers are impaired due to another reason, which may cause us to lose future business with such customers and, as a result, our ability to generate income would be adversely impacted;
●the strength of our professional reputation; and
●key customers could slow or stop spending on initiatives related to projects we are performing for them due to increased difficulty in the credit markets as a result of the recent economic crisis or other reasons.
Since many of our customer contracts allow our customers to terminate the contract without cause, our customers may terminate their contracts with us at will, which could impair our business, financial condition, results of operations and prospects.
Our failure to adequately expand our direct sales force will impede our growth.
We will need to continue to expand and optimize our sales infrastructure in order to grow our customer base and our business. We plan to continue to expand our direct sales force, both domestically and internationally. Identifying and recruiting qualified personnel and training them requires significant time, expense and attention. Our business may be adversely affected if our efforts to expand and train our direct sales force do not generate a corresponding increase in revenue. If we are unable to hire, develop and retain talented sales personnel or if new direct sales personnel are unable to achieve desired productivity levels in a reasonable period of time, we may not be able to realize the intended benefits of this investment or increase our revenue.
Our business is labor intensive and if we are unable to attract and retain key personnel and skilled labor, or if we encounter labor difficulties, our ability to bid for and successfully complete contracts may be negatively impacted.
Our ability to attract and retain reliable, qualified personnel is a significant factor that enables us to successfully bid for and profitably complete our work. Our future success depends on our ability to attract, hire and retain project managers, estimators, supervisors, foremen, equipment operators, engineers, linemen, laborers and other highly-skilled personnel. Our ability to do so depends on a number of factors, such as general rates of employment, competitive demands for employees possessing the skills we need and the level of compensation required to hire and retain qualified employees. We may also spend considerable resources training employees who may then be hired by our competitors, forcing us to spend additional funds to attract personnel to fill those positions. Competition for employees is intense, and we could experience difficulty hiring and retaining the personnel necessary to support our business. Our labor expenses may also increase as a result of a shortage in the supply of skilled personnel. If we do not succeed in retaining our current employees and attracting, developing and retaining new highly-skilled employees, our reputation may be harmed and our future earnings may be negatively impacted.
If we are unable to attract and retain qualified executive officers and managers, we will be unable to operate efficiently, which could adversely affect our business, financial condition, results of operations and prospects.
We depend on the continued efforts and abilities of our executive officers, as well as the senior management of our subsidiaries, to establish and maintain our customer relationships and identify strategic opportunities. The loss of any one of them could negatively affect our ability to execute our business strategy and adversely affect our business, financial condition, results of operations and prospects. Competition for managerial talent with significant industry experience is high and we may lose access to executive officers for a variety of reasons, including more attractive compensation packages offered by our competitors. Although we have entered into employment agreements with certain of our executive officers and certain other key employees, we cannot guarantee that any of them or other key management personnel will remain employed by us for any length of time.
Because we maintain a workforce based upon current and anticipated workloads, we may incur significant costs in adjusting our workforce demands, including addressing understaffing of contracts, if we do not receive future contract awards or if these awards are delayed.
Our estimates of future performance depend, in part, upon whether and when we will receive certain new contract awards. Our estimates may be unreliable and can change from time to time. In the case of larger projects, where timing is often uncertain, it is particularly difficult to project whether and when we will receive a contract award. The uncertainty of contract award timing can present difficulties in matching workforce size with contractual needs. If an expected contract award is delayed or not received, we could incur significant costs resulting from retaining more staff than is necessary. Similarly, if we underestimate the workforce necessary for a contract, we may not perform at the level expected by the customer and harm our reputation with the customer. Each of these may negatively impact our business, financial condition, results of operations and prospects.
Timing of the award and performance of new contracts could adversely affect our business, financial condition, results of operations and prospects.
It is generally very difficult to predict whether and when new contracts will be offered for tender because these contracts frequently involve a lengthy and complex design and bidding process that is affected by a number of factors, such as market conditions, financing arrangements and governmental approvals. Because of these factors, our results of operations and cash flows may fluctuate from quarter to quarter and year to year, and the fluctuation may be substantial. Such delays, if they occur, could adversely affect our operating results for current and future periods until the affected contracts are completed.
Our operating results may fluctuate due to factors that are difficult to forecast and not within our control.
Our past operating results may not be accurate indicators of future performance, and you should not rely on such results to predict our future performance. Our operating results have fluctuated significantly in the past, and could fluctuate in the future. Factors that may contribute to fluctuations include:
● changes in aggregate capital spending, cyclicality and other economic conditions, or domestic and international demand in the industries we serve;
● our ability to effectively manage our working capital;
● our ability to satisfy consumer demands in a timely and cost-effective manner;
● pricing and availability of labor and materials;
● our inability to adjust certain fixed costs and expenses for changes in demand;
● shifts in geographic concentration of customers, supplies and labor pools; and
● seasonal fluctuations in demand and our revenue.
Unanticipated delays due to adverse weather conditions, global climate change and difficult work sites and environments may slow completion of our contracts, impair our customer relationships and adversely affect our business, financial condition, results of operations and prospects.
Because some of our work is performed outdoors, our business is impacted by extended periods of inclement weather and is subject to unpredictable weather conditions, which could become more frequent or severe if general climatic changes occur. Generally, inclement weather is more likely to occur during the winter season, which falls during our first and fourth fiscal quarters. Additionally, adverse weather conditions can result in project delays or cancellations, potentially causing us to incur additional unanticipated costs, reductions in revenues or the payment of liquidated damages. In addition, some of our contracts require that we assume the risk that actual site conditions vary from those expected. Significant periods of bad weather typically reduce profitability of affected contracts, both in the current period and during the future life of affected contracts, which can negatively affect our results of operations in current and future periods until the affected contracts are completed.
Some of our projects involve challenging engineering, procurement and construction phases that may occur over extended time periods, sometimes up to several years. We may encounter difficulties in engineering, delays in designs or materials provided by the customer or a third party, equipment and material delivery delays, schedule changes, delays from customer failure to timely obtain rights-of-way, weather-related delays, delays by subcontractors in completing their portion of the project and other factors, some of which are beyond our control, but which may impact our ability to complete a project within the original delivery schedule. In some cases, delays and additional costs may be substantial, and we may be required to cancel a project and/or compensate the customer for the delay. We may not be able to recover any of these costs. Any such delays, cancellations, defects, errors or other failures to meet customer expectations could result in damage claims substantially in excess of revenue associated with a project. These factors could also negatively impact our reputation or relationships with our customers, which could adversely affect our ability to secure new contracts.
Environmental and other regulatory matters could adversely affect our ability to conduct our business and could require expenditures that could adversely affect our business, financial condition, results of operations and prospects.
Our operations are subject to laws and regulations relating to workplace safety and worker health that, among other things, regulate employee exposure to hazardous substances. While immigration laws require us to take certain steps intended to confirm the legal status of our immigrant labor force, we may nonetheless unknowingly employ illegal immigrants. Violations of laws and regulations could subject us to substantial fines and penalties, cleanup costs, third-party property damage or personal injury claims. In addition, these laws and regulations have become, and enforcement practices and compliance standards are becoming, increasingly stringent. Moreover, we cannot predict the nature, scope or effect of legislation or regulatory requirements that could be imposed, or how existing or future laws or regulations will be administered or interpreted, with respect to products or activities to which they have not been previously applied. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies, could require us to make substantial expenditures for, among other things, pollution control systems and other equipment that we do not currently possess, or the acquisition or modification of permits applicable to our activities.
If we fail to maintain qualifications required by certain governmental entities, we could be prohibited from bidding on certain contracts.
If we do not maintain qualifications required by certain governmental entities, such as low voltage electrical licenses, we could be prohibited from bidding on certain governmental contracts. A cancellation of an unfinished contract or our exclusion from the bidding process could cause our work crews to be idled for a significant period of time until other comparable work becomes available, which could adversely affect our business and results of operations. The cancellation of significant contracts or our disqualification from bidding for new contracts could reduce our revenues and profits and adversely affect our business, financial condition, results of operations and prospects.
Fines, judgments and other consequences resulting from our failure to comply with regulations or adverse outcomes in litigation proceedings could adversely affect our business, financial condition, results of operations and prospects.
From time to time, we may be involved in lawsuits and regulatory actions, including class action lawsuits that are brought or threatened against us in the ordinary course of business. These actions may seek, among other things, compensation for alleged personal injury, workers’ compensation, violations of the Fair Labor Standards Act and state wage and hour laws, employment discrimination, breach of contract, property damage, punitive damages, civil penalties, consequential damages or other losses, or injunctive or declaratory relief. Any defects or errors, or failures to meet our customers’ expectations could result in large damage claims against us. Claimants may seek large damage awards and, due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. Any failure to properly estimate or manage cost, or delay in the completion of projects, could subject us to penalties.
The ultimate resolution of these matters through settlement, mediation or court judgment could have a material impact on our financial condition, results of operations and cash flows. Regardless of the outcome of any litigation, these proceedings could result in substantial cost and may require us to devote substantial resources to defend ourselves. When appropriate, we establish reserves for litigation and claims that we believe to be adequate in light of current information, legal advice and professional indemnity insurance coverage, and we adjust such reserves from time to time according to developments. If our reserves are inadequate or insurance coverage proves to be inadequate or unavailable, our business, financial condition, results of operations and prospects may suffer.
We employ and assign personnel in the workplaces of other businesses, which subjects us to a variety of possible claims that could adversely affect our business, financial condition, results of operations and prospects.
We employ and assign personnel in the workplaces of other businesses. The risks of these activities include possible claims relating to:
●discrimination and harassment;
●wrongful termination or denial of employment;
●violations of employment rights related to employment screening or privacy issues;
●classification of employees, including independent contractors;
●employment of illegal aliens;
●violations of wage and hour requirements;
●retroactive entitlement to employee benefits; and
●errors and omissions by our temporary employees.
Claims relating to any of the above could subject us to monetary fines or reputational damage, which could adversely affect our business, financial condition, results of operations and prospects.
If we are required to reclassify independent contractors as employees, we may incur additional costs and taxes which could adversely affect our business, financial condition, results of operations and prospects.
We use a significant number of independent contractors in our operations for whom we do not pay or withhold any federal, state or provincial employment tax. There are a number of different tests used in determining whether an individual is an employee or an independent contractor and such tests generally take into account multiple factors. There can be no assurance that legislative, judicial or regulatory (including tax) authorities will not introduce proposals or assert interpretations of existing rules and regulations that would change, or at least challenge, the classification of our independent contractors. Although we believe we have properly classified our independent contractors, the U.S. Internal Revenue Service or other U.S. federal or state authorities or similar authorities of a foreign government may determine that we have misclassified our independent contractors for employment tax or other purposes and, as a result, seek additional taxes from us or attempt to impose fines and penalties. If we are required to pay employer taxes or pay backup withholding with respect to prior periods with respect to or on behalf of our independent contractors, our operating costs will increase, which could adversely impact our business, financial condition, results of operations and prospects.
Our dependence on subcontractors and suppliers could increase our costs and impair our ability to complete contracts on a timely basis or at all.
We rely on third-party subcontractors to perform some of the work on our contracts. We also rely on third-party suppliers to provide materials needed to perform our obligations under those contracts. We generally do not bid on contracts unless we have the necessary subcontractors and suppliers committed for the anticipated scope of the contract and at prices that we have included in our bid. Therefore, to the extent that we cannot engage subcontractors or suppliers, our ability to bid for contracts may be impaired. In addition, if a subcontractor or third-party supplier is unable to deliver its goods or services according to the negotiated terms for any reason, we may suffer delays and be required to purchase the services from another source at a higher price. We sometimes pay our subcontractors and suppliers before our customers pay us for the related services. If customers fail to pay us and we choose, or are required, to pay our subcontractors for work performed or pay our suppliers for goods received, we could suffer an adverse effect on our business, financial condition, results of operations and prospects.
Our insurance coverage may be inadequate to cover all significant risk exposures.
We will be exposed to liabilities that are unique to the services we provide. While we intend to maintain insurance for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to bear substantial costs resulting from risks and uncertainties of our business. It is also not possible to obtain insurance to protect against all operational risks and liabilities. The failure to obtain adequate insurance coverage on terms favorable to us, or at all, could have a material adverse effect on our business, financial condition, results of operations and prospects.
Our operations are subject to hazards that may cause personal injury or property damage, thereby subjecting us to liabilities and possible losses, which may not be covered by insurance.
Our workers are subject to hazards associated with providing construction and related services on construction sites. For example, some of the work we perform is underground. If the field location maps supplied to us are not accurate, or if objects are present in the soil that are not indicated on the field location maps, our underground work could strike objects in the soil containing pollutants that could result in a rupture and discharge of pollutants. In such a case, we may be liable for fines and damages. These operating hazards can cause personal injury and loss of life, damage to or destruction of property, plant and equipment and environmental damage. Even though we believe that the insurance coverage we maintain is in amounts and against the risks that we believe are consistent with industry practice, this insurance may not be adequate to cover all losses or liabilities that we may incur in our operations. To the extent that we experience a material increase in the frequency or severity of accidents or workers’ compensation claims, or unfavorable developments on existing claims, our business, financial condition, results of operations and prospects could be adversely affected.
The Occupational Safety and Health Act of 1970, as amended, or OSHA, establishes certain employer responsibilities, including the maintenance of a workplace free of recognized hazards likely to cause death or serious injury, compliance with standards promulgated by the Occupational Health and Safety and Health Administration and various recordkeeping, disclosure and procedural requirements. While we have invested, and will continue to invest, substantial resources in occupational health and safety programs, serious accidents or violations of OSHA rules may subject us to substantial penalties, civil litigation or criminal prosecution, which could adversely affect our business, financial condition, results of operations and prospects.
Defects in our specialty contracting services may give rise to claims against us, increase our expenses, or harm our reputation.
Our specialty contracting services are complex and our final work product may contain defects. We have not historically accrued reserves for potential claims as they have been immaterial. The costs associated with such claims, including any legal proceedings, could adversely affect our business, financial condition, results of operations and prospects.
Risks Related to Our Industry
Our industry is highly competitive, with a variety of larger companies with greater resources competing with us, and our failure to compete effectively could reduce the number of new contracts awarded to us or adversely affect our market share and harm our financial performance.
The contracts on which we bid are generally awarded through a competitive bid process, with awards generally being made to the lowest bidder, but sometimes based on other factors, such as shorter contract schedules or prior experience with the customer. Within our markets, we compete with many national, regional, local and international service providers, including Arrow Electronics, Inc., Black Box Corporation, Dimension Data, plc, Dycom Industries, Inc., Goodman Networks, Inc., MasTec, Inc., TeleTech Holdings, Inc., Tech Mahindra, Ltd., Unisys Corporation, Unitek Global Services, Inc. and Volt Information Sciences, Inc. Price is often the principal factor in determining which service provider is selected by our customers, especially on smaller, less complex projects. As a result, any organization with adequate financial resources and access to technical expertise may become a competitor. Smaller competitors are sometimes able to win bids for these projects based on price alone because of their lower costs and financial return requirements. Additionally, our competitors may develop the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services, and we may not be able to maintain or enhance our competitive position. We also face competition from the in-house service organizations of our customers whose personnel perform some of the services that we provide.
Some of our competitors have already achieved greater market penetration than we have in the markets in which we compete, and some have greater financial and other resources than we do. A number of national companies in our industry are larger than we are and, if they so desire, could establish a presence in our markets and compete with us for contracts. As a result of this competition, we may need to accept lower contract margins in order to compete against competitors that have the ability to accept awards at lower prices or have a pre-existing relationship with a customer. If we are unable to compete successfully in our markets, our business, financial condition, results of operations and prospects could be adversely affected.
Many of the industries we serve are subject to consolidation and rapid technological and regulatory change, and our inability or failure to adjust to our customers’ changing needs could reduce demand for our services.
We derive, and anticipate that we will continue to derive, a substantial portion of our revenue from customers in the telecommunications and utilities industries. The telecommunications and utilities industries are subject to rapid changes in technology and governmental regulation. Changes in technology may reduce the demand for the services we provide. For example, new or developing technologies could displace the wireline systems used for the transmission of voice, video and data, and improvements in existing technology may allow telecommunications providers to significantly improve their networks without physically upgrading them. Alternatively, our customers could perform more tasks themselves, which would cause our business to suffer. Additionally, the telecommunications and utilities industries have been characterized by a high level of consolidation that may result in the loss of one or more of our customers. Our failure to rapidly adopt and master new technologies as they are developed in any of the industries we serve or the consolidation of one or more of our significant customers could adversely affect our business, financial condition, results of operations and prospects.
Further, many of our telecommunications customers are regulated by the Federal Communications Commission, or the FCC, and other international regulators. The FCC and other regulators may interpret the application of their regulations in a manner that is different than the way such regulations are currently interpreted and may impose additional regulations, either of which could reduce demand for our services and adversely affect our business and results of operations.
Economic downturns could cause capital expenditures in the industries we serve to decrease, which may adversely affect our business, financial condition, results of operations and prospects.
The demand for our services has been, and will likely continue to be, cyclical in nature and vulnerable to general downturns in the United States economy. The United States economy is still recovering from a recession, and growth in United States economic activity has remained slow. It is uncertain when these conditions will significantly improve. The wireless telecommunications industry and the staffing services industry are both particularly cyclical in nature and vulnerable to general downturns in the United States and international economies. Our customers are affected by economic changes that decrease the need for or the profitability of their services. This can result in a decrease in the demand for our services and potentially result in the delay or cancellation of projects by our customers. Slow-downs in real estate, fluctuations in commodity prices and decreased demand by end-customers for services could affect our customers and their capital expenditure plans. As a result, some of our customers may opt to defer or cancel pending projects. A downturn in overall economic conditions also affects the priorities placed on various projects funded by governmental entities and federal, state and local spending levels.
In general, economic uncertainty makes it difficult to estimate our customers’ requirements for our services. Our plan for growth depends on expanding our company both in the United States and internationally. If economic factors in any of the regions in which we plan to expand are not favorable to the growth and development of the telecommunications industries in those countries, we may not be able to carry out our growth strategy, which could adversely affect our business, financial condition, results of operations and prospects.
Risks Related to Our Financial Results and Financing Plans
We have a history of losses and may continue to incur losses in the future.
We have a history of losses and may continue to incur losses in the future, which could negatively impact the trading value of our common stock. We incurred losses from operations of $18.6 million and $6.3 million in the years ended December 31, 2014 and 2013, respectively. In addition, we incurred a net loss attributable to common stockholders of $18.8 million and $25.4 million in the years ended December 31, 2014 and 2013, respectively. We may continue to incur operating and net losses in future periods. These losses may increase and we may never achieve profitability for a variety of reasons, including increased competition, decreased growth in the unified communications industry and other factors described elsewhere in this “Risk Factors” section. If we cannot achieve sustained profitability, our stockholders may lose all or a portion of their investment in our company.
We have identified material weaknesses in our internal control over financial reporting, and our management has concluded that our disclosure controls and procedures are not effective. We cannot assure you that additional material weaknesses or significant deficiencies will not occur in the future. If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to accurately report our financial results or prevent fraud, which may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.
We have historically had a small internal accounting and finance staff with limited experience in public reporting. This lack of adequate accounting resources has resulted in the identification of material weaknesses in our internal controls over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. In connection with the audit of our financial statements for the year ended December 31, 2014, our management team identified material weaknesses relating to(i) our failure to effectively implement comprehensive entity-level internal controls, (ii) our lack of a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. GAAP commensurate with our financial reporting requirements and, (iii) our lack of the quantity of resources necessary to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of the transactions we enter into. Our management also has concluded that our disclosure controls and procedures are not effective such that the information relating to our company required to be disclosed in the reports we file with the SEC (a) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) is accumulated and communicated to our management to allow timely decisions regarding required disclosure. We have taken steps in 2014 such as hiring a new CFO and additional accounting staff who have a background and knowledge in the application of U.S. GAAP. We plan to continue to take additional steps, to remediate these material weaknesses for the year ending December 31, 2015 to improve our financial reporting systems and implement new policies, procedures and controls. If we do not successfully remediate the material weaknesses described above, or if other material weaknesses or other deficiencies arise in the future, we may be unable to accurately report our financial results on a timely basis, which could cause our reported financial results to be materially misstated and require restatement which could result in the loss of investor confidence, delisting and/or cause the market price of our common stock to decline.
Lawsuits filed against us, if decided in the plaintiffs’ favor, may result in the payment of cash damages that could adversely affect our financial position and liquidity.
In March 2014, a purported class action suit was filed in the United States District Court for the District of New Jersey against our company, our Chairman of the Board and Chief Executive Officer, Mark Munro, and certain other defendants alleging violations by the defendants (other than Mr. Munro) of Section 10(b) of the Exchange Act and other related provisions in connection with certain alleged courses of conduct that were intended to deceive the plaintiff and the investing public and to cause the members of the purported class to purchase shares of our common stock at artificially inflated prices based on untrue statements of a material fact or omissions to state material facts necessary to make the statements not misleading. The complaint also alleges that Mr. Munro and our company violated Section 20 of the Exchange Act as controlling persons of the other defendants. The complaint seeks unspecified damages, attorney and expert fees, and other unspecified litigation costs. In January 2015, the plaintiff amended the complaint to add certain other third-party defendants.
In January 2015, a suit was filed in the United States District Court of the Southern District of New York against our company, Mr. Munro and Daniel J. Sullivan, our Chief Accounting Officer and former Chief Financial Officer, alleging, among other claims, our breach of contract due to our failure to pay certain post-closing purchase price payments to the sellers of IPC in connection with our purchase of IPC in January 2014, and that Messrs. Munro and Sullivan intentionally interfered with such contractual obligations.
As of the date of this report, we have not submitted our response to either complaint. We deny the allegations in each complaint and are proceeding to vigorously defend the suits. However, as the outcome of litigation is inherently uncertain, it is possible that the plaintiffs in one or both actions will prevail no matter how vigorously we defend ourselves, which could result in significant compensatory damages on the part of our company and Mr. Munro or Mr. Sullivan. Any such adverse decision in such actions could have a material adverse effect on our financial position and liquidity and on our business and results of operations. In addition, regardless of outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.
We have received subpoenas in the SEC investigation now known as “In the Matter of Certain Stock Promotions,” the consequences of which are unknown.
As disclosed in Item 3. Litigation, below, on May 21, 2014 we received a subpoena from the SEC that stated that the staff of the SEC is conducting an investigation now known as “In the Matter of Certain Stock Promotions,” and that the subpoena was issued as part of an investigation as to whether certain investor relations firms and their clients engaged in market manipulation. The SEC’s subpoena and accompanying letter did not indicate whether we are, or are not, under investigation. We have produced documents in response to that subpoena and several additional subpoenas from the SEC in connection with that matter and provided testimony to the SEC. The SEC may in the future require us to produce additional documents or information, or seek testimony from other members of our management team.
We are unaware of the scope or timing of the SEC’s investigation. As a result, we do not know how the SEC investigation is proceeding, when the investigation will be concluded, or if we will become involved to a greater extent than providing documents and testimony to the SEC. We also are unable to predict what action, if any, might be taken in the future by the SEC or its staff as a result of the matters that are the subject to its investigation or what impact, if any, the cost of continuing to respond to subpoenas might have on our financial position, results of operations, or cash flows. We have not established any provision for losses in respect of this matter In addition, complying with any such future requests by the SEC for documents or testimony could distract the time and attention of our officers and directors or divert our resources away from ongoing business matters. Furthermore, it is possible that we currently are, or may hereafter become a target of the SEC’s investigation. Any such investigation could result in significant legal expenses, the diversion of management’s attention from our business, damage to our business and reputation, and could subject us to a wide range of remedies, including an SEC enforcement action. There can be no assurance that any final resolution of this and any similar matters will not have a material adverse effect on our financial condition or results of operations.
Our substantial indebtedness could adversely affect our business, financial condition and results of operations and our ability to meet our payment obligations.
As of December 31, 2014, we had total indebtedness of approximately $61.4 million, consisting of $0.3 million of bank debt, $36.9 million of convertible debentures and notes payable, $20.7 million of related-party indebtedness and $3.5 million of contingent consideration for our acquisitions. Our substantial indebtedness could have important consequences to our stockholders. For example, it could:
● increase our vulnerability to and limit our flexibility in planning for, or reacting to, changes in our business;
● place us at a competitive disadvantage compared to our competitors that have less debt;
● limit our ability to borrow additional funds, dispose of assets, pay dividends and make certain investments; and
● make us more vulnerable to a general economic downturn than a company that is less leveraged.
A high level of indebtedness would increase the risk that we may default on our debt obligations. Our ability to meet our debt obligations and to reduce our level of indebtedness will depend on our future performance. General economic conditions and financial, business and other factors affect our operations and our future performance. Many of these factors are beyond our control. We may not be able to generate sufficient cash flows to pay the interest on our debt and future working capital, borrowings or equity financing may not be available to pay or refinance such debt. Factors that will affect our ability to raise cash through an offering of our capital stock or a refinancing of our debt include financial market conditions, the value of our assets and our performance at the time we need capital.
We have in the past failed to comply with certain financial covenants of our loan documents and similar defaults in the future could adversely affect our financial condition and our ability to meet our payment obligations on our indebtedness.
On September 23, 2013, we entered into a revolving credit and security agreement dated as of September 20, 2013, or the PNC Credit Agreement, among our company, our subsidiaries, as guarantors, and PNC Bank, National Association, or PNC Bank, as agent and a lender, that provided us a revolving credit facility in the principal amount of up to $10.0 million. As of December 31, 2013 and March 31, 2014, we were not in compliance with certain covenants in the PNC Credit Agreement, including covenants relating to the minimum EBITDA requirement and the fixed charge coverage ratio. On April 4, 2014, we terminated the PNC Credit Agreement. We have in the past also breached certain covenants under another loan agreement that had resulted in various events of default under such agreement, which events of default were either cured or waived by the lenders thereunder.
As of December 31, 2014, we were not, and as of the date of this report, we are not in default of any of the covenants of our outstanding indebtedness. However, any future breach of any of those covenants could result in defaults or events of default under such indebtedness, in which case, depending on the actions taken by the lenders thereunder or their successors or assignees, such lenders could elect to declare all amounts borrowed, together with accrued interest, to be due and payable. An event of default under such indebtedness could also create an event of default under our other debt agreements or securities. If following an event of default we are unable to repay the borrowings or interest then due under our loan agreements, the lenders could proceed against their collateral, if any, and if the indebtedness under any loan agreements or debt securities were to be accelerated, our assets may not be sufficient to repay such indebtedness in full.
Actual results could differ from the estimates and assumptions that we use to prepare our financial statements.
To prepare financial statements in conformity with GAAP, management is required to make estimates and assumptions as of the date of the financial statements that affect the reported values of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. Areas requiring significant estimates by our management include:
● contract costs and profits and application of percentage-of-completion accounting and revenue recognition of contract change order claims;
● provisions for uncollectible receivables and customer claims and recoveries of costs from subcontractors, suppliers and others;
● valuation of assets acquired and liabilities assumed in connection with business combinations; and
● accruals for estimated liabilities, including litigation and insurance reserves.
At the time the estimates and assumptions are made, we believe they are accurate based on the information available. However, our actual results could differ from, and could require adjustments to, those estimates.
Risks Related to Our Operating History and Results of Operations
Our limited operating history as an integrated company, recent acquisitions and the rapidly-changing telecommunications market may make it difficult for investors to evaluate our business, financial condition, results of operations and prospects, and also impairs our ability to accurately forecast our future performance.
Although we were incorporated in 1999, we were a development stage company with limited operations until 2010. We experienced rapid and significant expansion in the three years ended December 31, 2014 due to a series of strategic acquisitions. We acquired three companies in 2012, one company in 2013 and three companies in 2014.
As a result of our recent acquisitions, our financial results are heavily influenced by the application of the acquisition method of accounting. The acquisition method of accounting requires management to make assumptions regarding the assets purchased and liabilities assumed to determine their fair market value. If our assumptions are incorrect, any resulting change or modification could adversely affect our financial conditions and/or results of operations.
Further, our limited operating history as an integrated company, combined with our short history operating as providers of staffing and cloud-based services, may not provide an adequate basis for investors to evaluate our business, financial condition, results of operations and prospects, and makes accurate financial forecasting difficult for us. Because we operate in the rapidly-evolving IT and telecommunications markets and because our business is rapidly changing due to a series of acquisitions, we may have difficulty in engaging in effective business and financial planning. It may also be difficult for us to evaluate trends that may affect our business and whether our expansion may be profitable. Thus, any predictions about our future revenue and expenses may not be as accurate as they would be if we had a longer operating history or operated in a more predictable market.
If we are unable to sustain our recent revenue growth rates, we may never achieve or sustain profitability.
We experienced significant growth in recent years, primarily due to our strategic acquisitions. Our total revenues increased to $76.2 million from $51.4 million in the years ended December 31, 2014 and 2013, respectively. In order to become profitable and maintain our profitability, we must, among other things, continue to increase our revenues. We may be unable to sustain our recent revenue growth, particularly if we are unable to develop and market our specialty contracting and telecommunications staffing services, increase our sales to existing customers or develop new customers. However, even if our revenues continue to grow, they may not be sufficient to exceed increases in our operating expenses or to enable us to achieve or sustain profitability.
Our inability to obtain additional capital may prevent us from completing our acquisition strategy and successfully operating our business; however, additional financings may subject our existing stockholders to substantial dilution.
Until we can generate a sufficient amount of revenue, if ever, we expect to finance our anticipated future strategic acquisitions through public or private equity offerings or debt financings. Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available, we may be required to delay, reduce the scope of, or eliminate one or more strategic acquisitions or business plans. In addition, we could be forced to discontinue product development and reduce or forego attractive business opportunities. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience significant dilution. In addition, debt financing, if available, may involve restrictive covenants. We may seek to access the public or private capital markets whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Our access to the financial markets and the pricing and terms we receive in the financial markets could be adversely impacted by various factors, including changes in financial markets and interest rates.
Our forecasts regarding the sufficiency of our financial resources to support our current and planned operations are forward-looking statements and involve significant risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed elsewhere in this “Risk Factors” section. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Our future funding requirements will depend on many factors, including, but not limited to, the costs and timing of our future acquisitions.
We are an emerging growth company within the meaning of the Jumpstart Our Businesses Startups Act of 2012 and, as a result, have elected to comply with the reduced disclosure and other reporting requirements available to us as an EGC.
Because we qualify as an emerging growth company, or EGC, under the Jumpstart Our Businesses Startups Act of 2012, or JOBS Act, we have elected to comply with the reduced disclosure and other reporting requirements available to us as an EGC in connection with this report, and for a period of up to five years following our November 2013 offering of shares of common stock if we remain an EGC. For example, with respect to this report, we have provided only two fiscal years of audited financial information and selected financial data and have provided scaled-down disclosure on executive compensation, such as not including a “Compensation Discussion and Analysis” in this report. In addition, for as long as we remain an EGC, we are not subject to certain governance requirements, such as holding a “say-on-pay” and “say-on-golden-parachute” advisory votes, and we are not required to obtain an annual attestation report on our internal control over financial reporting from a registered public accounting firm pursuant to Section 404(b) of the Sarbanes-Oxley Act. We may take advantage of these reporting exemptions until we are no longer an EGC. We can be an EGC for a period of up to five years after our November 2013 equity offering, although we will cease to be an EGC earlier than that if our total annual gross revenues equal or exceed $1 billion in a fiscal year, if we issue more than $1 billion in non-convertible debt over a three-year period or if we become a “large accelerated filer” under Rule 12b-2 of the Exchange Act.
Accordingly, in this report you are not receiving the same level of disclosure as you would receive in an annual report on Form 10-K of a non-EGC issuer and, following this report, our stockholders will not receive the same level of disclosure that is afforded to stockholders of a non-EGC issuer. It is also possible that investors will find our shares of common stock to be less attractive because we have elected to comply with the reduced disclosure and other reporting requirements available to us as an EGC, which could adversely affect the trading market for our shares of common stock and the prices at which our stockholders may be able to sell shares of our common stock.
We exercise judgment in determining our provision for taxes in the United States and Puerto Rico that are subject to tax authority audit review that could result in additional tax liability and potential penalties that would negatively affect our net income.
The amounts we record in intercompany transactions for services, licenses, funding and other items affects our tax liabilities. Our tax filings are subject to review or audit by the U.S. Internal Revenue Service and state, local and foreign taxing authorities. We exercise judgment in determining our worldwide provision for income and other taxes and, in the ordinary course of our business, there may be transactions and calculations where the ultimate tax determination is uncertain. Examinations of our tax returns could result in significant proposed adjustments and assessment of additional taxes that could adversely affect our tax provision and net income in the period or periods for which that determination is made.
Risks Related to our Common Stock
Our common stock price has fluctuated widely in recent years, and the trading price of our common stock is likely to continue to be volatile, which could result in substantial losses to investors and litigation.
In addition to changes to market prices based on our results of operations and the factors discussed elsewhere in this “Risk Factors” section, the market price of and trading volume for our common stock may change for a variety of other reasons, not necessarily related to our actual operating performance. The capital markets have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. In addition, the average daily trading volume of the securities of small companies can be very low, which may contribute to future volatility. Factors that could cause the market price of our common stock to fluctuate significantly include:
●the results of operating and financial performance and prospects of other companies in our industry;
●strategic actions by us or our competitors, such as acquisitions or restructurings;
●announcements of innovations, increased service capabilities, new or terminated customers or new, amended or terminated contracts by our competitors;
●the public’s reaction to our press releases, media coverage and other public announcements, and filings with the Securities and Exchange Commission (“SEC”);
●market conditions for providers of services to telecommunications, utilities and cloud services customers;
●lack of securities analyst coverage or speculation in the press or investment community about us or opportunities in the markets in which we compete;
●changes in government policies in the United States and, as our international business increases, in other foreign countries;
●changes in earnings estimates or recommendations by securities or research analysts who track our common stock or failure of our actual results of operations to meet those expectations;
●dilution caused by the conversion into common stock of convertible debt securities or by the exercise of outstanding warrants;
●market and industry perception of our success, or lack thereof, in pursuing our growth strategy;
●changes in accounting standards, policies, guidance, interpretations or principles;
●any lawsuit involving us, our services or our products;
●arrival and departure of key personnel;
●sales of common stock by us, our investors or members of our management team; and
●changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural or man-made disasters.
Any of these factors, as well as broader market and industry factors, may result in large and sudden changes in the trading volume of our common stock and could seriously harm the market price of our common stock, regardless of our operating performance. This may prevent stockholders from being able to sell their shares at or above the price they paid for shares of our common stock, if at all. In addition, following periods of volatility in the market price of a company’s securities, stockholders often institute securities class action litigation against that company. Our involvement in any class action suit or other legal proceeding, including the existing lawsuits filed against us and described elsewhere in this report, could divert our senior management’s attention and could adversely affect our business, financial condition, results of operations and prospects.
The sale or availability for sale of substantial amounts of our common stock could adversely affect the market price of our common stock.
Sales of substantial amounts of shares of our common stock, or the perception that these sales could occur, could adversely affect the market price of our common stock and could impair our future ability to raise capital through common stock offerings. As of December 31, 2014, we had 17,910,081 shares of common stock issued and outstanding, of which 9,288,220 shares were restricted securities pursuant to Rule 144 promulgated by the SEC. The sale of these shares into the open market may adversely affect the market price of our common stock.
In addition, at December 31, 2014, we also had outstanding $28.6 million aggregate principal amount of convertible notes that were convertible into 3,882,139 shares of common stock and $2.3 million aggregate principal amount of our 12% Convertible Debentures due 2015, or our Convertible Debentures, that also were convertible into shares of our common stock. However, we cannot currently determine the total number of shares of our common stock that may be issued upon the conversion or repayment of the Convertible Debentures because the total number of shares and the conversion prices or the prices at which we can issue our common stock to pay down the principal of and interest on the Convertible Debentures depend on a number of factors, including the prices and nature of any equity securities we may issue in the future and the market prices of our common stock in the periods leading up to any particular amortization payment date on which we elect to make amortization payments on the Convertible Debentures in shares of our common stock. See Note 8 to Notes to our consolidated financial statements in this report. As of December 31, 2014, there were also outstanding warrants to purchase an aggregate of 1,411,795 shares of our common stock at a weighted-average exercise price of $5.29 per share, all of which warrants were exercisable as of such date, and outstanding options to purchase an aggregate of 175,000 shares of common stock at an exercise price of $3.72 per share, none of which options were exercisable as of such date. The conversion of a significant principal amount of our outstanding convertible debt securities into shares of our common stock, our repayment of a significant amount of principal, interest or other amounts payable under such debt securities in shares of our common stock or the exercise of outstanding warrants at prices below the market price of our common stock could adversely affect the market price of our common stock. The market price of our common stock also may be adversely affected by our issuance of shares of our capital stock or convertible securities in connection with future acquisitions, or in connection with other financing efforts.
Our certificate of incorporation and our bylaws, and certain provisions of Delaware corporate law, as well as certain of our contracts, contain provisions that could delay or prevent a change in control even if the change in control would be beneficial to our stockholders.
Delaware law, as well as our certificate of incorporation and bylaws, contains anti-takeover provisions that could delay or prevent a change in control of our company, even if the change in control would be beneficial to our stockholders. These provisions could lower the price that future investors might be willing to pay for shares of our common stock. These anti-takeover provisions:
●authorize our board of directors to create and issue, without stockholder approval, preferred stock, thereby increasing the number of outstanding shares, which can deter or prevent a takeover attempt;
●prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;
●establish a three-tiered classified board of directors requiring that not all members of our board be elected at one time;
●establish a supermajority requirement to amend our amended and restated bylaws and specified provisions of our amended and restated certificate of incorporation;
●prohibit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
●establish limitations on the removal of directors;
●empower our board of directors to fill any vacancy on our board of directors, whether such vacancy occurs as a result of an increase in the number of directors or otherwise;
●provide that our board of directors is expressly authorized to adopt, amend or repeal our bylaws;
●provide that our directors will be elected by a plurality of the votes cast in the election of directors;
●establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by our stockholders at stockholder meetings;
●eliminated the ability of our stockholders to call special meetings of stockholders and to act by written consent; and
●provide that the Court of Chancery of the State of Delaware will be the exclusive forum for any derivative action, actions asserting a breach of fiduciary duty and certain other actions against us or any directors or executive officers.
Section 203 of the Delaware General Corporation Law, the terms of our stock incentive plans, the terms of our change in control agreements with our senior executives and other contractual provisions may also discourage, delay or prevent a change in control of our company. Section 203 generally prohibits a Delaware corporation from engaging in a business combination with an interested stockholder for three years after the date the stockholder became an interested stockholder. Our stock incentive plans include change-in-control provisions that allow us to grant options or stock purchase rights that may become vested immediately upon a change in control. The terms of changes of control agreements with our senior executives and contractual restrictions with third parties may discourage a change in control of our company. Our board of directors also has the power to adopt a stockholder rights plan that could delay or prevent a change in control of our company even if the change in control is generally beneficial to our stockholders. These plans, sometimes called “poison pills,” are oftentimes criticized by institutional investors or their advisors and could affect our rating by such investors or advisors. If our board of directors adopts such a plan, it might have the effect of reducing the price that new investors are willing to pay for shares of our common stock.
Together, these charter, statutory and contractual provisions could make the removal of our management and directors more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock. Furthermore, the existence of the foregoing provisions, as well as the significant common stock beneficially owned by our executive officers, key non-executive officer employees, and members of our board of directors, could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.
We have never paid cash dividends and do not anticipate paying any cash dividends on our common stock.
We have never paid cash dividends and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain any earnings to finance our operations and growth. As a result, any short-term return on your investment will depend on the market price of our common stock, and only appreciation of the price of our common stock, which may never occur, will provide a return to stockholders. The decision whether to pay dividends will be made by our board of directors in light of conditions then existing, including, but not limited to, factors such as our financial condition, results of operations, capital requirements, business conditions, and covenants under any applicable contractual arrangements. Investors seeking cash dividends should not invest in our common stock.
If equity research analysts do not publish research or reports about our business, or if they issue unfavorable commentary or downgrade our common stock, the market price of our common stock will likely decline.
The trading market for our common stock will rely in part on the research and reports that equity research analysts, over whom we have no control, publish about us and our business. We may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the market price for our common stock could decline. In the event we obtain securities or industry analyst coverage, the market price of our common stock could decline if one or more equity analysts downgrade our common stock or if those analysts issue unfavorable commentary, even if it is inaccurate, or cease publishing reports about us or our business.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES.
Our principal executive offices are located in Shrewsbury, New Jersey in segregated offices comprising an aggregate of approximately 2,040 square feet. We are occupying our offices under a 36-month lease that expires in January 2017 and provides for monthly lease payments of $3,745 in the first year and increases of 2% per year thereafter.
Set forth below are the locations of the other properties leased by us, the businesses that use the properties, and the size of each such property. All of such properties are used by our company or by one of our subsidiaries principally as office facilities to house their administrative, marketing, and engineering and professional services personnel. We believe our facilities and equipment to be in good condition and reasonably suited and adequate for our current needs.
(1)This facility is leased pursuant to a month-to-month lease that provides for monthly rental payments of $1,500 per month.
(2)This facility is leased pursuant to a month-to-month lease that provides for aggregate rental payments of $1,792 per month.
(3)This facility is leased pursuant to a 38-month lease that expires in December 2015 and provides for aggregate rental payments of $4,063 per month for the lease term.
(4)This facility is leased pursuant to a 36-month lease that expired in April 2014 and was renewed for an additional 12 months through April 2015. The lease provides for aggregate rental payments of $8,956 for the 12-month extension.
(5)This facility is leased pursuant to a month-to-month lease that provides for monthly payments of $1,136 per month.
(6)This facility is leased pursuant to a month-to-month lease that provides for aggregate rental payments of $2,252 per month.
(7)This facility is leased pursuant to a month-to-month lease that provides for aggregate rental payments of $1,673 per month.
(8)This facility is licensed pursuant to a temporary license terminable by either party upon 30 days prior written notice and provides for aggregate payments of $200 per month. ADEX is also required to reimburse the licensor for its pro rata share of all utilities.
(9)This facility is leased pursuant to a three-year lease that expires in February 2015 and provides for monthly rental payments of $15,076 for the first year and for a 5% increase in the monthly rental payments in each of the second of third years.
(10)This facility is leased under a two-year lease that expires on January 1, 2017 and provides for monthly payments of $1,545 for the first year and a 3% increase in the monthly rental payments in the second year.
(11)This facility is leased pursuant to a five-year lease that expires in August 2019 and provides for monthly base rental payments of $2,030 for the first year of the lease and a 3% annual increase in base rent thereafter plus 1.3% of the operating expenses of the building.
(12)This facility is leased pursuant to a 48-month lease that expires in October 2017 and provides for aggregate monthly rental payments of $4,998.
(13)This facility is leased pursuant to a 57-month lease that expires in December 2016 and provides for aggregate monthly rental payments of $8,000.
(14)This facility is leased pursuant to a 56-month lease that expires in July 2017 and provides for aggregate monthly rental payments of $11,641 for the first 12 months, $11,793 for the next 12 months and $11,944 for the final 12 months.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Pending Litigation
Purported Class Action Suit. In March 2014, a complaint was filed in the United States District Court for the District of New Jersey against our company, our Chairman of the Board and Chief Executive Officer, Mark Munro, The DreamTeamGroup and MissionIR, as purported securities advertisers and investor relations firms, and John Mylant, a purported investor and investment advisor. The complaint was purportedly filed on behalf of a class of certain persons who purchased our common stock between November 5, 2013 and March 17, 2014. The complaint alleges violations by the defendants (other than Mark Munro) of Section 10(b) of the Exchange Act, and other related provisions in connection with certain alleged courses of conduct that were intended to deceive the plaintiff and the investing public and to cause the members of the purported class to purchase shares of our common stock at artificially inflated prices based on untrue statements of a material fact or omissions to state material facts necessary to make the statements not misleading. The complaint also alleges that Mr. Munro and our company violated Section 20 of the Exchange Act as controlling persons of the other defendants. The complaint seeks unspecified damages, attorney and expert fees, and other unspecified litigation costs.
On November 3, 2014, the United States District Court for the District of New Jersey issued an order appointing Robbins Geller Rudman & Dowd LLP as lead plaintiffs’ counsel and Cohn Lifland Pearlman Herrmann & Knopf LLP as liaison counsel for the pending actions. The lead filed an amended complaint in January 2015 adding additional third-party defendants. We filed a motion to dismiss the amended complaint in late January 2015 and the plaintiffs filed a second amended complaint in early March 2015. We filed a motion to dismiss the second amended complaint on March 13, 2015.
IPC-Related Litigation. We acquired IPC in January 2014, and during 2014 advised the sellers of IPC that a post-closing financial audit of IPC’s historical financial statements showed a discrepancy in the adjusted EBITDA of IPC as represented by the sellers. We made a claim for such misrepresentation against a cash portion of the IPC purchase price that remains in escrow. In January 2015, a complaint was filed in the United States District Court of the Southern District of New York against our company, Mr. Munro and Daniel J. Sullivan, our Chief Accounting Officer and former Chief Financial Officer. The complaint alleges, among other claims, our breach of contract, breach of implied covenant of good faith and fair dealing and unjust enrichment relating to our purported failure to pay certain post-closing purchase price payments to the sellers of IPC in connection with our purchase of IPC in January 2014. The complaint also alleges that Messrs. Munro and Sullivan intentionally interfered with such contractual obligations of our company under the related stock purchase agreement between our company and the plaintiffs. The complaint seeks unspecified damages, attorney and expert fees and other unspecified litigation costs. In addition, the complaint seeks specific performance of the enforcement of the terms of the purchase contract and our payment of not less than $2.5 million. We have not yet filed a response to this litigation.
We intend to dispute these claims and to defend these litigations vigorously. However, due to the inherent uncertainties of litigation, the ultimate outcome of each of these litigations is uncertain. An unfavorable outcome in either litigation could materially and adversely affect our business, financial condition and results of operations.
SEC Subpoenas
On May 21, 2014, we received a subpoena from the SEC that stated that the staff of the SEC is conducting an investigation In the Matter of Galena Biopharma, Inc. File No. HO 12356 (now known as “In the Matter of Certain Stock Promotions”) and that the subpoena was issued to us as part of an investigation as to whether certain investor relations firms and their clients engaged in market manipulation. The SEC’s subpoena and accompanying letter did not indicate whether we are, or are not, under investigation. We have produced documents in response to that subpoena and several additional subpoenas received from the SEC in connection with that matter and provided testimony to the SEC. We are seeking to cooperate with the SEC and its investigation and are continuing with our production of documents in response to the subpoenas.
We are unaware of the scope or timing of the SEC’s investigation. As a result, we do not know how the SEC investigation is proceeding, when the investigation will be concluded, or if we will become involved to a greater extent than merely responding to the SEC subpoenas or voluntarily participating in depositions. We also are unable to predict what action, if any, might be taken in the future by the SEC or its staff as a result of the matters that are the subject to its investigation.
Other
Currently, there is no other material litigation pending against our company other than as disclosed in the paragraphs above. From time to time, we may become a party to litigation and subject to claims incident to the ordinary course of our business. Although the results of such litigation and claims in the ordinary course of business cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, results of operations or financial condition. Regardless of outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.
As of December 31, 2014, no accruals for loss contingencies have been recorded as the outcomes of these cases are neither probable or reasonably estimable.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not Applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock began trading on the NASDAQ Capital Market on October 31, 2013 under the symbol “ICLD”. Prior thereto, our common stock traded on the OTCQB Marketplace operated by the OTC Markets Group Inc. The following table sets forth the high and low closing sales prices of our common stock for the periods indicated. All prices give effect to the one-for-125 reverse stock split of our common stock effected on January 14, 2013 and the one-for-four reverse stock split of our common stock effected on August 1, 2013. Quotations reflect inter-dealer prices, without retail mark-up, mark-down commission, and may not represent actual transactions.
As of March 16, 2015, the closing sale price of our common stock, as reported by the NASDAQ Capital Market, was $2.25 per share.
Holders
At March 16, 2015, we had approximately 344 record holders of our common stock. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers or registered clearing agencies.
Transfer Agent and Registrar
We have appointed Corporate Stock Transfer, 3200 Cherry Creek Dr. South, Denver, CO 80209 to act as the transfer agent of our common stock.
Dividend Policy
We currently intend to retain future earnings, if any, for use in the operation of our business and to fund future growth. We have never declared or paid cash dividends on our common stock and we do not intend to pay any cash dividends on our common stock for the foreseeable future. The terms of our outstanding Convertible Debentures prohibit our payment of cash dividends. Any future determination related to our dividend policy will be made at the discretion of our board of directors in light of conditions then-existing, including factors such as our results of operations, financial conditions and requirements, business conditions and covenants under any applicable contractual arrangements.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes the number of shares of our common stock authorized for issuance under our 2012 Performance Incentive Plan as of December 31, 2014, which was our only equity compensation plan at such date.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected consolidated financial data for our company for the years ended December 31, 2014 and 2013 that was derived from our audited consolidated financial statements included elsewhere in this report. The financial data set forth below should be read in conjunction with, and are qualified in their entirety by, reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our historical financial statements and related notes included elsewhere in this report. All dollar amounts are presented in thousands with the exception of share and per share data.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This management’s discussion and analysis of financial condition and results of operations contains certain statements that are forward-looking in nature relating to our business, future events or our future financial performance. Prospective investors are cautioned that such statements involve risks and uncertainties and that actual events or results may differ materially from the statements made in such forward-looking statements. In evaluating such statements, prospective investors should specifically consider the various factors identified in this report, including the matters set forth under Item 1A “Risk Factors,” which could cause actual results to differ from those indicated by such forward-looking statements.
We are a single-source provider of end-to-end IT and next-generation network solutions to the telecommunications service provider (carrier) and corporate enterprise markets through cloud platforms and professional services. We believe our market advantages center around our cloud-based applications and services portfolio and positioning. As a true infrastructure 2.0 provider, we add value by enabling applications and services while helping to contain costs. Customers now demand a partner that can provide end-to-end IT solutions, that offers a solution that allows the customer to move IT expenditures from capital costs to operating costs, and that offers the customer greater elasticity and the ability to rapidly deploy enterprise applications.
Telecommunications providers and enterprise customers continue to seek and outsource solutions in order to reduce their investment in capital equipment, provide flexibility in workforce sizing and expand product offerings without large increases in incremental hiring. As a result, we believe there is significant opportunity to expand both our United States and international telecommunications solutions services and staffing services capabilities. As we continue to expand our presence in the marketplace, we will target those customers going through new network deployments and wireless service upgrades.
We expect to continue to increase our gross margins by leveraging our single-source end-to-end network to efficiently provide a full spectrum of end-to-end IT and next-generation network solutions and staffing services to our customers. We believe our solutions and services offerings can alleviate some of the inefficiencies typically present in our industry, which result, in part, from the highly-fragmented nature of the telecommunications industry, limited access to skilled labor and the difficulty industry participants have in managing multiple specialty-service providers to address their needs. As a result, we believe we can provide superior service to our customers and eliminate certain redundancies and costs for them. We believe our ability to address a wide range of end-to-end solutions, network infrastructure and project-staffing service needs of our telecommunications industry clients is a key competitive advantage. Our ability to offer diverse technical capabilities (including design, engineering, construction, deployment, and installation and integration services) allows customers to turn to a single source for those specific specialty services, as well as to entrust us with the execution of entire turn-key solutions.
As a result of our recent acquisitions, we have become a multi-faceted company with an international presence. We believe this platform will allow us to leverage our corporate and other fixed costs and capture gross margin benefits. Our platform is highly scalable. We typically hire workers to staff projects on a project-by-project basis and our other operating expenses are primarily fixed. Accordingly, we are generally able to deploy personnel to infrastructure projects in the United States and beyond without incremental increases in operating costs, allowing us to achieve greater margins. We believe this business model enables us to staff our business efficiently to meet changes in demand.
Finally, given the worldwide popularity of telecommunications and wireless products and services, we will selectively pursue international expansion, which we believe represents a compelling opportunity for additional long-term growth.
Our planned expansion will place increased demands on our operational, managerial, administrative and other resources. Managing our growth effectively will require us to continue to enhance our operations management systems, financial and management controls and information systems and to hire, train and retain skilled telecommunications personnel. The timing and amount of investments in our expansion could affect the comparability of our results of operations in future periods.
Our recent and planned acquisitions have been and will be timed with additions to our management team of skilled professionals with deep industry knowledge and a strong track record of execution. Our senior management team brings an average of over 25 years of individual experience across a broad range of disciplines. We believe our senior management team is a key driver of our success and is well-positioned to execute our strategy.
We were incorporated in 1999, but functioned as a development stage company with limited activities through December 2009. Until September 2012, substantially all of our revenue came from our specialty contracting services. In September 2012, we acquired ADEX and TNS, in December 2012, we acquired ERFS and in April 2013, we acquired AW Solutions.
In January 2014, we acquired the operations of IPC, thereby entering the telecommunications hardware and software resale sector as well as expanding our services by adding a hardware and software maintenance division. In February 2014, we acquired the operations of RentVM, which allowed us entry into the cloud computing sector and expanded the range of products and services provided to our customers.
In 2013, we evaluated our reporting segments and determined that we operated in two reportable segments, specialty contracting services and telecommunication staffing services. The telecommunication staffing services segment was comprised of the ADEX reporting unit and provided contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. Specialty contracting services revenues were derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. Our operating divisions had been aggregated into the two reporting segments due to their similar economic characteristics, products, production methods and distribution methods. The specialty contracting service segment included our AW Solutions, TNS, Tropical and RM Engineering reporting units.
With the acquisitions of IPC and RentVM, we re-evaluated our operating subsidiaries and determined that the IPC and RentVM divisions should be aggregated into one of three reporting segments based on their economic characteristics, products, production methods and distribution methods. The results of operations of IPC and RentVM are categorized within the cloud and managed services segment. We also re-evaluated our previously-reported segments and determined that our specialty contracting services segment would be presented as the applications and infrastructure segment. We also re-evaluated our telecommunication staffing services segment and determined that it would be presented as the professional services segment.
During 2014, we experienced a decline in revenues in our professional services segment due to delays in work from a significant customer in our ADEX operating unit. As a result, we recorded intangible asset impairment expense of $2.4 million and goodwill impairment expense of $1.4 million. We continued to monitor the activities of this operating unit to determine if additional impairments are warranted and determined that there was no additional impairment as of December 31, 2014.
Due to the addition of the cloud and managed services segment in 2014, certain comparative percentages mentioned below in our results of operations for the year ended December 31, 2014 may not be meaningful (N/M).
Our revenue increased from $51.4 million for the year ended December 31, 2013 to $76.2 million for the year ended December 31, 2014. Our net loss attributable to common stockholders decreased from $25.4 million for the year ended December 31, 2013 to $18.8 million for the year ended December 31, 2014. As of December 31, 2014, our stockholders’ equity was $36.2 million. A significant portion of our services are performed under master service agreements and other arrangements with customers that extend for periods of one or more years. We are currently party to numerous master service agreements, and typically have multiple agreements with each of our customers. Master service agreements generally contain customer-specified service requirements, such as discrete pricing for individual tasks. To the extent that such contracts specify exclusivity, there are often a number of exceptions, including the ability of the customer to issue work orders valued above a specified dollar amount to other service providers, perform work with the customer’s own employees and use other service providers when jointly placing facilities with another utility. In most cases, a customer may terminate an agreement for convenience with written notice. The remainder of our services are provided pursuant to contracts for specific projects. Long-term contracts relate to specific projects with terms in excess of one year from the contract date. Short-term contracts for specific projects are generally of three to four months in duration.
During 2013 through 2014, a majority of our revenue and expense was generated by our acquired companies. Of the $76.2 million in total revenues in the year ended December 31, 2014, $41.0 million was generated by the companies we acquired in 2014 and 2013.
In 2014, $29.5 million of the total $56.1 million in cost of revenues was incurred by the companies we acquired in 2014 and 2013.
Gross profit generated by the companies we acquired in the years ended December 31, 2014 and 2013 accounted for $11.6 million of our $20.1 million gross profit during the year ended December 31, 2014.
The following table summarizes our revenues from multi-year master service agreements and other long-term contracts, as a percentage of contract revenues:
The percentage of revenue from long-term contracts varies between periods, depending on the mix of work performed under our contracts. All revenues derived from master service agreements are from customers that are serviced by our applications and infrastructure and professional services segments. The decline in revenues from multi-year master service agreements is due to the addition of our cloud and managed services segment, which does not derive revenues from multi-year master service agreements.
A significant portion of our revenue comes from one large customer within the professional services segment. The following table reflects the percentage of total revenue from our only customer that contributed at least 10% to our total revenue in either of the years ended December 31, 2014 or 2013:
Factors Affecting Our Performance
Changes in Demand for Data Capacity and Reliability.
Advances in technology architectures have supported the rise of cloud computing, which enables the delivery of a wide variety of cloud-based services, such as platform as a service (PaaS), infrastructure as a service (IaaS), database as a service (DbaaS), and software as a service (SaaS). Today, mission-critical applications can be delivered reliably, securely and cost-effectively to our customers over the internet without the need to purchase supporting hardware, software or ongoing maintenance. The lower total cost of ownership, better functionality and flexibility of cloud applications represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting cloud services to rapidly deploy and integrate applications without building out their own expensive infrastructure and to minimize the growth of their own IT departments and create business agility by taking advantage of accelerated time-to-market dynamics.
The telecommunications industry has undergone and continues to undergo significant changes due to advances in technology, increased competition as telephone and cable companies converge, the growing consumer demand for enhanced and bundled services and increased governmental broadband stimulus funding. As a result of these factors, the networks of our customers increasingly face demands for more capacity and greater reliability. Telecommunications providers continue to outsource a significant portion of their engineering, construction and maintenance requirements in order to reduce their investment in capital equipment, provide flexibility in workforce sizing, expand product offerings without large increases in incremental hiring and focus on those competencies they consider core to their business success. These factors drive customer demand for our services.
The proliferation of smart phones and other wireless data devices has driven demand for mobile broadband. This demand and other advances in technology have prompted wireless carriers to upgrade their networks. Wireless carriers are actively increasing spending on their networks to respond to the explosion in wireless data traffic, upgrade network technologies to improve performance and efficiency and consolidate disparate technology platforms. These customer initiatives present long-term opportunities for us for the wireless services we provide. Further, the demand for mobile broadband has increased bandwidth requirements on the wired networks of our customers. As the demand for mobile broadband grows, the amount of cellular traffic that must be “backhauled” over customers’ fiber and coaxial networks increases and, as a result, carriers are accelerating the deployment of fiber optic cables to cellular sites. These trends are increasing the demand for the types of services we provide.
Our Ability to Recruit, Manage and Retain High-Quality IT and Telecommunications Personnel.
The shortage of skilled labor in the telecommunications industry and the difficulties in recruiting and retaining skilled personnel can frequently limit the ability of specialty contractors to bid for and complete certain contracts. In September 2012, we acquired ADEX, an IT and telecommunications staffing firm. Through ADEX, we manage a database of more than 70,000 IT and telecom personnel, which we use to locate and deploy skilled workers for projects. We believe our access to a skilled labor pool gives us a competitive edge over our competitors as we continue to expand. However, our ability to continue to take advantage of this labor pool will depend, in part, on our ability to successfully integrate ADEX into our business.
Our Ability to Integrate Our Acquired Businesses and Expand Internationally.
We have completed seven material acquisitions since January 1, 2012 and plan to consummate additional acquisitions in the near term. Our success will depend, in part, on our ability to successfully integrate these businesses into our global IT and telecommunications platform. In addition, we believe international expansion represents a compelling opportunity for additional growth over the long-term because of the worldwide need for IT and telecommunications infrastructure. Our AW Solutions operations in Puerto Rico generated approximately $3.0 million of revenue during 2014. We plan to expand our global presence either through expanding our current operations or by acquiring subsidiaries with international platforms.
Our Ability to Expand and Diversify Our Customer Base.
Our customers for specialty contracting services consist of leading telephone, wireless, cable television and data companies. Ericsson Inc. is our principal telecommunications staffing services customer. Historically, our revenue has been significantly concentrated in a small number of customers. Although we still operate at a net loss, our revenue in recent years has increased as we have acquired additional subsidiaries and diversified our customer base and revenue streams. The percentage of our revenue attributable to our top 10 customers, as well as our only customer that contributed at least 10% of our revenue in at least one of the years specified in the following table, were as follows:
Business Unit Transitions.
Since January 1, 2012, we have acquired seven material companies, and each of these acquisitions has either enhanced certain of our existing business units or allowed us to gain market share in new lines of business. For example, our acquisition of TNS in September 2012 extended the geographic reach of our structured cabling and digital antenna system services. Our acquisition of AW Solutions in April 2013 broadened our suite of services and added new customers to which we can cross-sell our other services. Our acquisition of IPC in January 2014 improved our systems integration capabilities. Our acquisition of RentVM in February 2014 expanded our cloud and managed services capabilities by providing us a software-defined data center (“SDDC”) platform to offer enterprise-grade cloud computing solutions. Our acquisition of VaultLogix in October 2014 broadened our suite of cloud service offerings by adding VaultLogix’s cloud backup services to our wide range of cloud offerings and added new customers to which we can cross-sell our other services.
We intend to operate all of the companies we acquire in a decentralized model in which the management of the companies will remain responsible for daily operations while our senior management will utilize their deep industry expertise and strategic contacts to develop and implement growth strategies and leverage top-line and operating synergies among the companies, as well as provide overall general and administrative functions.
Giving effect to the completion of the VaultLogix acquisition in October 2014 and reflecting the consolidation of the other companies that we acquired in 2014 in our full-year results of operations, we expect our revenues, cost of revenues and operating expenses to increase substantially. Accordingly, our future results of operations may differ significantly from those described in this report. As a result, the impact of our 2014 acquisitions is not fully reflected in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section.
We expect these acquisitions to facilitate geographic diversification that should protect against regional cyclicality. We believe our diverse platform of services, capabilities, customers and geographies will enable us to grow as the market continues to evolve.
The table below summarizes the revenues for each of our reportable segments in the years ended December 31, 2014 and 2013.
Impact of Recently-Completed Acquisitions
We have grown significantly and expanded our service offerings and geographic reach through a series of strategic acquisitions. Since January 1, 2012, we have completed seven material acquisitions. We expect to regularly review opportunities, and periodically to engage in discussions, regarding possible additional acquisitions. Our ability to sustain our growth and maintain our competitive position may be affected by our ability to identify, acquire and successfully integrate companies.
Emerging Growth Company
On April 5, 2012, the Jumpstart Our Business Startups Act, or the JOBS Act, was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company,” we may delay adoption of new or revised accounting standards applicable to public companies until the earlier of the date that (i) we are no longer an emerging growth company or (ii) we affirmatively and irrevocably opt out of the extended transition period for complying with such new or revised accounting standards. We have elected not to take advantage of the benefits of this extended transition period. As a result, our financial statements will be comparable to those of companies that comply with such new or revised accounting standards. Upon issuance of new or revised accounting standards that apply to our financial statements, we will disclose the date on which we will adopt the recently-issued accounting guidelines.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based on our historical and pro forma consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make certain estimates and assumptions that affect the amounts reported therein and accompanying notes. On an ongoing basis, we evaluate these estimates and assumptions, including those related to recognition of revenue for costs and estimated earnings in excess of billings, the fair value of reporting units for goodwill impairment analysis, the assessment of impairment of intangibles and other long-lived assets, income taxes, asset lives used in computing depreciation and amortization, allowance for doubtful accounts, stock-based compensation expense for performance-based stock awards derivatives, contingent consideration and accruals for contingencies, including legal matters. These estimates and assumptions require the use of judgment as to the likelihood of various future outcomes and as a result, actual results could differ materially from these estimates.
We have identified the accounting policies below as critical to the accounting for our business operations and the understanding of our results of operations because they involve making significant judgments and estimates that are used in the preparation of our historical and pro forma consolidated financial statements. The impact of these policies affects our reported and expected financial results and are discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have discussed the development, selection and application of our critical accounting policies with the Audit Committee of our board of directors, and the Audit Committee has reviewed the disclosure relating to our critical accounting policies in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed below, are also important to understanding our historical consolidated financial statements. The notes to our consolidated financial statements in this report contain additional information related to our accounting policies, including the critical accounting policies described herein, and should be read in conjunction with this discussion.
Revenue Recognition.
Our revenues are generated from three reportable segments, applications and infrastructure, professional services, and cloud and managed services. We recognize revenue on arrangements in accordance with ASC Topic 605-10, “Revenue Recognition”. We recognize revenue only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.
The applications and infrastructure segment is comprised of TNS, Tropical, AW Solutions and RM Engineering. Applications and infrastructure services revenues are derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. The contracts of TNS, Tropical and RM Engineering provide that payment for our services may be based on either (i) direct labor hours at fixed hourly rates or (ii) fixed-price contracts. The services provided under the contracts are generally provided within one month. Occasionally, the services may be provided over a period of up to six months.
AW Solutions recognizes revenue using the percentage of completion method. Revenues and fees on these contracts are recognized specifically utilizing the efforts-expended method, which uses measures such as task duration and completion. The efforts-expended approach is an input method used in situations where it is more representative of progress on a contract than the cost-to-cost or the labor-hours methods. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. Changes in job performance conditions and final contract settlements may result in revisions to costs and income, which are recognized in the period revisions are determined.
AW Solutions also generates revenue from service contracts with certain customers. These contracts are accounted for under the proportional performance method. Under this method, revenue is recognized as projects within contracts are completed as of each reporting date.
The revenues of our professional services segment, which is comprised of our ADEX subsidiaries, are derived from contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. The contracts provide that payments made for our services may be based on either (i) direct labor hours at fixed hourly rates or (ii) fixed-price contracts. The services provided under these contracts are generally provided within a month. Occasionally, the services may be provided over a period of up to four months. If it is anticipated that the services will span a period exceeding one month, depending on the contract terms, we will provide either progress billing at least once a month or upon completion of the clients’ specifications. The aggregate amount of unbilled work-in-progress recognized as revenues was insignificant at December 31, 2014 and 2013.
ADEX’s Highwire division generates revenue through its telecommunications engineering group which contracts with telecommunications infrastructure manufacturers to install the manufacturer’s products for end users. This division of ADEX recognizes revenue using the proportional performance method. Under this method, revenue is recognized as projects within contracts are completed as of each reporting date.
Our applications and infrastructure and cloud and managed services segments sometimes require customers to provide a deposit prior to beginning work on a project. When this occurs, the deposit is recorded as deferred revenue and is recognized in revenue when the work is complete.
The revenues of our cloud and managed services segment, which is comprised of our RentVM, IPC and VaultLogix subsidiaries, are derived from the operations of IPC and the backup storage revenue from Vaultlogix. Our IPC subsidiary is a value-added reseller the revenues of which are generated from the resale of voice, video and data networking hardware and software contracted services for design, implementation and maintenance services for voice, video and data networking infrastructure. IPC’s and RentVM’s customers are higher education organizations, governmental agencies and commercial customers. IPC also provides maintenance and support, resells maintenance and support and provides professional services.
For multiple-element arrangements, IPC recognizes revenue in accordance with ASC 605-25, “Arrangements with Multiple Deliverables”. Under the relative fair value method, the total revenue is allocated among the elements based upon the relative fair value of each element as determined through the fair value hierarchy. Revenue is generally allocated in an arrangement using the estimated selling price of deliverables if it does not have vendor-specific objective evidence or third-party evidence of selling price.
Our VaultLogix subsidiary provides cloud-based on-line data backup services to its customers. Certain customers pay for their services before service begins. Revenue for these customers is deferred until the services are performed. As of December 31, 2014, VaultLogix did not have any material customers that paid for their services before service began. For all services, VaultLogix recognizes revenue when services are provided, evidence of an arrangement exists, fees are fixed or determinable and collection is reasonably assured. During 2013, we did not recognize any revenue from cloud-based services.
Allowance for Doubtful Accounts.
We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. Management analyzes the collectability of accounts receivable balances each period. This analysis considers the aging of account balances, historical bad debt experience, changes in customer creditworthiness, current economic trends, customer payment activity and other relevant factors. Should any of these factors change, the estimate made by management may also change, which could affect the level of our future provision for doubtful accounts. We recognize an increase in the allowance for doubtful accounts when it is probable that a receivable is not collectable and the loss can be reasonably estimated. Any increase in the allowance account has a corresponding negative effect on our results of operations. We believe that none of our significant customers were experiencing financial difficulties that would materially impact our trade accounts receivable or allowance for doubtful accounts as of December 31, 2014 and 2013.
Stock-Based Compensation.
Our stock-based award programs are intended to attract, retain and reward employees, officers, directors and consultants, and to align stockholder and employee interests. We granted stock-based awards to individuals in each of 2014 and 2013. Our policy going forward will be to issue awards under our 2012 Employee Incentive Plan and Employee Stock Purchase Plan.
Compensation expense for stock-based awards is based on the fair value of the awards at the measurement date and is included in operating expenses. The fair value of stock option grants is estimated on the date of grant using the Black-Scholes option pricing model based on certain assumptions including: expected volatility based on the historical price of our stock over the expected life of the option, the risk-free rate of return based on the United States treasury yield curve in effect at the time of the grant for the expected term of the option, the expected life based on the period of time the options are expected to be outstanding using historical data to estimate option exercise and employee termination; and dividend yield based on history and expectation of dividend payments. Stock options generally vest ratably over a three-year period and are exercisable over a period up to ten years.
The fair value of restricted stock is estimated on the date of grant and is generally equal to the closing price of our common stock on that date. The price of our common stock price has varied greatly during the years ended December 31, 2014 and 2013. Some of the factors that influenced the market price of our stock during these periods include:
●the closing of seven acquisitions (ADEX, TNS and ERFS in 2012, AW Solutions in 2013 and IPC, RentVM and VaultLogix in 2014);
●increasing indebtedness to fund such acquisitions;
●the approval and eventual effectuation of a one-for-125 reverse stock split in January 2013 and a one-for-four reverse stock split in August 2013, which caused uncertainty and volatility; and
●our stock being very thinly traded prior to the listing of our common stock on the Nasdaq Capital Market in October 2013, resulting in large fluctuations.
The total amount of stock-based compensation expense ultimately is based on the number of awards that actually vest, as well as the vesting period of all stock-based awards. Accordingly, the amount of compensation expense recognized during any fiscal year may not be representative of future stock-based compensation expense.
The following tables summarize our stock-based compensation for the years ended December 31, 2014 and 2013.
All shares issued in 2013 were immediately vested.
Components of Results of Operations
Revenue.
Refer to the discussion below for further detail on changes in revenue by segment.
Cost of Revenues.
Cost of revenues includes all direct costs of providing services under our contracts, including costs for direct labor provided by employees, services by independent subcontractors, operation of capital equipment (excluding depreciation and amortization), direct materials, insurance claims and other direct costs. Cost of revenues in the year ended December 31, 2014 was 74% of revenues as compared to 73% of revenues in the year ended December 31, 2013. This increase in cost of revenues was primarily due to the lower margins earned on those sales within our cloud and managed services segment, which decreased our overall margin. Cost of revenues as a percentage of revenues in the cloud and managed services segment was 77% and 0% of revenues in the years ended December 31, 2014 and 2013, respectively. Cost of revenues as a percentage of revenues in the professional services business was 76% and 79% of revenues in the years ended December 31, 2014 and 2013, respectively. Cost of revenues as a percentage of revenues in the applications and infrastructure business was 66% and 60% of revenues in the years ended December 31, 2014 and 2013, respectively.
For a majority of the contract services we perform, our customers provide all required materials while we provide the necessary personnel, tools and equipment. Materials supplied by our customers, for which the customer retains financial and performance risk, are not included in our revenue or costs of revenues. We expect cost of revenues to continue to increase if we succeed in continuing to grow our revenue.
General and Administrative Costs.
General and administrative costs include all of our corporate costs, as well as costs of our subsidiaries’ management personnel and administrative overhead. These costs primarily consist of employee compensation and related expenses, including legal, consulting and professional fees, information technology and development costs, provision for or recoveries of bad debt expense and other costs that are not directly related to performance of our services under customer contracts. Information technology and development costs included in general and administrative expenses are primarily incurred to support and to enhance our operating efficiency. We expect these expenses to continue to generally increase as we expand our operations, but expect that such expenses as a percentage of revenues will decrease if we succeed in increasing revenues.
Goodwill and Indefinite Lived Intangible Assets
Goodwill was generated through the acquisitions we have made since 2011. As the total consideration we paid for our completed acquisitions exceeded the value of the net assets acquired, we recorded goodwill for each of our completed acquisitions (see Note 5 of the Notes to our consolidated financial statements included in this report). At the date of acquisition, we performed a valuation to determine the value of the goodwill and intangible assets, along with the allocation of assets and liabilities acquired. The goodwill is attributable to synergies and economies of scale provided to us by the acquired entity.
We perform our annual impairment test at the operating segment level. Our three reportable segments are applications and infrastructure, professional services, and cloud and managed services. Professional services is comprised of the ADEX entities, applications and infrastructure is comprised of TNS, Tropical, AW Solutions and RM Engineering, the managed services operating segment, comprised of the IPC and RentVM components and the cloud services operating segment comprised of VaultLogix. These reporting units are aggregated to form four operating segments and three reportable segments for financial reporting and for the evaluation of goodwill for impairment. As our business evolves and the acquired entities continue to be integrated, our operating segments may change. This may require us to reassess how goodwill at our reporting units are evaluated for impairment.
We perform the impairment testing at least annually (at December 31) or at other times if we believe that it is more likely than not that there may be an impairment to the carrying value of our intangible assets with indefinite lives and goodwill. If it is more likely than not that goodwill impairment exists, the second step of the goodwill impairment test should be performed to measure the amount of impairment loss, if any.
We consider the results of an income approach and a market approach in determining the fair value of the reportable units. We evaluated the forecasted revenue using a discounted cash flow model for each of the reporting units. We also noted no unusual cost factors that would impact operations based on the nature of the working capital requirements of the components comprising the reportable units. Current operating results, including any losses, are evaluated by us in the assessment of goodwill and other intangible assets. The estimates and assumptions used in assessing the fair value of the reporting units and the valuation of the underlying assets and liabilities are inherently subject to significant uncertainties. Key assumptions used in the income approach in evaluating goodwill are forecasts for each of the reporting unit revenue growth rates along with forecasted discounted free cash flows for each reporting unit, aggregated into each reporting segment. For the market approach, we used the guideline public company method, under which the fair value of a business is estimated by comparing the subject company to similar companies with publicly traded ownership interests. From these “guideline” companies, valuation multiples are derived and then applied to the appropriate operating statistics of the subject company to arrive at indications of value.
While we use available information to prepare estimates and to perform impairment evaluations, actual results could differ significantly from these estimates or related projections, resulting in impairment related to recorded goodwill balances. Additionally, adverse conditions in the economy and future volatility in the equity and credit markets could impact the valuation of our reporting units. We can provide no assurances that, if such conditions occur, they will not trigger impairments of goodwill and other intangible assets in future periods.
Events that could cause the risk for impairment to increase are the loss of a major customer or group of customers, the loss of key personnel and changes to current legislation that may impact our industry or its customers’ industries.
With regard to other long-lived assets and intangible assets with indefinite-lives, we follow a similar impairment assessment. We will assess the quantitative factors to determine if an impairment test of the indefinite-lived intangible asset is necessary. If the quantitative assessment reveals that it is more likely than not that the asset is impaired, a calculation of the asset’s fair value is made. Fair value is calculated using many factors, which include the future discounted cash flows as well as the estimated fair value of the asset in an arm’s-length transaction.
We review finite-lived intangible assets for impairment whenever an event occurs or circumstances change that indicates that the carrying amount of such assets may not be fully recoverable. Recoverability is determined based on an estimate of undiscounted future cash flows resulting from the use of an asset and its eventual disposition. An impairment loss is measured by comparing the fair value of the asset to its carrying value. If we determine the fair value of an asset is less than the carrying value, an impairment loss is incurred. Impairment losses, if any, are reflected in operating income or loss in the consolidated statements of operations during the period incurred.
During the second quarter of 2014, we began experiencing declines in revenues within our professional services reporting segment due to delays in work from a significant customer. The delays continued into the third quarter of 2014 when it became apparent that anticipated revenue and profitability trends within our professional services reporting segment were not being achieved to the extent forecasted. We updated the forecast for the professional services segment, of which ADEX is a reporting unit, based on the most recent financial results and best estimates of future operations. The updated forecast reflects slower growth in revenues and lower margins for the professional services segment due to lower demand from customers.
We evaluated the recoverability of our long-lived assets in the professional services reporting segment using a two-step impairment process. The first step of the long-lived assets impairment test is to identify potential impairment by comparing the fair value of a segment with its net book value (or carrying amount), including long-lived assets. If the fair value of a segment exceeds its carrying amount, long-lived assets of the segment is considered not to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of the segment exceeds its fair value, the second step of the long-lived assets impairment test is performed to measure the amount of the impairment loss, if any. The second step of the long-lived assets impairment test compares the implied fair value of the segment’s long-lived assets with the carrying amount of that long-lived assets. If the carrying amount of the segment’s long-lived assets exceeds the implied fair value of that long-lived assets, an impairment loss is recognized in an amount equal to that excess. The implied fair value of long-lived assets is determined in the same manner as the amount of long-lived assets recognized in a business combination. That is, the fair value of the segment is allocated to all of the assets and liabilities of that segment (including any unrecognized intangible assets) as if the segment had been acquired in a business combination and the fair value of the segment was the purchase price paid to acquire the segment.
In order to determine the fair value of the customer relationships, we utilized an income approach known as excess earnings methodology. Excess earnings are computed as the projected earnings derived from the current customer base net of working capital on tangible and intangible fixed assets. Noncompete agreements were evaluated based on the probability of competition and the revenue that could potentially be generated from the agreements. The fair value of the corporate trade name was determined using the Relief from Royalty Method (“RFRM”), a variation of the “Income Approach”. The RFRM is used to estimate the cost savings that accrue to the owner of an intangible asset who would otherwise have to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate is based on empirical, market-derived royalty rates for guideline intangible assets when available. The royalty rate is applied to the projected revenue over the expected remaining life of the intangible asset to estimate the royalty savings. The net after-tax royalty savings are calculated for each year in the remaining economic life of the intangible asset and discounted to present value. Additionally, as part of the analysis, the operating income of the professional services segment was benchmarked to determine a range of royalty rates that would be reasonable based on a profit-split methodology. The profit-split methodology is based upon assumptions that the total amount of royalties paid for licensable intellectual property should approximate in order to determine a reasonable royalty rate to estimate the fair value of the corporate trade name.
We tested goodwill at the ADEX reporting unit as of September 30, 2014 using a two-step goodwill impairment process. The first step of the goodwill impairment test is to identify potential impairment by comparing the fair value of a segment with its net book value (or carrying amount), including goodwill. If the fair value of a segment exceeds its carrying amount, goodwill of the segment is considered not to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of the segment exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the segment’s goodwill with the carrying amount of that goodwill. If the carrying amount of the segment’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the segment is allocated to all of the assets and liabilities of that segment (including any unrecognized intangible assets) as if the segment had been acquired in a business combination and the fair value of the segment was the purchase price paid to acquire the segment.
As of September 30, 2014, we performed the two-step definite and indefinite lived intangible asset and goodwill impairment process and determined that the professional services reporting segment failed both tests. As a result, we performed an impairment analysis with respect to the carrying value of the intangible assets and goodwill in the professional services reporting segment. Based on the testing performed, we recorded a non-cash impairment charge of $3.8 million related to the professional services reporting segment, of which $1.4 million related to goodwill and $2.4 million related to intangible assets.
Fair Value of Embedded Derivatives.
We used the Black-Scholes option-pricing model to determine the fair value of the derivative liability related to the warrants and the put and effective price of future equity offerings of equity-linked financial instruments. We derived the fair value of warrants using the common stock price, the exercise price of the warrants, risk-free interest rate, the historical volatility, and our dividend yield. We do not have sufficient historical data to use our historical volatility; therefore the expected volatility is based on the historical volatility of comparable companies. We developed scenarios to take into account estimated probabilities of future outcomes. The fair value of the warrant liabilities is classified as Level 3 within our fair value hierarchy.
See Footnote 2 at Notes to Consolidated Financial Statements (F-7)
In December 2013, we entered into a securities purchase agreement with various institutional investors pursuant to which we issued to such investors the Convertible Debentures in the original aggregate principal amount of $11.6 million and an aggregate of 36,567 shares of our common stock for an aggregate purchase amount of $11.6 million. The Convertible Debentures mature on June 13, 2015 and bear interest at the rate of 12% per annum and are payable in accordance with an amortization schedule.
The Convertible Debentures are convertible into shares of our common stock at the election of the holder thereof at a conversion price equal to the lesser of (i) $6.36, or (ii) 85% of the price per share of our common stock in the first underwritten public offering we complete of not less than $10 million of our equity securities. The conversion price is subject to customary anti-dilution provisions. On the date of issuance of the Convertible Debentures, we recorded a derivative liability in the amount of $6.6 million in connection with the embedded features of the Convertible Debentures, which was recorded as a debt discount and is being amortized over the life of the Convertible Debentures. The amount of the derivative liability was calculated using the binomial method.
The aggregate fair value of our derivative liabilities as of December 31, 2014 and 2013 amounted to $2.4 million and $19.9 million, respectively.
Income Taxes.
In the years ended December 31, 2014 and 2013, we booked a provision for state, local and foreign income taxes due of $0.5 million and $0.2 million, respectively. Certain states do not recognize net operating loss carryforwards, and we have operations in some of those states. The provision for state and local income taxes in the years ended December 31, 2014 and 2013 were offset due to a benefit from deferred taxes of $3.7 million and $0.8 million in the years ended December 31, 2014 and 2013, respectively. This tax benefit was a result of our acquisition of IPC in 2014 and ADEX and T N S in 2012, which resulted in a deferred tax liability based on the value of the intangible assets acquired. This benefit was offset by the fact that ADEX and T N S were cash-basis taxpayers when they were acquired and were converted to accrual-basis taxpayers upon acquisition, which resulted in an increase in liability. As of December 31, 2014 and 2013, we had federal net operating loss carryforwards (NOLs) of $44.7 million and $9.9 million, respectively, which will be available to reduce future taxable income and expense through 2030. Utilization of the net operating loss and credit carryforwards is subject to an annual limitation due to the ownership percentage change limitations provided by Section 382 of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization. We have adjusted our deferred tax asset to record the expected impact of the limitations.
Credit Risk.
We are subject to concentrations of credit risk relating primarily to our cash and equivalents, accounts receivable, other receivables and costs and estimated earnings in excess of billings. Cash and equivalents primarily include balances on deposit in banks. We maintain substantially all of our cash and equivalents at financial institutions we believe to be of high credit quality. To date, we have not experienced any loss or lack of access to cash in our operating accounts.
We grant credit under normal payment terms, generally without collateral, to our customers. These customers primarily consist of telephone companies, cable broadband MSOs and electric and gas utilities. With respect to a portion of the services provided to these customers, we have certain statutory lien rights that may, in certain circumstances, enhance our collection efforts. Adverse changes in overall business and economic factors may impact our customers and increase potential credit risks. These risks may be heightened as a result of economic uncertainty and market volatility. In the past, some of our customers have experienced significant financial difficulties and, likewise, some may experience financial difficulties in the future. These difficulties expose us to increased risks related to the collectability of amounts due for services performed. We believe that none of our significant customers were experiencing financial difficulties that would materially impact the collectability of our trade accounts receivable as of December 31, 2014.
Contingent Consideration.
We recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree or assets of the acquiree in a business combination. The contingent consideration is classified as either a liability or equity in accordance with ASC 480-10 (“Accounting for certain financial instruments with characteristics of both liabilities and equity”). If classified as a liability, the liability is remeasured to fair value at each subsequent reporting date until the contingency is resolved. Increases in fair value are recorded as losses on our consolidated statement of operations, while decreases are recorded as gains. If classified as equity, contingent consideration is not remeasured and subsequent settlement is accounted for within equity.
Litigation and Contingencies.
Litigation and contingencies are reflected in our consolidated financial statements based on management’s assessment of the expected outcome of such litigation or expected resolution of such contingency. An accrual is made when the loss of such contingency is probable and reasonably estimable. If the final outcome of such litigation and contingencies differs significantly from our current expectations, such outcome could result in a charge to earnings.
Results of Operations
The following table shows our results of operations for the years ended December 31, 2014 and 2013. The historical results presented below are not necessarily indicative of the results that may be expected for any future period. All dollar amounts are presented in thousands, except share and per share data.
Year ended December 31, 2014 compared to year ended December 31, 2013
Revenue.
Total revenue for the year ended December 31, 2014 was $76.2 million, which represented an increase of $24.8 million, or 48%, compared to total revenue of $51.4 million for the year ended December 31, 2013.
Applications and infrastructure revenues increased in 2014 due to a full year of revenues from AW Solutions. We owned AW Solutions for nine months in 2013.
We experienced a decline in revenue in our professional services segment. During 2014, one of our largest customers reduced the number of personnel it required from ADEX, one of our companies in our professional services segment. As a result, 2014 revenue from this customer declined by $9.1 million and 2014 ADEX revenue declined by $10.6 million. Offsetting the decrease in revenue from the professional services segment was revenue of $6.2 million from the HighWire division of ADEX, which was acquired during 2014.
The increase in cloud and managed services revenue in 2014 was attributed to revenue generated by our companies acquired in 2014, which accounted for all of the increase.
Cost of revenue and gross margin.
Cost of revenue for the years ended December 31, 2014 and 2013 primarily consisted of direct labor provided by employees, services provided by subcontractors, direct material and other related costs. As discussed above, for a majority of the contract services we perform, our customers provide all necessary materials and we provide the personnel, tools and equipment necessary to perform installation and maintenance services. Cost of revenue increased by $18.8 million, or 51%, for the year ended December 31, 2014, to $56.1 million, as compared to $37.3 million for the year ended December 31, 2013. The increase in cost of revenue was attributable to our acquisitions, as well as lower cost of revenues related to our professional services segment. Costs of revenue as a percentage of revenues were 74% and 73% for the years ended December 31, 2014 and 2013, respectively.
Our gross profit percentage was 26% and 27% for the years ended December 31, 2014 and 2013, respectively. The steady gross profit percentage was due to additional margin provided by our recent acquisitions, which was partially offset by declining margins within our applications and infrastructure segment. Our margins declined within our applications and infrastructure segment due to discounts applied to several large projects to which we were engaged to perform in 2014.
General and Administrative.
General and administrative costs include all of our corporate costs, as well as the costs of our subsidiaries’ management personnel and administrative overhead. These costs consist of office rental, legal, consulting and professional fees, travel costs and other costs that are not directly related to the performance of our services under customer contracts. General and administrative expenses increased $4.0 million, or 51%, to $11.9 million in the year ended December 31, 2014, as compared to $7.9 million in the year ended December 31, 2013. The increase was primarily the result of additional general and administrative expense of $2.8 million due to the acquisitions we completed in 2014. Additionally, general and administrative expenses increased in 2014 due to increased accounting and legal expense related to acquisitions and financing initiatives. As a percentage of revenue, general and administrative expenses remained at 21% for both 2014 and 2013.
Salaries and Wages.
For the year ended December 31, 2014, salaries and wages increased $11.5 million to $19.8 million as compared to approximately $8.3 million for the year ended December 31, 2013. The increase primarily was due to the acquisitions we completed in 2014, which added salary and wage expenses of $9.4 million. Of the $9.4 million of additional salaries, $1.9 million related to new employees hired in 2014. Salaries and wages increased in our corporate overhead expenses for the year ended December 31, 2014 compared to the year ended December 31, 2013, primarily as a result of an increase in stock-based compensation of $1.7 million in 2014 compared to 2013. Salaries and wages were 26% of revenue in the year ended December 31, 2014, as compared to 16% in the year ended December 31, 2013. In the future, salaries and wages should not increase proportionally to the increase in our revenues.
Interest Expense.
Interest expense for the year ended December 31, 2014 and 2013 was $13.9 million and $5.6 million, respectively. The expense incurred in the 2014 period primarily related to interest expense of $4.8 million related to the related-party loans and 12% debentures, $7.7 million of amortization of debt discounts and $1.4 million related to amortization of loan costs related to the 12% debentures and our former PNC Bank revolving credit facility. In the 2013 period, $2.4 million of interest charges were related to a term loan that was repaid in 2014.
Net Loss Attributable to our Common Stockholders.
Net loss attributable to our common stockholders was $18.8 million for year ended December 31, 2014, as compared to net loss attributable to common stockholders of $25.4 million for the year ended December 31, 2013.
The decrease in net loss attributable to our common stockholders resulted from decreases in the change in the fair value of derivative instruments, contingent consideration and conversion features of $41.6 million. During 2014 and 2013, we recognized a gain in the fair value of derivative instruments of $25.8 million and a loss in fair value of derivative instruments of $14.2 million, respectively. During 2014 and 2013, the Company recognized a gain in the fair value of contingent consideration of $867 thousand and a loss in the fair value of contingent consideration of $3.1 million, respectively. Lastly, during 2014 and 2013, the Company recognized a loss on the fair value of conversion feature of $2.4 million and $0, respectively and recorded a net benefit from income taxes of $3.2 million and $0.6 million as of December 31, 2014 and 2013, respectively.
These decreases were offset by increases in salaries and wages and general and administrative expenses of $15.5 million during 2014 compared to 2013 due to an increase in personnel as we implemented our aggressive cloud centered growth strategy. Additional increases included interest expense of $8.3 million related to debt financings, losses on extinguishment of debt and conversion of debt of $12.1 million. We also had increases in non-cash losses of $3.8 million related to the write down of goodwill and increases in depreciation/amortization expense of $3.0 million. We also incurred non-cash stock compensation expense of $4.2 million for 2014 compared to $3.5 million for 2013.
Liquidity, Capital Resources and Cash Flows
Working Capital.
At December 31, 2014, we had working capital deficit of approximately $13.1 million, as compared to working capital of approximately $4.2 million at December 31, 2013. The decrease of $17.3 million in our working capital from December 31, 2013 to December 31, 2014 was primarily the result of the cash payment of approximately $13.5 million in connection with our acquisition of IPC on January 1, 2014 as discussed below, and additional borrowings in the year ended December 31, 2014.
The increase in our working capital at December 31, 2013 was attributable, in part, to our requirement for a cash payment of approximately $13.5 million in connection with our acquisition of IPC on January 1, 2014. Giving effect to such cash payment on January 1, 2014 and to the increase in our working capital in the amount of approximately $0.4 million due to our consolidation of the working capital of IPC as of such date, on a pro forma basis we would have had a working capital deficit of approximately $7.6 million at December 31, 2013. We raised $11.6 million through the issuance of the Convertible Debentures, and an additional $2.0 million through the sale of debt securities, in December 2013. The proceeds of such financings were used for the cash portion of the purchase price of IPC.
On or prior to December 31, 2015, we have obligations relating to the payment of indebtedness as follows:
● $4.0 million related to term loans due June 1, 2015 and June 24, 2015;
● $2.3 million payable to the holders of the Convertible Debentures, which is payable in monthly installments through June 1015;
● $2.0 million related to term loans, which is payable in quarterly installments through December 2015;
● $1.0 million relating to a term loan due November 14, 2015; and
● $0.4 million relating to promissory notes held by related parties that mature prior to December 31, 2015.
We anticipate meeting our cash obligations on our indebtedness that is payable on or prior to December 31, 2015 from earnings from operations, including, in particular, VaultLogix, which was acquired in October 2014, and possibly from the proceeds of additional indebtedness or equity raises. If we are not successful in obtaining additional financing when required, we expect that we will be able to renegotiate and extend certain of our notes payable as required to enable us to meet our debt obligations as they become due, although there can be no assurance that we will be able to do so.
Our future capital requirements for our operations will depend on many factors, including the profitability of our businesses, the number and cash requirements of other acquisition candidates that we pursue, and the costs of our operations. We have been investing in sales personnel in anticipation of increasing revenue opportunities in the cloud and managed services segment of our business, which has contributed to our losses from operations. Our management has taken several actions to ensure that we will have sufficient liquidity to meet our obligations through December 31, 2015, including the reduction of certain general and administrative expenses, consulting expenses and other professional services fees. Additionally, if our actual revenues are less than forecasted, we anticipate implementing headcount reductions to a level that more appropriately matches then-current revenue and expense levels. We also are evaluating other measures to further improve our liquidity, including, the sale of equity or debt securities and entering into joint ventures with third parties. Lastly, we may elect to reduce certain related-party and third party debt by converting such debt into common shares. In February and March 2015, we entered into agreements with related party debt holders to extend the maturity dates and lower the interest rates on such debt. We are currently in discussions with a third party on a credit facility to enhance our liquidity position. Our management believes that these actions will enable us to meet our liquidity requirements through December 31, 2015. There is no assurance that we will be successful in any capital-raising efforts that we may undertake to fund operations during 2015.
We plan to generate positive cash flow from our recently-completed acquisitions to address some of our liquidity concerns. However, to execute our business plan, service our existing indebtedness and implement our business strategy, we anticipate that we will need to obtain additional financing from time to time and may choose to raise additional funds through public or private equity or debt financings, a bank line of credit, borrowings from affiliates or other arrangements. We cannot be sure that any additional funding, if needed, will be available on terms favorable to us or at all. Furthermore, any additional capital raised through the sale of equity or equity-linked securities may dilute our current stockholders’ ownership in us and could also result in a decrease in the market price of our common stock. The terms of those securities issued by us in future capital transactions may be more favorable to new investors and may include the issuance of warrants or other derivative securities, which may have a further dilutive effect. We also may be required to recognize non-cash expenses in connection with certain securities we issue, such as convertible notes and warrants, which may adversely impact our financial condition. Furthermore, any debt financing, if available, may subject us to restrictive covenants and significant interest costs. There can be no assurance that we will be able to raise additional capital, when needed, to continue operations in their current form.
We had capital expenditures of $0.6 million and $0.1 million in the years ended December 31, 2014 and 2013, respectively. We expect our capital expenditures for next 12 months will be consistent with our prior spending. These capital expenditures will be primarily utilized for equipment needed to generate revenue and for office equipment. We expect to fund such capital expenditures out of our working capital.
We have satisfied our capital and liquidity needs primarily through sales of equity securities, debt offerings and bank borrowings. As of December 31, 2014, we had cash of $5.5 million, which was exclusively denominated in U.S. dollars and consisted of bank deposits. As of December 31, 2014, none of our cash was held by foreign subsidiaries.
Summary of Cash Flows.
The following summary of our cash flows for the years ended December 31, 2014 and 2013 has been derived from our historical consolidated financial statements, which are included elsewhere in this report:
Net cash used in operating activities. We have historically experienced cash deficits from operations as we continued to expand our business and sought to establish economies of scale. Our largest uses of cash for operating activities are for general and administrative expenses. Our primary source of cash flow from operating activities is cash receipts from customers. Our cash flow from operations will continue to be affected principally by the extent to which we grow our revenues and increase our headcount.
Net cash used in operating activities for the year ended December 31, 2014 was $10.4 million, which included $5.3 million in stock issuance charges, charges of $9.0 million related to amortization of debt discount and deferred issuance costs, gains of 25.8 million on the fair value of derivative liabilities, losses of $10.8 million on the extinguishment of debt and debt modification charges, losses of $2.3 million on the conversion of debt, goodwill and intangible asset impairment charges of $3.8 million, deferred income taxes of $3.7 million, and changes in accounts receivable, inventory, other assets, accounts payable and accrued expenses of $2.7 million. Non-cash charges related to depreciation and amortization totaled $4.1 million. Net cash provided by operating activities for the year ended December 31, 2013 of $2.8 million was primarily attributable to a net loss of $24.3 million offset by increases in the fair value of our derivative liability and our accounts payable and accrued expenses of $14.2 million and $6.3 million, respectively.
Net cash used in investing activities. Net cash used in investing activities for the year ended December 31, 2014 was $16.1 million, which consisted of $15.5 million related to cash payments for the purchase of capital equipment and cash consideration related to our acquisitions of IPC, RentVM, VaultLogix and a non-controlling interest in Nottingham. We also had capital expenditures of $0.6 million. Net cash used in investing activities for the year ended December 31, 2013 was $1.2 million, consisting primarily of cash used for acquisitions and purchases of capital equipment.
Net cash provided by financing activities. Net cash provided by financing activities for the year ended December 31, 2014 was $14.1 million, which resulted from proceeds from third-party borrowings of $15.2 million, related-party borrowings of $7.9 million and the proceeds of $4.2 million from the sale of common stock in a private placement, which were partially offset by the repayments of term loans and bank borrowings of $13.7 million and the settlement of contingent consideration of $1.8 million. Net cash provided by financing activities for the year ended December 31, 2013 was $15.1 million, which resulted primarily from the proceeds of $17.1 million we received from the sale of the Convertible Debentures and other borrowings, the public offering of our common stock which generated $2.8 million, net of issuance costs, and the proceeds of $0.8 million we received from the sale of preferred stock, offset in part by repayments of notes and loans payable of $3.0 million, increase in deferred loan costs of $1.8 million and the redemption of outstanding preferred stock of $3.0 million.
Indebtedness.
White Oak Loan Agreement. In connection with our acquisition of VaultLogix and its affiliated companies in October 2014, VaultLogix entered into a Loan and Security Agreement, effective as of October 9, 2014, or the White Oak Loan Agreement, with the lenders party thereto, White Oak Global Advisors, LLC, as Administrative Agent, and Data Protection Services LLC, U.S. Data Security Acquisition, LLC and U.S. Data Security Corporation, each of which was affiliated with VaultLogix and acquired by us at that time, as guarantors. Pursuant to the White Oak Loan Agreement, the lenders provided VaultLogix a term loan in the aggregate principal amount of $13.3 million. Interest on such term loan accrues at a rate per annum equal to the sum of (a) the greater of (i) the LIBOR Index Rate (as defined in the White Oak Loan Agreement), as adjusted as of each Libor Index Adjustment Date (as defined in the White Oak Loan Agreement) and (ii) 1.00% per annum; plus (b) 1,300 basis points per annum.
The proceeds of the term loan were used by us to finance our acquisition of VaultLogix and its affiliated companies on such date, to repay certain outstanding indebtedness of VaultLogix and to pay certain fees, costs and expenses related to such loan.
All obligations of VaultLogix under the White Oak Loan Agreement are unconditionally guaranteed by the VaultLogix affiliates we acquired as part of our acquisition of VaultLogix. In addition, in connection with the closing of the term loan, we entered into a guarantee agreement in favor of the lenders, and a pledge agreement and a security agreement pursuant to which we pledged substantially all of our assets, subject to certain customary exceptions, to secure out obligations under our guarantee agreement.
In the White Oak Loan Agreement, VaultLogix made certain representations and warranties, and agreed to certain affirmative covenants, negative covenants and financial covenants. The White Oak Loan Agreement also contains events of default including, but not limited to, the failure to make payments of interest, if any, on, or principal under the Term Loan, the failure to comply with certain covenants and agreements specified in the Loan Agreement and other loan documents entered into in connection therewith for a period of time after notice has been provided, the acceleration of certain other indebtedness resulting from the failure to make any payment when due on such other indebtedness, certain events of insolvency and the occurrence of any event, development or condition which has had or could reasonably be expected to have a material adverse effect. If any such event of default occurs, all obligations of VaultLogix under the White Oaks Loan Agreement, including the payment of principal, interest and any other monetary obligations under the term loan, may be declared immediately due and payable.
Bridge Financing Agreement. On December 1, 2014, we entered into a Bridge Financing Agreement with a third-party lender pursuant to which we issued to the lender for gross proceeds of $4.0 million (i) senior secured notes in the aggregate principal amount of $4.0 million that accrue interest at the rate of 12% per annum and (ii) a four-year warrants that are exercisable to purchase up to 400,000 shares of our common stock at an exercise price of $5.00 per share, subject to adjustment as set forth therein. The secured notes mature upon the earlier of (x) June 1, 2015 or (y) the date of a Major Transaction (as defined). In addition, upon maturity of the secured notes, we must pay to the lender additional interest that accrues over the term of the secured notes at the rate of 4% per annum. The secured notes are secured by (i) a first priority security interest in and to all of our accounts receivable and the accounts receivable of our subsidiaries (other than VaultLogix), and (ii) a first priority security interest and lien on substantially all of our assets, which lien and security interest will only go into effect at such time as the lien on such assets of the lenders under the White Oak Loan Agreement is released. The net proceeds from this loan were used for working capital purposes. Aegis Capital Corp., the representative of the underwriters in our November 13, 2013 equity offering, served as the placement agent in connection with this financing and received a placement agent fee equal to 3.5% of the net proceeds from this financing.
12% Convertible Promissory Note. On July 1, 2014, we issued to 31 Group, LLC, an institutional investor, a convertible promissory note in the principal amount of $1.5 million that accrued interest at the rate of 12% per annum, was set to mature on July 1, 2015 and was convertible into shares of our common stock at a conversion price of $6.37 per share, subject to adjustment for stock splits, stock combinations, stock dividends or similar transactions. The maturity date of this note could have been extended at the option of the holder through the date that is 20 business days after the consummation of a fundamental transaction (as defined in the note) in the event that a fundamental transaction was publicly announced or a fundamental transaction notice (as defined in the note) was delivered prior to the maturity date. In connection with such issuance, we also issued to the purchaser a three-year warrant to purchase 58,870 shares of common stock at an initial exercise price of $7.25 per share. As we did not repay the note in full on or prior to August 15, 2014, the purchaser received a security interest in all of our assets on that date. This note was repaid in full in December 2014.
12% Convertible Debentures. On December 13, 2013, we entered into a securities purchase agreement with certain institutional investors pursuant to which we issued to such investors Convertible Debentures in an original aggregate principal amount of $11.6 million and an aggregate of 36,567 shares of our common stock. In connection with the issuance of the Convertible Debentures, we paid a placement agent fee to Aegis Capital Corp., the representative of the underwriters in this offering, in the amount of $1 million, resulting in net proceeds to us of $10.6 million.
The Convertible Debentures bear interest at the rate of 12% per annum, and are payable in accordance with an amortization schedule, with monthly payments beginning on July 13, 2014 and ending on the final maturity date of June 13, 2015. At our election, subject to compliance with certain terms and conditions in the purchase agreement, the monthly amortization payments may be paid by the issuance of shares of our common stock at a price per share equal to the lesser of (i) the conversion price of the Convertible Debentures at that time and (ii) 75% of the average of the daily volume weighted average price, or VWAP, of our common stock for the five-trading-day period ending on, and including, the trading day immediately preceding the trading day that is five days prior to the applicable monthly amortization date.
The Convertible Debentures are convertible into shares of our common stock at the election of the holder thereof at a conversion price equal to the lesser of (i) $6.36, or (ii) 85% of the price per share of our common stock in our next underwritten public offering of not less than $10 million of our equity securities, subject in each case to customary anti-dilution provisions. Notwithstanding the foregoing, the Convertible Debentures held by a particular holder will not be convertible if such conversion would result in such holder owning more than 4.99% of the issued and outstanding shares of our common stock after such conversion. Beginning on June 13, 2014, we may have elected to force a holder of a Convertible Debenture to convert all, but not less than all, amounts outstanding under such Convertible Debenture into shares of our common stock at the applicable conversion price; provided, that we may only elect such forced conversion if certain conditions are met, including the condition that our common stock has been trading at 150% or higher of the applicable conversion price for 30 consecutive trading days with an average daily trading volume of not less than $1 million of shares per day. We did not exercise our ability to force any holders of our Convertible Debentures to convert as of December 31, 2014.
Related Party Promissory Notes. On July 5, 2011, we entered into a definitive master funding agreement with MMD Genesis LLC, or MMD Genesis, a company the three principals of which are our Chairman of the Board and Chief Executive Officer, Mark Munro, one of our directors, Mark F. Durfee, and Douglas Shooker, the principal of Forward Investments LLC, the beneficial owner of more than 5% of our common stock. Pursuant to the master funding agreement, MMD Genesis made loans to us from time to time to fund certain of our working capital requirements and a portion of the cash purchase prices of our business acquisitions. All such loans originally bore interest at the rate of 2.5% per month and matured on June 30, 2014. At December 31, 2013, outstanding loans from MMD Genesis in the aggregate principal amount of $3.9 million were outstanding.
During 2014, the outstanding principal amount of the loans from MMD Genesis in the amount of $3.9 million, and accrued interest thereon in the amount of $1 million, was restructured. Additionally, during 2014, certain related parties made additional loans to our company. As a result, the following related-party notes were outstanding as of December 31, 2014:
●notes issued to Mark Munro in the principal amount of $1.3 million that bear interest at the rate of 12% and 18% per annum and mature on March 31, 2016;
●notes issued to CamaPlan FBO Mark Munro IRA in the principal amount of $0.6 million that bear interest at the rate of 12% per annum and mature on March 31, 2016;
●a note issued to 1112 Third Avenue Corp., a company controlled by Mark Munro, in the principal amount of $0.4 million that bears interest at the rate of 12% per annum and matures on March 31, 2016;
●notes issued to Mark Munro 1996 Charitable Remainder UniTrust, which is not a related party, in the principal amount of $0.6 million that bear interest at the rates of 12% and 18% per annum and mature on March 31, 2016. As of December 31, 2014 the Mark Munro 1996 Charitable Remainder UniTrust is no longer a related party;
●notes issued to Pascack Road, LLC, a company controlled by Mark Durfee, in the principal amount of $2.7 million that bear interest at the rate of 12% and 18% per annum and mature on March 31, 2016;
●notes issued to Forward Investments, LLC in the principal amount of $9.1 million that bears interest at rates of 2%, 10% and 18% per annum, mature on June 30, 2015 and certain notes are convertible into shares of our common stock at an initial conversion price of $6.36 per share.
We have paid interest on these loans through issuances of common stock.
Obligations Under Purchase Agreements for Recent Acquisitions
In connection with the acquisitions of our subsidiaries, we entered into purchase agreements pursuant to which we agreed to certain on-going financial and other obligations. The following is a summary of the material terms of the purchase agreements for our recent acquisitions for which we have on-going financial obligations.
AW Solutions. On April 3, 2013, we entered into a purchase agreement, or the AWS Agreement, with AW Solutions Inc., AW Solutions Puerto Rico, LLC and each of the equity owners of such companies pursuant to which we acquired all of the outstanding capital stock of AW Solutions Inc. and the membership interests of AW Solutions Puerto Rico, LLC for an aggregate purchase price of $8.8 million, subject to certain customary working capital adjustments.
As consideration for the purchase of AW Solutions, we issued to the sellers at the closing an aggregate of 203,735 shares of our common stock.
At the closing of the acquisition on April 15, 2013, we made a cash payment to the sellers in the amount of $0.5 million, and made a cash payment in the amount of $25 thousand to an escrow agent, which amount was released from escrow to the sellers in April 2014. We also issued promissory notes the sellers in the aggregate principal amount of $2.1 million, of which notes in the aggregate principal amount of $1.6 million were paid in 2013 and the remaining notes were satisfied in full by our issuance of an aggregate of 42,341 shares of our common stock in January 2014.
The AWS Agreement provides for certain earn-out payments to the sellers based on the first and second anniversary EBITDA of AW Solutions. Following the first anniversary of the closing date, we calculated the EBITDA of AW Solutions for the twelve-month period beginning on the closing date and ending on the first anniversary of the closing date, or the First Anniversary EBITDA, and satisfied our earn-out payment obligation for the initial earn-out period by issuing to the sellers an aggregate of 329,640 shares of common stock and agreeing to pay to such sellers an additional $0.5 million in cash.
Following the second anniversary of the closing date, we will calculate the EBITDA of AW Solutions for the twelve-month period beginning on the first anniversary of the closing date and ending on the second anniversary of the closing date, or the Second Anniversary EBITDA, which will be subject to review by the sellers in accordance with the AWS Agreement. We will make an earn-out payment to the sellers based on the Second Anniversary EBITDA, or the Second EBITDA Adjustment, as follows:
(i)if the Second Anniversary EBITDA is less than or equal to the First Anniversary EBITDA, then the Second EBITDA Adjustment will be zero;
(ii)if the amount by which the Second Anniversary EBITDA exceeds the First Anniversary EBITDA, or the EBITDA Growth Amount, is less than $1.0 million, the Second EBITDA Adjustment will be equal to 2.0 times the EBITDA Growth Amount and will be paid by us to the sellers in cash;
(iii)if the EBITDA Growth Amount is equal to or greater than $1.0 million and less than $3.0 million, then the Second EBITDA Adjustment will be equal to 2.25 times the EBITDA Growth Amount, of which 88.88% will be paid by us to the sellers in cash and 11.12% will be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the second anniversary of the closing date; or
(iv)if the EBITDA Growth Amount is equal to or greater than $3.0 million, then the Second EBITDA Adjustment will be equal to 2.5 times the EBITDA Growth Amount, of which 80% will be paid by us to the sellers in cash and 20% will be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on second anniversary of the closing date.
On December 31, 2013, we evaluated the amount of contingent consideration to be paid and increased the amount by $1.7 million to $4.4 million on December 31, 2013. During 2014, we paid out $1.8 million related to the contingent consideration. In addition, we evaluated the amount of contingent consideration to be paid and decreased the amount by $2.1 million which was recorded as a gain on fair value of contingent consideration on the consolidated statement of operations. As of December 31, 2014, the value of the contingent consideration was $0.5 million.
RentVM. On February 3, 2014, we entered into a Stock Purchase Agreement, or the RentVM Agreement, with RentVM and the stockholders of RentVM pursuant to which we acquired all the outstanding capital stock of RentVM. In consideration for such shares of capital stock, at closing we issued 400,000 shares of our common stock, of which (i) an aggregate of 331,601 of the shares were issued to the sellers and (ii) 68,399 of the shares were placed in escrow until our audited consolidated financial statements for the year ending December 31, 2014 are filed with the SEC. The escrowed shares secure, among other things, the sellers’ indemnification obligations under the RentVM Agreement. Notwithstanding the foregoing, provided no claim for indemnity has been made, or if a claim has been made and there are sufficient escrowed shares remaining to satisfy such claim, the sellers may request a release of up to 25% of the remaining escrowed shares to cover personal tax liabilities associated with the acquisition. We intend to release the escrowed shares to the sellers by April 30, 2015.
Up to and including the 90th calendar day following the closing date of the acquisition, we had the option to purchase from the sellers, on a pro rata basis, for an aggregate option purchase price of $1.0 million in cash, a number of shares of our common stock equal to the quotient of $1.0 million divided by $14.62 (the closing price of our common stock on the trading day immediately preceding the date of the RentVM Agreement). We did not exercise this option.
Integration Partners - NY Corporation. Effective as of January 1, 2014, we consummated the acquisition of all of the outstanding capital stock of IPC, pursuant to the terms of a Stock Purchase Agreement, dated as of December 12, 2013 and amended on January 1, 2014, or the IPC Agreement, by and among IPC, the sole stockholders of IPC and our company. The purchase price for the acquisition was paid as follows:
●an aggregate of $12.5 million was paid to owners of IPC;
●a convertible promissory note was issued to an owner of IPC in the original principal amount of $6.3 million;
●an aggregate of 51,562 shares of our common stock was issued to the owners of IPC or their designee(s); and
●$1.0 million and 47,080 shares of our common stock was placed in escrow to secure the sellers’ indemnification and certain other obligations under the IPC Agreement.
As additional earn-out consideration, pursuant to the terms of the IPC Agreement, we were to pay to a former owner of IPC an amount equal to (i) the product of 0.6 multiplied by the EBITDA of IPC for the 12-month period beginning on January 1, 2014, plus (ii) in the event that such 12-month EBITDA exceeded the closing trailing-twelve-month EBITDA by 5.0% or more, an amount equal to 2.0 multiplied by this difference, which amount was payable in cash, or at our election, shares of our common stock. For the year ended December 31, 2014, we did not record any contingent consideration.
The promissory note we issued at closing accrues interest at the rate of 8% per annum, and originally matured on December 31, 2014. On December 31, 2014, the maturity date was extended to May 30, 2016. In consideration of this extension, we issued to Frank Jadevaia, our President and the holder of such promissory note, 100,000 shares of our common stock, valued at $0.3 million as of the date of the extension. The $0.3 million was recorded as a loss on debt modification in the consolidated statement of operations as of December 31, 2014. At the election of the holder of such promissory note, such promissory note is convertible into shares of our common stock at a conversion price of $16.99 per share (subject to equitable adjustments for stock dividends, stock splits, recapitalizations and other similar events). Beginning on July 1, 2014, if our common stock is trading at a price of greater than or equal to $16.99 for ten consecutive trading days, we may elect to force the conversion of such promissory note.
VaultLogix. Effective as of October 9, 2014, we consummated the acquisition of all of the outstanding membership interests of VaultLogix and its affiliated companies for an aggregate purchase price of $44.25 million pursuant to the terms of a purchase agreement, dated as of March 19, 2014, or VaultLogix Agreement, by and among VaultLogix, the holders of the membership interests of VaultLogix and our company. The purchase price for the acquisition was paid to the sellers as follows:
(i)$16.4 million in cash,
(ii)an aggregate of 1,008,690 shares of our common stock was issued to the sellers of VaultLogix or their designees; and
(iii)an aggregate of $15.6 million in unsecured convertible promissory notes were issued to the sellers of VaultLogix.
The promissory notes we issued at closing will accrue interest at the rate of 8% per annum, payable at maturity, and are due and payable on October 9, 2017. Such promissory notes are convertible into shares of our common stock at a conversion price equal to $6.37 per share; provided, however, that 20% of the principal amount of each promissory note is not convertible until January 9, 2016.
On a date when (i) the shares of common stock issuable upon conversion of the promissory notes may be sold without restriction or volume limitations under Rule 144 under the Securities Act, and (ii) the average closing price of our common stock is at least 105% of the then-applicable conversion price of the promissory notes on the three trading days immediately prior to such date, we may require the conversion into common stock of all or part of the outstanding amounts then owed under the promissory notes at the then-applicable conversion price. In addition, if on or after the maturity date, (i) we are restricted or otherwise unable to pay in cash all outstanding amounts under the promissory notes, (ii) the promissory notes have not otherwise been paid in full within ten business days following the maturity date, or (iii) we are not at such time entitled to require the conversion of the promissory notes, then, in the event that both (i) and (iii) above apply, we, and in the event that both (ii) and (iii) above apply, the holders of the promissory notes, shall have the right to convert all outstanding amounts owing under the promissory notes into shares of our common stock at a conversion price (in lieu of the then-applicable conversion price) equal to the average closing price of our common stock on the three trading days immediately preceding the date of such conversion.
If the price per share of our common stock on April 7, 2015 is less than $14.85, as adjusted for stock splits, dividends, recapitalizations or transactions having a similar effect, then we are required to issue to the sellers of VaultLogix additional shares of common stock in an aggregate amount equal to the product of (x) a fraction, the numerator of which is $16.50 minus the closing price of our common stock on April 7, 2015, and the denominator of which is such closing price on April 7, 2015, multiplied by (y) 1,008,690, which was the aggregate number of shares of our common stock issued to the such sellers at the closing. However, the for purposes of such calculation, the closing price per share of our common stock on April 7, 2015 will not be less than $12.50.
Proceeds from Equity Issuances.
In the years ended December 31, 2014 and 2013, we raised net proceeds of $4.2 million and $5.8 million, respectively, from the sale of equity securities.
Accounts Receivable
We had accounts receivable at December 31, 2014 and 2013 of $19.4 million and $7.8 million, respectively. Our day’s sales outstanding calculated on an annual basis at December 31, 2014 and 2013 was 93 days and 66 days, respectively.
Capital expenditures
We had capital expenditures of $0.6 million and $0.1 million for the years ended December 31, 2014 and 2013, respectively. We expect our capital expenditures for the 12 months ending December 31, 2015 to increase as a result of our expanded cloud offerings, which are more capital intensive than our other products. These capital expenditures will be primarily utilized for equipment needed to generate revenue and for office equipment. We expect to fund such capital expenditures out of our working capital.
Off-balance sheet arrangements
During the years ended December 31, 2014 and 2013, other than operating leases, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contingencies
Other than the purported class action lawsuit disclosed herein under the caption “Business - Legal Proceedings,” we only are involved in claims and legal proceedings arising from the ordinary course of our business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and the amount can be reasonably estimated. If these estimates and assumptions change or prove to be incorrect, it could have a material impact on our financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Smaller reporting companies are not required to provide the information required by this item.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated balance sheets as of December 31, 2014 and 2013, and the related consolidated statements of operations and stockholders’ deficit and cash flows for each of the two years in the years ended December 31, 2014 and 2013, together with the related notes and the report of our independent registered public accounting firm, are set forth on pages to of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Management’s Report on Internal Control over Financial Reporting
Evaluation of Disclosure Controls and Procedures.
We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
As of the end of the period covered by this Annual Report on Form 10-K, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation and the material weaknesses described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective such that the information relating to our company required to be disclosed in our Securities and Exchange Commission reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure as a result of material weaknesses in our disclosure controls and procedures. The material weaknesses relate to our inability to timely file our reports and other information with the SEC as required under Section 13 of the Exchange Act, together with material weaknesses in our internal control over financial reporting. Our management also has identified material weaknesses in our internal controls over financial reporting relating to (i) our failure to effectively implement comprehensive entity-level internal controls, (ii) our lack of a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. GAAP commensurate with our financial reporting requirements and, (iii) our lack of the quantity of resources necessary to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of the transactions into which we enter. Our management believes that these weaknesses are due in part to the small size of our staff, which makes it challenging to maintain adequate disclosure controls. To remediate the material weaknesses in disclosure controls and procedures, we plan to hire additional experienced accounting and other personnel to assist with filings and financial record keeping and to take additional steps to improve our financial reporting systems and implement new policies, procedures and controls.
Management’s Report on Internal Control over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
●pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
●provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
●provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (1992). Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of these controls. Based on this assessment, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that as of December 31, 2014, our internal control over financial reporting was not effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles as a result of the material weaknesses identified in our disclosure controls and procedures.
Our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2014 the following material weaknesses existed:
(1)We did not effectively implement comprehensive entity-level internal controls, as evidenced by the following control deficiencies:
●Entity Level Internal Control Evaluation. We did not formally consider entity-wide controls that are pervasive across our company when considering whether control activities are sufficient to address identified risks.
●Assessment of Information Technology. We did not formally evaluate the extent of our needed information technology controls in relation to our assessment of processes and systems supporting financial reporting.
●Ongoing and Separate Evaluations. We did not effectively create and maintain effective evaluations on the progress of our remediation efforts nor the consistent evaluations of the operating effectiveness of our internal controls over financial reporting.
●Reporting Deficiencies. We did not perform timely and sufficient internal or external reporting of our progress and evaluation of prior year material weaknesses or the current fiscal year internal control deficiencies.
(2)We lack a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. generally accepted accounting principles, or GAAP, commensurate with our financial reporting requirements. The monitoring of our accounting and reporting functions were either not designed and in place or not operating effectively. As a result, numerous adjustments to our financial statements were identified and this fact, coupled with the lack of personnel, limits our ability to prepare and timely issue our required filings with the SEC.
(3)We lack the quantity of resources to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of transactions entered into by our company.
Remediation of Internal Control Deficiencies and Expenditures
It is reasonably possible that, if not remediated, one or more of the material weaknesses described above could result in a material misstatement in our reported financial statements that might result in a material misstatement in a future annual or interim period.
We believe that we are addressing the deficiencies that affected our internal control over financial reporting and we are developing specific action plans for each of the above material weaknesses. Because the remedial actions require hiring of additional personnel, upgrading certain of our information technology systems and relying extensively on manual review and approval, the successful operation of these controls for at least several quarters may be required before management may be able to conclude that the material weaknesses have been remediated. We intend to continue to evaluate and strengthen our internal control over financial reporting. These efforts require significant time and resources. If we are unable to establish adequate internal control over financial reporting, we may encounter difficulties in the audit or review of our financial statements by our independent registered public accounting firm, which in turn may have a material adverse effect on our ability to prepare financial statements in accordance with GAAP and to comply with our SEC reporting obligations.
Changes in Internal Controls over Financial Reporting
During the quarter ended December 31, 2014, the integration of the accounting systems related to our acquisition of VaultLogix constituted a material change in our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Executive Officers and Directors
The following sets forth information about our executive officers and directors as of March 20, 2015.
The following is information about the experience and attributes of the members of our board of directors and senior executive officers as of the date of this report. The experience and attributes of our directors discussed below provide the reasons that these individuals were selected for board membership, as well as why they continue to serve in such positions.
Mark Munro, Chief Executive Officer and Chairman of the Board. Mr. Munro has served as our Chief Executive Officer and as the Chairman of our Board since December 2011. Mr. Munro is also the Founder and has been President of Munro Capital Inc., a private equity investment firm, since 2005. Mr. Munro has been the Chief Executive Officer and owner of 1112 Third Ave Corp., a real estate holding company, since October 2000. He has also been an investor in private companies for the last seven years, including VaultLogix, LLC, a provider of online data backup solutions for business data. Prior to forming Munro Capital, Mr. Munro founded, built and sold Eastern Telcom Inc., a telecommunication company, from 1990 to 1996. Mr. Munro has been directly involved in over $150 million of private and public transactions as both an investor and entrepreneur. Mr. Munro received his B.A. in economics from Connecticut College. Mr. Munro brings extensive business experience, including years as a successful entrepreneur and investor, to our board of directors and executive management team.
Mark F. Durfee, Director. Mr. Durfee has been a member of our board of directors since December 2012. Mr. Durfee has been a principal at Auerbach Acquisition Associates II, Inc., a private equity fund, since August 2007. Mr. Durfee also worked for Kinderhook Capital Management, LLC, an investment manager, as a partner from January 1999 to December 200, at which he was responsible for investing in over 40 middle market companies. He has been a director of Home Sweet Home Holdings, Inc., a wholesaler of home furnishings, since January 2012. Mr. Durfee received his B.S. from the University of Wyoming in finance. Mr. Durfee brings over 25 years of experience as a private equity investor to our board of directors.
Charles K. Miller, Director. Mr. Miller has been a member of our board of directors since November 2012. He has been the Chief Financial Officer of Tekmark Global Solutions, LLC, a provider of information technology, communications and consulting services, since September 1997. Mr. Miller received his B.S. in accounting and his M.B.A. from Rider University and is a Certified Public Accountant in New Jersey. Mr. Miller brings over 30 years’ of financial experience to our board of directors.
Neal L. Oristano, Director. Mr. Oristano has been a member of our board of directors since December 2012. Mr. Oristano has been the Vice President - Service Provider Sales Segment at Cisco Systems Inc., an internet protocol-based networking and products company, since August 2011. Prior to that, he was the Senior Vice President - Service Provider Sales at Juniper Networks, Inc., a networking software and systems company, from July 2004 to July 2011. Mr. Oristano received his B.S. from St. Johns University in marketing. Mr. Oristano brings 33 years of technology experience, including enterprise and service provider leadership, to our board of directors.
Frank Jadevaia, President. Mr. Jadevaia has served as our President since January 2014. From November 2005 to January 2014, prior to our acquisition of IPC, Mr. Jadevaia was a Managing Partner at IPC. From November 2001 to November 2006, he was a Vice President of Sales of Nortel Networks Corporation, a telecommunications equipment manufacturer. Mr. Jadevaia received his B.S. from Bloomfield College in business. Mr. Jadevaia brings extensive enterprise and service provider management experience to our executive management team.
Timothy A. Larkin, Chief Financial Officer. Mr. Larkin has served as our Chief Financial Officer since October 2014. Prior to joining our company, Mr. Larkin was employed for more than 19 years by Warren Resources, Inc., a publicly-traded oil and gas drilling company, most recently as Chief Financial Officer from January 1995 to July 2013 and Executive Vice President from March 2004 to January 2014. Mr. Larkin has a B.S. in accounting from Villanova University. Mr. Larkin brings extensive experience in finance for both publicly-traded and private companies to our executive management team.
Effective March 20, 2015, Roger M. Ponder, our former Chief Operating Officer, retired from employment with our company. Our President, Frank Jadevaia, has assumed the duties previously performed by Mr. Ponder.
Board Composition
Our board of directors consists of four members, all of whom, with the exception of our chief executive officer, Mr. Munro, are “independent directors,” as defined in applicable rules of the SEC and NASDAQ. All directors will hold office until their successors have been elected. Officers are appointed and serve at the discretion of our board of directors. There are no family relationships among any of our directors or executive officers.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers and directors and persons who own more than 10% of a registered class of our equity securities to file reports of ownership of, and transactions in, our equity securities with the SEC. Such executive officers, directors and 10% stockholders also are required to furnish us with copies of all Section 16(a) reports they file.
Based on a review of the copies of such reports and the written representations of such reporting persons, we believe that all Section 16(a) filing requirements applicable to our executive officers, directors and 10% stockholders were complied with during 2014, with the exception of a Statement of Changes of Beneficial Ownership of Securities on Form 4 for our chairman of the board and chief executive officer, Mark Munro, filed on June 5, 2014; a Statement of Changes of Beneficial Ownership of Securities on Form 4 for our director, Mark F. Durfee, filed on April 22, 2014; a Statement of Changes in Beneficial Ownership of Securities on Form 4 for our director, Neal L. Oristano, filed on April 22, 2014; an Initial Statement of Beneficial Ownership of Securities on Form 3 for our President, Frank Jadevaia, filed on February 10, 2014 and amended on June 2, 2014 and a Statement of Changes in Beneficial Ownership on Form 4 for Mr. Jadevaia, which has not yet been filed; an Initial Statement of Beneficial Ownership of Securities on Form 3 for our chief financial officer, Timothy A. Larkin, which has not yet been filed; and an Initial Statement of Beneficial Ownership of Securities on Form 3 for Douglas R. Shooker, the beneficial owner of more than 10% of our common stock at the time of filing, filed on January 28, 2014.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics that applies to all of our employees, officers and directors. We will provide a copy of our Code of Business Conduct and Ethics, without charge, to any person desiring a copy, by written request to our company at 1030 Broad Street, Suite 102, Shrewsbury, NJ 07702, Attention: Corporate Secretary.
Stockholder Procedures to Recommend Director Nominees
Pursuant to our corporate bylaws, nominations of persons for election to our board of directors at an annual meeting or at a special meeting (but only if our board of directors has first determined that directors are to be elected at such special meeting) may be made at such meeting (i) by or at the direction of our board of directors, including by any committee or persons appointed by the board of directors, or (ii) by any stockholder who (A) was a stockholder of record (and, with respect to any beneficial owner, if different, on whose behalf such nomination is proposed to be made, only if such beneficial owner was the beneficial owner of our shares) both at the time of giving the required notice (as discussed below) and at the time of the meeting, (B) is entitled to vote at the meeting, and (C) complied with the notice procedures as to such nomination as described below.
For nominations to be made at an annual meeting by a stockholder, the stockholder must (i) provide a “timely” notice (as described below) thereof in writing and in “proper form” (as described below) to our Secretary and (ii) provide any updates or supplements to such timely notice at the times and in the forms as described below. Without qualification, if our board of directors has first determined that directors are to be elected at such special meeting, then for nominations to be made at a special meeting by a stockholder, the stockholder must (i) provide timely notice thereof in writing and in proper form to our at our principal executive offices and (ii) provide any updates or supplements to such notice at the times and in the forms described below. In no event shall any adjournment or postponement of an annual meeting or special meeting or the announcement thereof commence a new time period for the giving of a stockholder’s notice as described below.
To be “timely” with respect to an annual meeting of stockholders, a stockholder’s notice must be delivered to or mailed and received at our principal executive offices not earlier than the close of business on the 120th day and not later than the close of business on the 90th day prior to the first anniversary of the preceding year’s annual meeting; provided, however, that in the event that the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the 120th day prior to such annual meeting and not later than the close of business on the ninetieth 90th day prior to such annual meeting or, if the first public disclosure of the date of such annual meeting is less than 100 days prior to the date of such annual meeting, the close of business on the tenth day following the day on which public disclosure of the date of such annual meeting was made.
To be “timely” with respect to a special meeting, a stockholder’s notice for nominations to be made at a special meeting by a stockholder must be delivered to or mailed and received at our principal executive offices not earlier than the close of business on the 120th day prior to such special meeting and not later than the close of business on the 90th day prior to such special meeting or, if the first public disclosure of the date of such special meeting is less than 100 days prior to the date of such special meeting, the tenth day following the day on which public disclosure of the date of such special meeting was first made.
To be in a “proper form”, a stockholder’s notice to our Secretary is required to set forth:
(i)As to the stockholder providing the notice and each other Proposing Person (as defined below), (A) the name and address of the stockholder providing the notice and of the other Proposing Persons, and (B) any Disclosable Interests (as defined in our bylaws) of the stockholder providing the notice (or, if different, the beneficial owner on whose behalf such notice is given) and/or each other Proposing Person;
(ii)As to each person whom the stockholder proposes to nominate for election as a director, (A) all information with respect to such proposed nominee that would be required by the Amended Bylaws to be set forth in a stockholder’s notice if such proposed nominee were a Proposing Person, (B) all information relating to such proposed nominee that is required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors in a contested election pursuant to Section 14 under the Exchange Act and the rules and regulations thereunder (including such proposed nominee’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected) and (C) a description of all direct and indirect compensation and other material monetary agreements, arrangements and understandings during the past three years, and any other material relationships, between or among the stockholder providing the notice (or, if different, the beneficial owner on whose behalf such notice is given) and/or any Proposing Person, on the one hand, and each proposed nominee, his or her respective affiliates and associates and any other persons with whom such proposed nominee (or any of his or her respective affiliates and associates) is Acting in Concert (as defined in our bylaws), on the other hand, including, without limitation, all information that would be required to be disclosed pursuant to Item 404 under Regulation S-K if such stockholder or beneficial owner, as applicable, and/or such Proposing Person were the “registrant” for purposes of such rule and the proposed nominee were a director or executive officer of such registrant; and
(iii)We may require any proposed nominee to furnish such other information (including one or more accurately completed and executed questionnaires and executed and delivered agreements) as may reasonably be required by us to determine the eligibility of such proposed nominee to serve as an independent director of our company or that could be material to a reasonable stockholder’s understanding of the independence or lack of independence of such proposed nominee.
For purposes of our bylaws, the term “Proposing Person” means: (i) the stockholder providing the notice of the nomination proposed to be made at the meeting, (ii) the beneficial owner, if different, on whose behalf the nomination proposed to be made at the meeting is made, (iii) any affiliate or associate of such beneficial owner (as such terms are defined in Rule 12b-2 under the Exchange Act) and (iv) any other person with whom such stockholder or such beneficial owner (or any of their respective affiliates or associates) is acting in concert.
A stockholder providing notice of any nomination proposed to be made at a meeting shall further update and supplement such notice, if necessary, so that the information provided or required to be provided in such notice shall be true and correct as of the record date for the meeting and, if different, as of the date that is ten business days prior to the meeting or any adjournment or postponement thereof, and such update and supplement shall be delivered to or mailed and received by our Secretary at our principal executive offices not later than five business days after the record date for the meeting (in the case of the update and supplement required to be made as of the record date), and not later than eight business days prior to the date for the meeting or any adjournment or postponement thereof (in the case of the update and supplement required to be made as of ten business days prior to the meeting or any adjournment or postponement thereof).
The chairman of our board of directors or any other officer presiding at the meeting shall have the power, if the facts warrant, to determine that a nomination was not properly made in accordance with our bylaws, and if he or she should so determine, he or she shall so declare such determination to the meeting and the defective nomination shall be disregarded.
In addition to the requirements described herein with respect to any nomination proposed to be made at a meeting, each Proposing Person shall comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to any such nominations.
Staggered Board
Pursuant to our certificate of incorporation and our bylaws, our board of directors has been divided into three classes and the members of each class serve for a staggered, three-year term. Upon the expiration of the term of a class of directors, a director in that class will be elected for a three-year term at the annual meeting of stockholders in the year in which his or her term expires. The classes currently are composed as follows:
●Mark F. Durfee is a Class I director, whose term will expire at the fiscal annual meeting of stockholders for the year ending December 31, 2017;
●Neal L. Oristano is a Class II director, whose term will expire at the fiscal annual meeting of stockholders for the year ending December 31, 2015; and
●Mark Munro and Charles K. Miller are Class III directors, whose terms will expire at the fiscal annual meeting of stockholders for the year ending December 31, 2016.
Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of our directors. This classification of our board of directors may have the effect of delaying or preventing changes in control of our company.
Board Committees
Our board of directors has established the committees described below and may establish others from time to time. The charters for each of our committees are available on our corporate website.
Audit Committee. Our audit committee is comprised of Mark F. Durfee, Charles K. Miller and Neal L. Oristano. Mr. Miller is the chairperson of the committee. Our board of directors has determined that each member of the audit committee is “independent” for audit committee purposes as that term is defined in the applicable rules of the Securities and Exchange Commission and NASDAQ. Our board of directors has designated Charles K. Miller as an “audit committee financial expert,” as defined under the applicable rules of the Securities and Exchange Commission. The audit committee’s responsibilities include:
●appointing, approving the compensation of, and assessing the independence of our independent registered public accounting firm;
●pre-approving auditing and permissible non-audit services, and the terms of such services, to be provided by our independent registered public accounting firm;
●reviewing annually a report by the independent registered public accounting firm regarding the independent registered public accounting firm’s internal quality control procedures and various issues relating thereto;
●reviewing and discussing with management and the independent registered public accounting firm our annual and quarterly financial statements and related disclosures;
●coordinating the oversight and reviewing the adequacy of our internal control over financial reporting with both management and the independent registered public accounting firm;
●establishing policies and procedures for the receipt and retention of accounting related complaints and concerns, including a confidential, anonymous mechanism for the submission of concerns by employees;
●periodically reviewing legal compliance matters, including any securities trading policies, periodically reviewing significant accounting and other financial risks or exposures to our company, reviewing and, if appropriate, approving all transactions between our company or its subsidiaries and any related party (as described in Item 404 of Regulation S-K);
●establishing policies for the hiring of employees and former employees of the independent registered public accounting firm; and
●reviewing the audit committee report required by Securities and Exchange Commission rules to be included in our annual proxy statement.
The audit committee also has the power to investigate any matter brought to its attention within the scope of its duties. It also has the authority to retain counsel and advisors to fulfill its responsibilities and duties.
Compensation Committee. Our compensation committee is comprised of Mark F. Durfee, Charles K. Miller and Neal L. Oristano. Mr. Oristano is the chairperson of the committee. Our board of directors has determined that each member of the compensation committee is an independent director for compensation committee purposes as that term is defined in the applicable rules of NASDAQ, is a “non-employee director” within the meaning of Rule 16b-3(d)(3) promulgated under the Exchange Act and is an “outside director” within the meaning of Section 162(m) of the Internal Revenue Code, as amended. The compensation committee’s responsibilities include, among other things:
●annually reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer;
●annually evaluating the performance of our chief executive officer in light of such corporate goals and objectives and approving the compensation of our chief executive officer;
●annually reviewing and approving the compensation of our other executive officers;
●annually reviewing our compensation, welfare, benefit and pension plans, and similar plans;
●reviewing and making recommendations to the board of directors with respect to director compensation; and
●reviewing for inclusion in our proxy statement the report of the compensation committee required by the Securities and Exchange Commission.
The compensation committee also has the power to investigate any matter brought to its attention within the scope of its duties. It also has the authority to retain counsel and advisors to fulfill its responsibilities and duties.
Governance and Nominating Committee. Our Governance and Nominating Committee, or nominating committee, is comprised of Mark F. Durfee, Charles K. Miller and Neal L. Oristano. Mr. Durfee is the chairperson of the committee. Our board of directors has determined that each of the committee members is an independent director for nominating committee purposes as that term is defined in the applicable rules of NASDAQ. The nominating committee’s responsibilities include, among other things:
●developing and recommending to the board of directors criteria for board of directors and committee membership;
●identifying individuals qualified to become board of directors members;
●recommending to the board of directors the persons to be nominated for election as directors and to each of the board of directors’ committees;
●annually reviewing our corporate governance guidelines; and
●monitoring and evaluating the performance of the board of directors and leading the board in an annual self-assessment of its practices and effectiveness.
The Governance and Nominating Committee also has the power to investigate any matter brought to its attention within the scope of its duties. It also has the authority to retain counsel and advisors to fulfill its responsibilities and duties.
Limitation of Liability and Indemnification
As permitted by the Delaware General Corporation Law, we have adopted provisions in our certificate of incorporation and bylaws that limit or eliminate the personal liability of our directors. Consequently, a director will not be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, except for liability for:
●any breach of the director’s duty of loyalty to us or our stockholders;
●any act or omission not in good faith or that involves intentional misconduct or a knowing violation of law;
●any unlawful payments related to dividends or unlawful stock repurchases, redemptions or other distributions; or
●any transaction from which the director derived an improper personal benefit.
These limitations of liability do not alter director liability under the U.S. federal securities laws and do not affect the availability of equitable remedies, such as an injunction or rescission.
In addition, our bylaws provide that:
●we will indemnify our directors, officers and, at the discretion of our board of directors, certain employees and agents to the fullest extent permitted by the Delaware General Corporation Law; and
●we will advance expenses, including attorneys’ fees, to our directors and to our officers and certain employees, in connection with legal proceedings, subject to limited exceptions.
We also have entered into indemnification agreements with each of our executive officers and directors. These agreements provide that we will indemnify each of our executive officers and directors to the fullest extent permitted by law and will advance expenses to each indemnitee in connection with any proceeding in which indemnification is available.
We expect to obtain general liability insurance that covers certain liabilities of our directors and officers arising out of claims based on acts or omissions in their capacities as directors or officers, including liabilities under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
The above provisions may discourage stockholders from bringing a lawsuit against our directors for breach of their fiduciary duty. The provisions may also have the effect of reducing the likelihood of derivative litigation against directors and officers, even though such an action, if successful, might otherwise benefit us and our stockholders. Furthermore, a stockholder’s investment may be adversely affected to the extent we pay the costs of settlement and damage awards against directors and officers pursuant to these indemnification provisions. We believe that these provisions, the indemnification agreements and the insurance are necessary to attract and retain talented and experienced directors and officers.
At present, there is no pending litigation or proceeding involving any of our directors or officers where indemnification will be required or permitted. We are not aware of any threatened litigation or proceedings that might result in a claim for such indemnification.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following summary compensation table sets forth the compensation paid to the following persons for the last two completed fiscal years.
(a) our principal executive officer;
(b) each of our two most highly compensated executive officers who were serving as executive officers at the end of the fiscal year ended December 31, 2014 who had total compensation exceeding $100,000; and
(c) up to two additional individuals for whom disclosure would have been provided under (b) but for the fact that the individual was not serving as one of our executive officers at the end of the most recently completed financial year.
These individuals are referred to as the “named executive officers” in this report. The following table provides a summary of compensation paid for the years ended December 31, 2014 and 2013 to the named executive officers:
Summary Compensation Table
(1)The amounts shown reflect the grant date fair value of each award computed in accordance with FASB ASC Topic 718, Compensation-Stock Compensation. The assumptions used to calculate the value of stock awards are described under the caption “Critical Accounting Policies and Estimates - Stock-Based Compensation” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and in Note 2 to our consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this report.
(2)While Mr. Munro became our Chief Executive Officer in December 2011, by agreement with Mr. Munro, he began receiving cash compensation for his services in May 2013.
(3)Mr. Jadevaia joined our company as President in January 2014.
(4)Mr. Sullivan served as our Chief Financial Officer until October 14, 2014, on which date Mr. Sullivan became our Chief Accounting Officer.
(5)While Mr. Ponder became our Chief Operating Officer on November 2012, by agreement with Mr. Ponder, he commenced receiving cash compensation in May 2013. Effective March 20, 2015, Mr. Ponder retired from his
employment with our company.
(6)Mr. Davis joined our company as Senior Vice President of Sales and Marketing in February 2014.
Employment and Severance Agreements
In February 2014, we entered into three-year employment agreements with our President, Frank Jadevaia, and our Vice President of Sales and Marketing, Scott Davis, and in October 2014, we entered into a three-year employment agreement with our Chief Financial Officer, Timothy A. Larkin. Pursuant to such employment agreements, such officers are entitled to the following compensation:
Each employment agreement is for a term of three-years, provided that such agreements will be automatically extended for additional one-year terms unless either party gives written notice of termination not less than sixty (60) days prior to the termination of the then-current term. Each executive is entitled to the annual compensation described above, and is eligible to receive an annual incentive bonus as determined by our board of directors of a percentage of such executive’s base salary as described above. During the term of employment, each executive is entitled to participate all employee pension and welfare benefit plans and programs, and fringe benefit plans and programs, made available to our employees generally, subject to the eligibility and participations restrictions of each such plan or program. Each executive also is entitled to reimbursement for all reasonable business expenses incurred by such executive in connection with carrying out such executive’s duties.
Each employment agreement is terminable by us for at any time, (i) for Cause (as defined in such employment agreements), (ii) without Cause upon at least thirty (30) days prior written notice to the executive, (iii) in the event of the executive’s death, or (iv) in the event of the executive’s disability, as determined in good faith by our board of directors. Each executive may terminate the agreement at any time upon not less than thirty (30) days prior written notice; provided, however, that each executive may terminate the agreement immediately for Good Reason (as defined in such employment agreements) if we have not remedied the circumstances giving rise to the basis of such termination for Good Reason within the applicable cure period. If the executive’s employment is terminated without Cause or by the executive for Good Reason, in addition to payment of any accrued obligations, such executive will be entitled to certain severance benefits based on such executive’s base salary and targeted incentive bonus amount then in effect, and such executive shall also be entitled to incentive bonuses with respect to the current year that would otherwise have been payable to such executive had such executive’s employment not been terminated.
Pursuant to such employment agreements, each executive also is subject to customary confidentiality restrictions and work-product provisions, and each executive also is subject to customary non-competition covenants and non-solicitation covenants with respect to our employees, consultants and customers.
We do not maintain any retirement plans, tax-qualified or nonqualified, for our executives or other employees.
Outstanding Equity Awards at Fiscal Year-End
The following table itemizes outstanding equity awards held by the named executive officers as of December 31, 2014.
(1) Unvested shares of restricted stock are generally forfeited if the named executive officer’s employment terminates, except to the extent otherwise provided in an employment agreement or award agreement.
(2) This restricted stock award vests in three equal annual installments beginning May 29, 2015.
(3) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $5.97, which was the closing market price of one share of our common stock on May 29, 2014.
(4) This restricted stock award vests in full on August 28, 2015.
(5) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $5.19, which was the closing market price of one share of our common stock on August 28, 2014.
Equity Incentive Plans
2012 Performance Incentive Plan. On November 16, 2012, we adopted our 2012 Performance Incentive Plan, or the 2012 Plan, to provide an additional means to attract, motivate, retain and reward selected employees and other eligible persons. Our stockholders approved the plan on or about November 22, 2012. Employees, officers, directors and consultants that provide services to us or one of our subsidiaries may be selected to receive awards under the 2012 Plan.
Our board of directors, or one or more committees appointed by our board or another committee (within delegated authority), administers the 2012 Plan. The administrator of the 2012 Plan has broad authority to:
●select participants and determine the types of awards that they are to receive;
●determine the number of shares that are to be subject to awards and the terms and conditions of awards, including the price (if any) to be paid for the shares or the award and establish the vesting conditions (if applicable) of such shares or awards;
●cancel, modify or waive our rights with respect to, or modify, discontinue, suspend or terminate any or all outstanding awards, subject to any required consents;
●construe and interpret the terms of the 2012 Plan and any agreements relating to the Plan;
●accelerate or extend the vesting or exercisability or extend the term of any or all outstanding awards subject to any required consent;
●subject to the other provisions of the 2012 Plan, make certain adjustments to an outstanding award and authorize the termination, conversion, substitution or succession of an award; and
●allow the purchase price of an award or shares of our common stock to be paid in the form of cash, check or electronic funds transfer, by the delivery of previously-owned shares of our common stock or by a reduction of the number of shares deliverable pursuant to the award, by services rendered by the recipient of the award, by notice and third party payment or cashless exercise on such terms as the administrator may authorize or any other form permitted by law.
A total of 3,058,749 shares of our common stock is authorized for issuance with respect to awards granted under the 2012 Plan. The share limit will automatically increase on the first trading day in January of each year by an amount equal to lesser of (i) 4% of the total number of outstanding shares of our common stock on the last trading day in December in the prior year, (ii) 2,000,000 shares, or (iii) such lesser number as determined by our board of directors. Any shares subject to awards that are not paid, delivered or exercised before they expire or are canceled or terminated, or fail to vest, as well as shares used to pay the purchase or exercise price of awards or related tax withholding obligations, will become available for other award grants under the 2012 Plan. As of the date of this report, stock grants of an aggregate of 1,957,353 shares have been made under the 2012 Plan, and 1,101,396 shares authorized under the 2012 Plan remain available for award purposes.
Awards under the 2012 Plan may be in the form of incentive or nonqualified stock options, stock appreciation rights, stock bonuses, restricted stock, stock units and other forms of awards including cash awards. The administrator may also grant awards under the plan that are intended to be performance-based awards within the meaning of Section 162(m) of the U.S. Internal Revenue Code. Awards under the plan generally will not be transferable other than by will or the laws of descent and distribution, except that the plan administrator may authorize certain transfers.
Nonqualified and incentive stock options may not be granted at prices below the fair market value of the common stock on the date of grant. Incentive stock options must have an exercise price that is at least equal to the fair market value of our common stock, or 110% of fair market value of our common stock in the case of incentive stock option grants to any 10% owner of our common stock, on the date of grant. These and other awards may also be issued solely or in part for services. Awards are generally paid in cash or shares of our common stock. The plan administrator may provide for the deferred payment of awards and may determine the terms applicable to deferrals.
As is customary in incentive plans of this nature, the number and type of shares available under the 2012 Plan and any outstanding awards, as well as the exercise or purchase prices of awards, will be subject to adjustment in the event of certain reorganizations, mergers, combinations, recapitalizations, stock splits, stock dividends or other similar events that change the number or kind of shares outstanding, and extraordinary dividends or distributions of property to the stockholders. In no case (except due to an adjustment referred to above or any repricing that may be approved by our stockholders) will any adjustment be made to a stock option or stock appreciation right award under the 2012 Plan (by amendment, cancellation and regrant, exchange or other means) that would constitute a repricing of the per-share exercise or base price of the award.
Generally, and subject to limited exceptions set forth in the 2012 Plan, if we dissolve or undergo certain corporate transactions such as a merger, business combination or other reorganization, or a sale of all or substantially all of our assets, all awards then-outstanding under the 2012 Plan will become fully vested or paid, as applicable, and will terminate or be terminated in such circumstances, unless the plan administrator provides for the assumption, substitution or other continuation of the award. The plan administrator also has the discretion to establish other change-in-control provisions with respect to awards granted under the 2012 Plan. For example, the administrator could provide for the acceleration of vesting or payment of an award in connection with a corporate event that is not described above and provide that any such acceleration shall be automatic upon the occurrence of any such event.
Our board of directors may amend or terminate the 2012 Plan at any time, but no such action will affect any outstanding award in any manner materially adverse to a participant without the consent of the participant. Plan amendments will be submitted to stockholders for their approval as required by applicable law or any applicable listing agency. The 2012 Plan is not exclusive - our board of directors and compensation committee may grant stock and performance incentives or other compensation, in stock or cash, under other plans or authority.
The 2012 Plan will terminate on November 16, 2022. However, the plan administrator will retain its authority until all outstanding awards are exercised or terminated. The maximum term of options, stock appreciation rights and other rights to acquire common stock under the 2012 Plan is ten years after the initial date of the award.
Employee Stock Purchase Plan. On November 16, 2012, we adopted the Employee Stock Purchase Plan, or the Purchase Plan, to provide an additional means to attract, motivate, retain and reward employees and other eligible persons by allowing them to purchase additional shares of our common stock. Our stockholders approved the plan on or about November 22, 2012. The below summary of the Purchase Plan is what we expect the terms of offerings under the plan to be.
The Purchase Plan is designed to allow our eligible employees and the eligible employees of our participating subsidiaries to purchase shares of our common stock, at semi-annual intervals, with their accumulated payroll deductions.
Share Reserve. A total of 585,586 shares of our common stock is available for issuance under the Purchase Plan. The share limit will automatically increase on the first trading day in January of each year by an amount equal to lesser of (i) 1% of the total number of outstanding shares of our common stock on the last trading day in December in the prior year, (ii) 500,000 shares, or (iii) such lesser number as determined by our board of directors.
Offering Periods. The Purchase Plan will operate as a series of offering periods. Offering periods will be of six months’ duration unless otherwise provided by the plan administrator, but in no event less than three months or longer than 27 months. The timing of the initial offering period under the plan will be established by the plan administrator.
Eligible Employees. Individuals scheduled to work more than 20 hours per week for more than five calendar months per year may join an offering period on the start date of that period. Employees may participate in only one offering period at a time.
Payroll Deductions; Purchase Price. A participant may contribute up to 15% of his or her cash earnings through payroll deductions, and the accumulated deductions will be applied to the purchase of shares on each semi-annual purchase date. Unless otherwise provided in advance by the plan administrator, the purchase price per share will be equal to 85% of the fair market value per share on the start date of the offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date. The number of shares a participant may purchase under the Purchase Plan is subject to certain limits imposed by the plan and applicable tax laws.
Change in Control. If we are acquired by merger or sale of all or substantially all of our assets or more than 50% of our voting securities, then all outstanding purchase rights will automatically be exercised on or prior to the effective date of the acquisition, unless the plan administrator provides for the rights to be settled in cash or exchanged or substituted on the transaction. Unless otherwise provided in advance by the plan administrator, the purchase price will be equal to 85% of the market value per share on the start date of the offering period in which the acquisition occurs or, if lower, 85% of the fair market value per share on the purchase date.
Other Plan Provisions. No new offering periods will commence on or after November 16, 2032. Our board of directors may at any time amend, suspend or discontinue the Purchase Plan. However, certain amendments may require stockholder approval.
Director Compensation
Our board of directors has approved a compensation policy for members of the board who are not employed by us or any of our subsidiaries (“non-employee directors”). Under the policy, each non-employee director continuing to serve in such capacity after an annual meeting of our stockholders will receive an award of restricted stock units, with the number of units to be determined by dividing $30,000 by the per-share closing price of our common stock on the grant date. A non-employee director who is appointed to the board after the date of the annual meeting in any year (other than in connection with an annual meeting and who has not been employed by us or one of our subsidiaries in the preceding six months) will receive a grant of restricted stock units, with the number of units to be determined by dividing $30,000 by the per-share closing price of our common stock on the grant date and pro-rating that number based on the period of time that has elapsed since the last annual meeting. Each of these grants will vest on a quarterly basis through the date of the next annual meeting (or, if earlier, the first anniversary of the date of grant).
In addition, our director compensation policy provides that a non-employee director who serves as Chairman of the Board will receive an annual cash retainer of $35,000. A non-employee director who serves on our Audit Committee will receive an annual cash retainer of $20,000, a non-employee director who serves on our Compensation Committee will receive an annual cash retainer of $10,000, and a non-employee director who serves on our Governance and Nominating Committee will receive an annual cash retainer of $10,000. Non-employee directors also are entitled to receive a fee of $1,500 for each meeting of the board or a board committee that they attend in person (with the director being entitled to one meeting fee if meetings of the board and a board committee are held on the same day). We also reimburse our non-employee directors for their reasonable travel expenses incident to attending meetings of our board or board committees.
The following table sets forth information about the compensation of the non-employee members of our board of directors who served as a director during the year ended December 31, 2014. Other than as set forth in the table and described more fully below, during the year ended December 31, 2014, we did not pay any fees, make any equity awards or non-equity awards or pay any other compensation to the non-employee members of our board of directors. Mr. Munro, our Chief Executive Officer, receives no compensation for his service as a director, and is not included in the table below.
(1)The amounts shown reflect the grant date fair value of each award computed in accordance with FASB ASC Topic 718, Compensation-Stock Compensation. The assumptions used to calculate the value of stock awards are described under the caption “Critical Accounting Policies and Estimates-Stock-Based Compensation” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in this report and in Note 2 to our consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this report.
Compensation Committee Interlocks and Insider Participation
None of the members of our Compensation Committee is or has at any time during the past year been an officer or employee of ours. None of our executive officers currently serves or in the past year has served as a member of the Board of Directors or Compensation Committee of any entity that has one or more executive officers serving on our board or Compensation Committee.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
The following table sets forth certain information regarding the beneficial ownership of our common stock as of March 16, 2015 by:
●each person known by us to be a beneficial owner of more than 5% of our outstanding common stock;
●each of our directors;
●each of our named executive officers; and
●all directors and executive officers as a group.
The amounts and percentages of common stock beneficially owned are reported on the basis of regulations of the Securities and Exchange Commission governing the determination of beneficial ownership of securities. Under the rules of the Securities and Exchange Commission, a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the voting of such security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days after March 16, 2015. Under these rules, more than one person may be deemed a beneficial owner of the same securities and a person may be deemed a beneficial owner of securities as to which he has no economic interest. Except as indicated by footnote, to our knowledge, the persons named in the table below have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them.
In the table below, the percentage of beneficial ownership of our common stock is based on 19,446,199 shares of our common stock outstanding as of March 16, 2015. Unless otherwise noted below, the address of the persons listed on the table is c/o InterCloud Systems, Inc., 1030 Broad Street, Suite 102, Shrewsbury, NJ 07702.
* Less than 1.0%.
(1) Includes (i) 1,162,689 shares of common stock held by Mr. Munro, including 500,000 shares that are subject to a three-year vesting schedule, (ii) 268,739 shares of common stock held by Mark Munro IRA, (iii) 161,081 shares held by 1112 Third Avenue Corp., (iv) and (iv) 4,769 shares held by MMD Genesis LLC. Mr. Munro has sole voting and investment power over the shares held by 1112 Third Avenue Corp. Mr. Munro, Mr. Mark Durfee and Mr. Douglas Shooker share voting and investment power over the shares held by MMD Genesis LLC.
(2) Includes (i) 37,515 shares held by Mr. Durfee, (ii) 1,225,217 shares held by Pascack Road LLC, and (ii) 4,769 shares held by MMD Genesis LLC. Mr. Durfee has sole voting and investment power over the shares held by Pascack Road LLC. Mr. Durfee, Mr. Mark Munro and Mr. Douglas Shooker share voting and investment power over the shares held by MMD Genesis LLC.
(3) Includes (i) 457,331 shares of common stock, including 250,000 shares that are subject to a three-year vesting schedule, and (ii) 368,151 shares of common issuable upon conversion of a convertible promissory note (based on the original principal amount of such note).
(4) Includes (i) 4,659 shares of common stock held by Mr. Shooker; (ii) 984,800 shares of common stock held by Forward Investments LLC, (iii) 4,769 shares of common stock held by MMD Genesis LLC and (iv) 1,767,024 shares of common stock issuable upon conversion of convertible promissory notes held by Forward Investments LLC. Mr. Shooker is the manager of Forward Investments LLC. Mr. Shooker and Mr. Mark Durfee share voting and investment power over the shares held by MMD Genesis LLC. The address of Mr. Shooker and Forward Investments LLC is 14161 North Donnelly, Mt. Dora, Florida 32757.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Procedures for Approval of Related Party Transactions
A “related party transaction” is a transaction, arrangement or relationship in which we or any of our subsidiaries was, is or will be a participant, and which involves an amount exceeding $120,000, and in which any related party had, has or will have a direct or indirect material interest. A “related party” includes
●any person who is, or at any time during the applicable period was, one of our executive officers or one of our directors;
●any person who beneficially owns more than 5% of our common stock;
●any immediate family member of any of the foregoing; or
●any entity in which any of the foregoing is a partner or principal or in a similar position or in which such person has a 10% or greater beneficial ownership interest.
In March 2014, our board of directors adopted a written related party transactions policy. Pursuant to this policy, the audit committee of our board of directors will review all material facts of all related party transactions and either approve or disapprove entry into the related party transaction, subject to certain limited exceptions. In determining whether to approve or disapprove entry into a related party transaction, our audit committee shall take into account, among other factors, the following: (i) whether the related party transaction is on terms no less favorable to us than terms generally available from an unaffiliated third-party under the same or similar circumstances, (ii) the extent of the related party’s interest in the transaction and (iii) whether the transaction would impair the independence of a non-employee director.
Related Party Transactions
Loan Transactions. During the year ended December 31, 2013, MMD Genesis LLC, a company the three principals of which are our Chairman of the Board and Chief Executive Officer, Mark Munro, one of our directors, Mark F. Durfee, and Douglas Shooker, the principal of Forward Investments LLC, the beneficial owner of more than 5% of our common stock, made loans to us from time to time in the aggregate principal amount of $3,675,000 to fund certain of our working capital requirements and a portion of the cash purchase price of our acquisition of IPC. At December 31, 2013, we had outstanding loans from MMD Genesis in the aggregate principal amount of $350,000.
On January 1, 2014, the outstanding principal amount of the loans from MMD Genesis in the amount of $3,925,000, and accrued interest thereon in the amount of $994,996, was restructured and, in lieu thereof, we issued to the principals of MMD Genesis LLC or their designees the following notes:
●a note issued to Mark Munro 1996 Charitable Remainder UniTrust in the principal amount of $275,000 that initially bore interest at the rate of 12% per annum and matured on March 31, 2016;
●a note issued to CamaPlan FBO Mark Munro IRA in the principal amount of $346,904 that initially bore interest at the rate of 12% per annum and matured on March 31, 2016;
●a note issued to 1112 Third Avenue Corp., a company controlled by Mark Munro, in the principal amount of $375,000 that initially bore interest at the rate of 12% per annum and matured on March 31, 2016;
●a note issued to Mark Munro in the principal amount of $737,000 that initially bore interest at the rate of 12% per annum and matured on March 31, 2016;
●a note issued to Pascack Road, LLC, a company controlled by Mark Durfee, in the principal amount of $1,575,000 that initially bore interest at the rate of 12% per annum and matured on March 31, 2016;
●a note issued to Forward Investments, LLC in the principal amount of $650,000 that bears interest at the rate of 10% per annum, matures on June 30, 2015 and is convertible into shares of our common stock at an initial conversion price of $6.36 per share; and
●a note issued to Forward Investments, LLC in the principal amount of $2,825,000 that bears interest at the rate of 2% per annum, matures on June 30, 2015 and is convertible into shares of our common stock at an initial conversion price of $6.36 per share.
As of the restructuring date, we recorded $895,000 of interest expense related to the restructuring of these loans within the consolidated statement of operations.
On May 29, 2014, we issued an aggregate of 8,934 shares of our common stock to Mark Munro, Mark Munro 1996 Charitable Remainder Unitrust, CamaPlan FBO Mark Munro IRA and 1112 Third Avenue Corp. in settlement of outstanding accrued interest owed to such note holders through March 31, 2014. On July 25, 2014, we issued to such note holders an aggregate of 10,800 shares of our common stock in settlement of outstanding accrued interest owed to such note holders through June 30, 2014. On July 25, 2014, we issued an aggregate of 26,189 shares of our common stock to Forward Investments, LLC in settlement of outstanding accrued interest owed to such note holder through June 30, 2014. On July 25, 2014, we issued an aggregate of 16,901 shares of our common stock to Pascack Road, LLC in settlement of outstanding accrued interest owed to such note holder through June 30, 2014.
On February 4, 2014 and March 28, 2014, Forward Investments, LLC made loans to us for working capital purposes in the amounts of $1.8 million and $1.2 million, respectively. Such loans are evidenced by promissory notes that bear interest at the rate of 10% per annum, mature on June 30, 2015 and are convertible into shares of our common stock at an initial conversion price of $6.36 per share. We have not made any payments of principal on such promissory notes. On July 25, 2014, we paid the accrued interest on such promissory notes through June 30, 2014 by issuing an aggregate of 16,608 shares of our common stock.
On May 7, 2014, Mark Munro 1996 Charitable Remainder Unitrust made a loan to us in the amount of $300,000. On June 19, 2014, Forward Investments LLC made a loan to us in the amount of $500,000. On June 20, 2014, Pascack Road LLC, a company owned by one of our directors, Mark F. Durfee, made a loan to us in the amount of $300,000. On July 11, 2014, Forward Investments, LLC and Pascack Road LLC each made a loan to us in the amount of $200,000. On July 29, 2014, Mark Munro IRA made a loan to us in the amount of $200,000. On August 12, 2014, Forward Investments, LLC made a loan to us in the amount of $600,000. On September 2, 2014, Forward Investments, LLC, Pascack Road LLC, and Mark Munro each made a loan to us in the amount of $100,000. On September 8, 2014 Forward Investments, LLC, and Pascack Road LLC, each made a loan to us in the amount of $150,000. On September 9, 2014, Mark Munro made a loan to us in the amount of $150,000. All of such loans were made to us for working capital purposes and are evidenced by promissory notes that initially bore interest at the rate of 18% per annum and matured on November 1, 2014. We have not made any payments of principal on such promissory notes. On July 25, 2014, we paid the accrued interest on such promissory notes through June 30, 2014 by issuing an aggregate of 2,255 shares of our common stock.
On July 3, 2014, we obtained an unsecured $3.0 million interim revolving line of credit from MMD Genesis LLC, the Mark Munro 1996 Charitable Remainder UniTrust, CamaPlan FBO Mark Munro IRA, Mark Munro, Pascack Road, LLC, and Forward Investments, LLC, all of which are related parties, to provide us working capital as well as cash to make certain of our amortization payments in respect of the Convertible Debentures. The line of credit has a maturity date of March 31, 2016, and bears interest at the rate of 1.5% per month on funds drawn.
On February 25, 2015, we restructured the terms of certain promissory notes issued by us to each of Mark Munro, Cama Plan FBO Mark Munro IRA, 1112 Third Ave. Corp., the Mark Munro 1996 Charitable Remainder Trust and Pascack Road, LLC, to extend the maturity dates thereof and to reduce the interest rate accruing thereon. The following notes were restructured as follows:
● notes issued to Mark Munro in the aggregate principal amount of $1,337,000 had the interest rates reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;
●notes issued to CamaPlan FBO Mark Munro IRA in the aggregate principal amount of $596,904 had the interest rates reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;
●a note issued to 1112 Third Avenue Corp., a company controlled by Mark Munro, in the principal amount of $375,000 had the interest rate reduced from 12% to 3% per annum and the maturity date extended from March 31, 2016 to January 1, 2018;
●notes issued to Mark Munro 1996 Charitable Remainder UniTrust in the aggregate principal amount of $575,000 had the interest rates reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018; and
●notes issued to Pascack Road, LLC in the aggregate principal amount of $2,650,000 had the interest rate reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018.
In consideration for such restructuring, we issued to Mark Munro 159,300 shares of unregistered common stock, the CamaPlan FBO Mark Munro IRA 81,290 shares of unregistered common stock, 1112 Third Avenue Corp. 87,500 shares of unregistered common stock, the Mark Munro 1996 Charitable Remainder UniTrust 89,900 shares of unregistered common stock and Pascack Road, LLC 381,100 shares of unregistered common stock.
On March 4, 2015, we restructured the terms of certain promissory notes issued by us to Forward Investments, LLC, to extend the maturity dates thereof, reduce the seniority and reduce the interest rate accruing thereon. The following notes were restructured as follows:
● notes issued to Forward Investments, LLC in the aggregate principal amount of $3,650,000 that bear interest at the rate of 10% per annum, had the maturity date extended from June 30, 2015, to July 1, 2016;
● notes issued to Forward Investments, LLC in the principal amount of $2,825,000 that bear interest at the rate of 2% per annum, had the maturity date extended from June 30, 2015, to July 1, 2016; and
● notes issued to Forward Investments, LLC in the aggregate principal amount of $2,645,000 were converted from senior notes to junior notes, had the interest rate reduced from 18% to 3% per annum, had the maturity dates extended by approximately three years to January 1, 2018, and were made convertible into shares of our common stock at an initial conversion price of $6.36 per share, subject to further adjustment as set forth therein.
In addition, on March 4, 2015, Forward Investments, LLC agreed to lend to us an amount substantially similar to the accrued interest that we then owed to Forward Investments, LLC on such notes. In consideration for such restructuring and additional payments made by Forward Investments, LLC to us, we issued to Forward Investments, LLC an additional convertible note in the principal amount of $1,730,000 that bears interest at the rate of 3% per annum, has a maturity date of January 1, 2018, and has an initial conversion price of $6.36 per share, subject to further adjustment as set forth therein.
In connection with the transactions effected with Forward Investments LLC on March 4, 2015, we also entered into a put option agreement with Forward Investments, LLC pursuant to which we sold to Forward Investments, LLC, in consideration of a payment to us of $30,000, an option to lend to us up to an additional $8.0 million, in increments of $1.0 million, at any time prior to March 3, 2020. Any such loans will be evidenced by promissory notes that bear interest at the rate of 10% per annum, mature 30 months from the date of issuance, with the option for Forward Investments, LLC to extend the maturity date to any date that is on or prior to the date that is 48 months from the date of issuance, and are convertible into shares of our common stock at an initial conversion price equal to the lower of (i) $6.36 per share until the Convertible Debentures are repaid in full and thereafter $2.35 per share, and (ii) subject to the receipt of stockholder approval, if required, the lowest sale price at which we sell or issue shares of common stock, or securities convertible into or exercisable to purchase shares of common stock, while such note is outstanding, subject in either case to adjustment as set forth therein.
Restricted Stock Grants. On April 11, 2014, our board of directors approved a grant under our 2012 Performance Incentive Plan of 25,000 shares of our common stock to Scott Davis, our Senior Vice President of Sales and Marketing. The closing sale price of our common stock on the NASDAQ Capital Market on April 11, 2014 was $5.99.
On May 19, 2014, our board of directors approved grants under our 2012 Performance Incentive Plan of 25,000 shares of our common stock to each of Messrs. Sullivan and Ponder. The closing sale price of our common stock on the NASDAQ Capital Market on May 19, 2014 was $4.69.
On May 29, 2014, our board of directors approved grants under our 2012 Performance Incentive Plan of 500,000 shares of our common stock to Mr. Munro and 250,000 shares to Frank Jadevaia, our President, which share grants vest over a period of three years. The closing sale price of our common stock on the NASDAQ Capital Market on May 29, 2014 was $5.99.
On August 27, 2014, our board of directors approved grants under our 2012 Performance Incentive Plan of 25,000 shares of our common stock to Mr. Ponder and 50,000 shares to Mr. Sullivan. The closing sale price of our common stock on the NASDAQ Capital Market on August 27, 2014 was $5.35.
For additional information regarding such stock grants, see Item 11. “Executive Compensation - Summary Compensation Table.”
Extension of Promissory Note. In December 2014, we issued to Frank Jadevaia, our President, 100,000 shares of our common stock in consideration of the agreement of Mr. Jadevaia to extend from December 31, 2014 to December 31, 2015 the maturity date of our 8% promissory note in the principal amount of $6,254,873 that was issued to Mr. Jadevaia in connection with our acquisition of IPC in January 2014. The shares of common stock issued to Mr. Jadevaia were valued at $292,000, or $2.92 per share, on the date of issuance.
Independence of the Board of Directors
Our board of directors consists of four members: Messrs. Mark Munro, Mark Durfee, Charles Miller and Neal Oristano. Our board of directors determined that all of the members of our board of directors, except our chief executive officer, Mr. Munro, are “independent directors” as defined in applicable rules of the SEC and NASDAQ. All directors will hold office until their successors have been elected. Officers are appointed and serve at the discretion of our board of directors.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The aggregate fees billed by BDO USA, LLP, our principal accountants for the year ended December 31, 2014, for professional services rendered for the audit of our annual financial statements included in our Annual Reports on Form 10-K, for the reviews of the financial statements included in our Quarterly Reports on Form 10-Q, and for services in connection with statutory and regulatory filings or engagements were approximately $697,500 and $1,065,000 for the fiscal years ended December 31, 2014 and 2013, respectively.
Audit-Related Fees
Included in audit fees are those fees in connection with our registration statement efforts on Form S-1 and S-3, respectively, filed on various dates during 2014 totaling $175,000.
In 2013, fees associated with the audit of our annual financial statements and reviews of our quarterly financial statements amounted to approximately $340,000, and fees in connection with our registration statement on Form S-1 that was filed in connection with our November 2013 equity offering amounted to approximately $725,000.
Audit-related fees included charges totaling approximately $125,000 associated with the audit of Integration Partners-NY Corporation as filed with Amendment No. 1 to our Current Report on Form 8-K and fees totaling approximately $60,000 associated with the audit of AW Solutions, LLC as part of our acquisition of that company.
All Other Fees
Other than as reported above, we did not engage our principal accountants to render any other services to us during the last two fiscal years.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Exhibits
The exhibits required by this item are listed on the Exhibit Index attached hereto.
Financial Statements
Our financial statements and the related Report of Independent Registered Public Accounting Firm are presented in the “F” pages following this report after the “Index to Financial Statements” attached hereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 23, 2015
By: /s/ Mark Munro
Mark Munro
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Mark Munro
Chief Executive Officer and Chairman of the Board of Directors
March 23,
Mark Munro
(Principal Executive Officer)
/s/ Timothy A. Larkin
Chief Financial Officer
March 23,
Timothy A. Larkin
(Principal Financial Officer and Principal
Accounting Officer)
/s/ Mark Durfee
Director
March 23,
Mark Durfee
/s/ Charles K. Miller
Director
March 23,
Charles K. Miller
/s/ Neal L. Oristano
Director
March 23,
Neal L. Oristano
EXHIBIT INDEX
† Certain schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The registrant undertakes to furnish supplemental copies of any of the omitted schedules upon request by the Securities and Exchange Commission.
INTERCLOUD SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
InterCloud Systems, Inc.
Shrewsbury, New Jersey
We have audited the accompanying consolidated balance sheets of InterCloud Systems, Inc. as of December 31, 2014 and 2013 and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the two years in the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financials statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financials reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of InterCloud Systems, Inc. at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
New York, New York
March 23, 2015
INTERCLOUD SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
See Notes to Consolidated Financial Statements.
INTERCLOUD SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLAR AMOUNT IN THOUSANDS)
See Notes to Consolidated Financial Statements.
INTERCLOUD SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
See Notes to Consolidated Financial Statements.
INTERCLOUD SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
See Notes to Consolidated Financial Statements.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. DESCRIPTION OF BUSINESS
InterCloud Systems, Inc. (the “Company”) was incorporated on November 22, 1999 under the laws of the State of Delaware. Prior to December 31, 2009, the Company was a development-stage company and had limited activity. The Company’s initial activities were devoted to developing a business plan, structuring and positioning itself to take advantage of available acquisition opportunities and raising capital for future operations and administrative functions. The Company began filing periodic reports with the Securities and Exchange Commission in November 2000. On October 31, 2013, the Company’s common stock and warrants were listed on The NASDAQ Capital Market under the symbols "ICLD" and "ICLDW," respectively.
On December 7, 2012, the Company’s stockholders approved a reverse stock split of its common stock at a ratio of 1-for-125. The reverse stock split became effective on January 14, 2013. On May 15, 2013, the Company’s stockholders approved a reverse stock split of its common stock at a ratio of 1-for-4. The reverse stock split became effective on August 1, 2013. All applicable share and per-share amounts have been retroactively adjusted to reflect the reverse stock splits.
Since January 2013, the Company has also completed the following material and immaterial acquisitions:
●AW Solutions Inc. On April 15, 2013, the Company acquired all the outstanding capital stock of AW Solutions, Inc. (“AWS”), a Florida corporation, and all outstanding membership interests of AW Solutions Puerto Rico, LLC (“AWS Puerto Rico”), a Puerto Rico limited liability company (collectively, the “AWS Entities”). The AWS Entities are professional multi-service line, telecommunications infrastructure companies that provide outsourced services to the wireless and wireline industry.
●Integration Partners-NY Corporation. In January 2014, the Company acquired Integration Partners-NY Corporation (“IPC”), a full-service voice and data network engineering firm based in New York. IPC serves both corporate enterprises and telecommunications service providers.
●RentVM, Inc. In February 2014, the Company acquired RentVM, Inc. or RentVM, a New Jersey-based provider of infrastructure-as-a-service IaaS, Platform as a service, PaaS and SaaS technology to SMB, enterprise, and carrier customers across all major verticals. Iaas, Paas and Saas allow customers to run their application on RentVM equipment without the customer purchasing capital equipment. In a private, public, or hybrid cloud environment. RentVM expands the Company’s cloud and managed services capabilities by providing a software defined data center (SDDC) platform to offer enterprise-grade cloud computing solutions.
●Highwire Broadview Technologies, Inc. On April 1, 2014, the Company’s subsidiary, ADEX Corporation, acquired the assets of Broadview Technologies, Inc., DBA High Wire Networks (“High Wire”), a telecommunications infrastructure engineering firm based in Alabama.
●Nottingham Enterprises LLC. In July 2014, the Company purchased a 40% interest of Nottingham Enterprises LLC (“Nottingham”), a reseller of telecommunications hardware.
●VaultLogix, LLC. In October 2014, the Company acquired VaultLogix, LLC and certain related entitles (“VaultLogix”), a leading provider of cloud backup services to nearly 10,000 businesses around the world. VaultLogix safeguards a wide range of enterprise-class operating systems and applications through its unique combination of encryption, block-level data duplication and compression. In addition, through its partner program, VaultLogix offers software branding, a robust partner portal and dedicated account management.
●PCS Holding LLC. On December 1, 2014, the Company’s subsidiary, VaultLogix, executed an agreement with PCS Holding LLC to purchase the assets of Axim Cloud (“Axim”). Axim sells Amazon web services, including cloud storage services.
●Logical Link. On December 1, 2014, the Company’s subsidiary, AWS, acquired the assets of FRJ, LLC, DBA Logical Link, an Outside Plant (OSP) engineering company that specializes in field design and drafting of Wireline, Fiber & DAS deployments. Logical Link also performs construction and installation through subcontractors.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND ACCOUNTING FOR INVESTMENT IN AFFILIATE COMPANIES
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles in the United States. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which include Tropical Communications, Inc. (“Tropical”) (since August 2011), Rives-Monteiro Leasing, LLC (“RM Leasing”) (since December 2011), ADEX Corporation, ADEX Puerto Rico, LLC and HighWire (collectively, “ADEX” or “ADEX entities”) (since September 2012), TNS, Inc. (“TNS”) (since September 2012), the AWS Entities (since April 2013), IPC (since January 2014), RentVM (since February 2014), and VaultLogix (since October 2014). The results of operations for the year ended December 31, 2013 include the accounts of Environmental Remediation and Financial Service, LLC (“ERFS”) (acquired in 2012, disposed of in November 2013) as discontinued operations. All significant inter-company accounts and transactions have been eliminated in consolidation.
The Company consolidates all entities in which it has a controlling voting interest and a variable interest in a variable interest entity (“VIE”) in which the Company is deemed to be the primary beneficiary.
The consolidated financial statements include the accounts of Rives-Montiero Engineering, LLC ("RM Engineering") (since December 2011), in which the Company owns an interest of 49%. The Company has the ability to exercise its call option to acquire the remaining 51% of RM Engineering for a nominal amount and thus makes all significant decisions related to RM Engineering even though it absorbs only 49% of the losses. Additionally, substantially all of the entity’s activities either involve or are conducted on behalf of the entity by the 51% holder of RM Engineering.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The consolidation of RM Engineering resulted in increases of $1,038 in assets and $450 in liabilities in the Company’s consolidated balance sheet and $3,122 in revenue and $33 in net loss in the consolidated statement of operations as of and for the year ended December 31, 2014.
The consolidation of RM Engineering resulted in increases of $1,000 in assets and $398 in liabilities in the Company’s consolidated balance sheet and $3,100 in revenue and $158 in net income in the consolidated statement of operations as of and for the year ended December 31, 2013.
Liquidity
At December 31, 2014, the Company had working capital deficit of approximately $13,097, as compared to working capital of approximately $4,197 at December 31, 2013. The decrease of $17,294 in the Company’s working capital from December 31, 2013 to December 31, 2014 was primarily the result of the cash payment of approximately $13,451 in connection with the Company’s acquisition of IPC on January 1, 2014 as discussed below, and additional borrowings in the year ended December 31, 2014.
The increase in the Company’s working capital at December 31, 2013 was attributable, in part, to a requirement for a cash payment of approximately $13,451 in connection with the acquisition of IPC on January 1, 2014. The Company raised $11,625 through the issuance of the Convertible Debentures, and an additional $1,725 through the sale of debt securities, in December 2013. The proceeds of such financings were used for the cash portion of the purchase price of IPC.
On or prior to December 31, 2015, the Company has obligations relating to the payment of indebtedness as follows:
● $4,000 related to term loans due June 1, 2015 and June 24, 2015;
● $2,331 payable to the holders of the Convertible Debentures, which is payable in monthly installments through June 1015;
●$2,000 related to term loans, which is payable in quarterly installments through December 2015;
●$1,000 relating to a term loan due November 1, 2015; and
● $350 relating to promissory notes held by related parties that mature prior to December 31, 2015.
The Company anticipates meeting its cash obligations on indebtedness that is payable on or prior to December 31, 2015 from earnings from operations, including, in particular, the operations of VaultLogix, which was acquired in October 2014, and possibly from the proceeds of additional indebtedness or equity raises. If the Company is not successful in obtaining additional financing when required, the Company expects that it will be able to renegotiate and extend certain of its notes payable as required to enable it to meet certain debt obligations as they become due, although there can be no assurance that the Company will be able to do so.
The Company’s future capital requirements for its operations will depend on many factors, including the profitability of its businesses, the number and cash requirements of other acquisition candidates that the Company pursues, and the costs of operations. The Company has been investing in sales personnel in anticipation of increasing revenue opportunities in the cloud and managed services segment of its business, which has contributed to the losses from operations. The Company’s management has taken several actions to ensure that it will have sufficient liquidity to meet its obligations through December 31, 2015, including the reduction of certain general and administrative expenses, consulting expenses and other professional services fees. Additionally, if the Company’s actual revenues are less than forecasted, the Company anticipates implementing headcount reductions to a level that more appropriately matches then-current revenue and expense levels. The Company is evaluating other measures to further improve its liquidity, including, the sale of equity or debt securities and entering into joint ventures with third parties. Lastly, the Company may elect to reduce certain related-party and third party debt by converting such debt into common shares. Refer to Note 19 Subsequent Events for a discussion on restructuring of related party debt and the extension of maturity dates. The Company is currently in discussion with a third party on a credit facility to enhance its liquidity position. The Company’s management believes that these actions will enable the Company to meet its liquidity requirements through December 31, 2015. There is no assurance that the Company will be successful in any capital-raising efforts that it may undertake to fund operations during 2015.
The Company plans to generate positive cash flow from its recently-completed acquisitions to address some of the liquidity concerns. However, to execute the Company’s business plan, service existing indebtedness and implement its business strategy, the Company anticipates that it will need to obtain additional financing from time to time and may choose to raise additional funds through public or private equity or debt financings, a bank line of credit, borrowings from affiliates or other arrangements. The Company cannot be sure that any additional funding, if needed, will be available on terms favorable to the Company or at all. Furthermore, any additional capital raised through the sale of equity or equity-linked securities may dilute the Company’s current stockholders’ ownership and could also result in a decrease in the market price of the Company’s common stock. The terms of those securities issued by the Company in future capital transactions may be more favorable to new investors and may include the issuance of warrants or other derivative securities, which may have a further dilutive effect. The Company also may be required to recognize non-cash expenses in connection with certain securities it issues, such as convertible notes and warrants, which may adversely impact the Company’s financial condition. Furthermore, any debt financing, if available, may subject the Company to restrictive covenants and significant interest costs. There can be no assurance that the Company will be able to raise additional capital, when needed, to continue operations in their current form.
USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Changes in estimates and assumptions are reflected in reported results in the period in which they become known. Use of estimates includes the following: 1) valuation of derivative instruments and preferred stock, 2) allowance for doubtful accounts, 3) estimated useful lives of property, equipment and intangible assets, 4) valuation of contingent consideration, 5) revenue recognition, 6) estimates related to deferred tax assets, 7) valuation of intangible assets,8) goodwill impairment, 9) indefinite lived intangible assets, and 10) estimates in connection with the allocation of the purchase price allocations.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SEGMENT INFORMATION
As of December 31, 2013, the Company reported two operating segments, which consisted of specialty contracting services and telecommunications staffing services. The Company acquired four companies since January 1, 2013. In connection with such acquisitions, the Company evaluated each newly-acquired company’s sources of revenues and costs of revenues and determined that three of the four additional companies did not share similar economic characteristics with the two existing operating segments. As such, it was determined that the three companies should be reported as a separate operating segment, cloud and managed services and the fourth acquisition was aggregated within the professional services segment.
In 2014, the Company operated in four operating segments - as an applications and infrastructure provider, as a professional services provider and as a cloud services provider and managed services provider. The applications and infrastructure segment provides engineering and professional consulting services and voice, data and optical solutions. The engineering, design, installation and maintenance services of the applications and infrastructure segment support the build-out and operation of enterprise, fiber optic, Ethernet and wireless networks. The professional services segment provides outsourced services to the wireless and wireline industry and information technology industry. The cloud services segment provides cloud computing and storage services to customers. The managed services segment provides hardware and software products to customers and provides maintenance and support for those products. The Company has concluded that it has three reportable segments, the applications and infrastructure operating segment and the professional services operating segment are considered individual reporting segments, while the cloud services and managed services operating segments are aggregated into one reportable segment.
The Company’s reporting units have been aggregated into one of four operating segments due to their similar economic characteristics, products, or production and distribution methods. The first operating segment is applications and infrastructure, which is comprised of the components TNS, AWS, Tropical and RM Engineering. The Company’s second operating segment is professional services, which consists of the ADEX components. The Company’s third operating segment is cloud services, which consists of the VaultLogix components and the fourth operating segment is and managed services, which consists of the IPC and RentVM components.
Refer to Note 17. Segment Information for a detailed discussion on the change in reporting segments.
CASH
Cash consists of checking accounts and money market accounts. The Company considers all highly-liquid investments purchased with an original maturity of three months or less to be cash.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Management reviews a customer’s credit history before extending credit. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Estimates of uncollectible amounts are reviewed each period, and changes are recorded in the period in which they become known. Management analyzes the collectability of accounts receivable each period. This review considers the aging of account balances, historical bad debt experience, changes in customer creditworthiness, current economic trends, customer payment activity and other relevant factors. Should any of these factors change, the estimate made by management may also change. Allowance for doubtful accounts was $1,545 and $738 at December 31, 2014 and 2013, respectively.
INVENTORY
The inventory balance at December 31, 2014 relates to the Company’s IPC subsidiary. IPC purchases inventory for resale to customers and records it at lower of cost or market until sold. Inventory consists of networking equipment that was purchased and not delivered to customers as of December 31, 2014. The Company did not hold any inventory as of December 31, 2013 as all inventory relates to the IPC subsidiary, which was acquired in January 2014.
BUSINESS COMBINATIONS
The Company accounts for its business combinations under the provisions of Accounting Standards Codification ("ASC") Topic 805-10, Business Combinations ("ASC 805-10"), which requires that the purchase method of accounting be used for all business combinations. Assets acquired and liabilities assumed, including non-controlling interests, are recorded at the date of acquisition at their respective fair values. ASC 805-10 also specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combinations and are expensed as incurred. If the business combination provides for contingent consideration, the Company records the contingent consideration at fair value at the acquisition date and any changes in fair value after the acquisition date are accounted for as measurement-period adjustments if they pertain to additional information about facts and circumstances that existed at the acquisition date and that the Company obtained during the measurement period. Changes in fair value of contingent consideration resulting from events after the acquisition date, such as earn-outs, are recognized as follows: 1) if the contingent consideration is classified as equity, the contingent consideration is not re-measured and its subsequent settlement is accounted for within equity, or 2) if the contingent consideration is classified as a liability, the changes in fair value are recognized in earnings.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The estimated fair value of net assets acquired, including the allocation of the fair value to identifiable assets and liabilities, was determined using Level 3 inputs in the fair value hierarchy (see Fair Value of Financial Instruments in Note 2). The estimated fair value of the net assets acquired was determined using the income approach to valuation based on the discounted cash flow method. Under this method, expected future cash flows of the business on a stand-alone basis are discounted back to a present value. The estimated fair value of identifiable intangible assets, consisting of customer relationships, the trade names and non-compete agreements acquired, also were determined using an income approach to valuation based on excess cash flow, relief of royalty and discounted cash flow methods.
The discounted cash flow valuation method requires the use of assumptions, the most significant of which include: future revenue growth, future earnings before interest, taxes, depreciation and amortization, estimated synergies to be achieved by a market participant as a result of the business combination, marginal tax rate, terminal value growth rate, weighted average cost of capital and discount rate.
The excess earnings method used to value customer relationships requires the use of assumptions, the most significant of which include: the remaining useful life, expected revenue, survivor curve, earnings before interest and tax margins, marginal tax rate, contributory asset charges, discount rate and tax amortization benefit.
The most significant assumptions under the relief of royalty method used to value trade names and developed technology include: estimated remaining useful life, expected revenue, royalty rate, tax rate, discount rate and tax amortization benefit. The discounted cash flow method used to value non-compete agreements includes assumptions such as: expected revenue, term of the non-compete agreements, probability and ability to compete, operating margin, tax rate and discount rate. Management has developed these assumptions on the basis of historical knowledge of the business and projected financial information of the Company. These assumptions may vary based on future events, perceptions of different market participants and other factors outside the control of management, and such variations may be significant to estimated values.
GOODWILL AND INDEFINTITE LIVED INTANGIBLE ASSETS
Goodwill was generated through the acquisitions made by the Company between 2013 and 2014. As the total consideration paid exceeded the value of the net assets acquired, the Company recorded goodwill for each of the completed acquisitions. At the date of acquisition, the Company performed a valuation to determine the value of the intangible assets, along with the allocation of assets and liabilities acquired. The goodwill is attributable to synergies and economies of scale provided to the Company by the acquired entity (see Note 3. Acquisitions and Disposals of Subsidiaries).
The Company tests its goodwill and indefinite-lived intangible assets for impairment at least annually (as of December 31) and whenever events or circumstances change that indicate impairment may have occurred. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in the Company’s expected future cash flows; a sustained, significant decline in the Company’s stock price and market capitalization; a significant adverse change in legal factors or in the business climate of its segments; unanticipated competition; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of goodwill, the indefinite-lived intangible assets and the Company’s consolidated financial results.
Goodwill has been assigned to the reporting unit to which the value relates. The Company aggregates its reporting units and tests its goodwill for impairment at the operating segment level. Ten of the Company's fourteen reporting units have goodwill. The Company tests goodwill by estimating the fair value of the reporting unit using a Discounted Cash Flow (“DCF”) model. The key assumptions used in the DCF model to determine the highest and best use of estimated future cash flows include revenue growth rates and profit margins based on internal forecasts, terminal value and an estimate of a market participant's weighted-average cost of capital used to discount future cash flows to their present value.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company tested the indefinite-lived intangible assets using a Relief From Royalty Method (“RFRM”) under the Income Approach in conjunction with a Market Approach Method. The key assumptions used in the RFRM model include revenue growth rates, the terminal value and the assumed discount rate. The Market Approach Method uses one or more methods that compare the Company to similar businesses, business ownership interest and securities that have been sold. Certain elements of the Market Approach Method are incorporated in the RFRM. While the Company uses available information to prepare estimates and to perform impairment evaluations, actual results could differ significantly from these estimates or related projections, resulting in impairment related to recorded goodwill balances. Additionally, adverse conditions in the economy and future volatility in the equity and credit markets could impact the valuation of the Company's reporting units. The Company can provide no assurances that, if such conditions occur, they will not trigger impairments of goodwill and other intangible assets in future periods within all segments.
During 2014, indicators of potential impairment of goodwill and indefinite-lived intangible assets were identified by management in the professional services segment. The Company's management then determined that the ADEX operating segment assets were impaired and recognized an impairment loss of $1,369 related to goodwill and $2,392 related to intangible assets as the carrying value of the ADEX business unit was in excess of its fair value. If ADEX’s projected long-term sales growth rate, profit margins or terminal rate continue to change, or the assumed weighted-average cost of capital is considerably higher, future testing may indicate additional impairment in this reporting unit and, as a result, the remaining assets may also be impaired. See Note 5, Goodwill and Intangible Assets for further information.
With regard to other long-lived assets and intangible assets with indefinite-lives, the Company follows a similar impairment assessment. The Company will assess the quantitative factors to determine if an impairment test of the indefinite-lived intangible asset is necessary. If the quantitative assessment reveals that it is more likely than not that the asset is impaired, a calculation of the asset’s fair value is made. Fair value is calculated using many factors, which include the future discounted cash flows as well as the estimated fair value of the asset in an arm’s-length transaction. As of December 31, 2014 and 2013, respectively, the results of the Company’s analysis indicated that no impairment existed.
REVENUE RECOGNITION
The Company’s revenues are generated from their three reportable segments: applications and infrastructure, professional services, and cloud and managed services. The Company recognizes revenue on arrangements in accordance with ASC Topic 605-10, “Revenue Recognition”. The Company recognizes revenue only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.
The applications and infrastructure segment revenues are derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. The contracts of TNS, Tropical and RM Engineering provide that payment for the Company’s services may be based on either direct labor hours at fixed hourly rates or fixed-price contracts. The services provided under the contracts are generally provided within one month. Occasionally, the services may be provided over a period of up to six months.
AWS recognizes revenue using the percentage of completion method. Revenues and fees on these contracts are recognized utilizing the efforts-expended method, which uses measures such as task duration and completion. The efforts-expended approach is an input method used in situations where it is more representative of progress on a contract than the cost-to-cost or the labor-hours methods. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. Changes in job performance conditions and final contract settlements may result in revisions to costs and income, which are recognized in the period in which revisions are determined.
AWS also generates revenue from service contracts with certain customers. These contracts are accounted for under the proportional performance method. Under this method, revenue is recognized in proportion to the value provided to the customer for each project as of each reporting date.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The revenues of the Company’s professional services segment, which is comprised of the ADEX subsidiaries, are derived from contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. The contracts provide that payments made for the Company’s services may be based on either direct labor hours at fixed hourly rates or fixed-price contracts. The services provided under these contracts are generally provided within one month. Occasionally, the services may be provided over a period of up to four months. If it is anticipated that the services will span a period exceeding one month, depending on the contract terms, the Company will provide either progress billing at least once a month or upon completion of the clients’ specifications. The aggregate amount of unbilled work-in-progress recognized as revenues was insignificant at December 31, 2014 and 2013, respectively.
ADEX’s HighWire division generates revenue through its telecommunications engineering group which contracts with telecommunications infrastructure manufacturers to install the manufacturer’s products for end users. Highwire recognizes revenue using the proportional performance method. Under the proportional performance method, the Company recognizes revenue when a project within a contract is completed. Management judgments and estimates must be made and used in connection with revenue recognized using the proportional performance method. If management made different judgments and estimates, then the amount and timing of revenue for any period could differ materially from the reported revenue.
The Company sometimes requires customers to provide a deposit prior to beginning work on a project. When this occurs, the deposit is recorded as deferred revenue and is recognized in revenue when the work is complete.
The Company’s IPC subsidiary, which is included in the Company’s cloud and managed services segment, is a value-added reseller whose revenues are generated from the resale of voice, video and data networking hardware and software contracted services for design, implementation and maintenance services for voice, video, and data networking infrastructure. IPC’s customers are higher education organizations, governmental agencies and commercial customers. IPC also provides maintenance and support and professional services.
For multiple-element arrangements, IPC recognizes revenue in accordance with ASC 605-25, “Arrangements with Multiple Deliverables”. The Company allocates revenue for such arrangements based on the relative selling prices of the elements applying the following hierarchy: first vendor specific objective evidence (“VSOE”), then third-party evidence (“TPE”) of selling price if VSOE is not available, and finally our estimate of the selling price if neither VSOE nor TPE is available. VSOE exists when we sell the deliverables separately and represents the actual price charged by us for each deliverable. Estimated selling price reflects our best estimate of what the selling prices of each deliverable would be if it were sold regularly on a standalone basis taking into consideration the cost structure of our business, technical skill required, customer location and other market conditions. Each element that has standalone value is accounted for as a separate unit of accounting. Revenue allocated to each unit of accounting is recognized when the service is provided or the product is delivered.
The Company’s VaultLogix subsidiary, which is included in the Company’s cloud and managed services segment, provides on-line data backup services to their customers. VaultLogix recognizes revenue in accordance with ASC Topic 605-10. Certain customers pay for their services in advance of services being performed. Revenue for these customers is deferred until the services are performed. During 2013, the Company did not recognize any revenue from cloud-based services.
LONG-LIVED ASSETS, INCLUDING DEFINITE-LIVED INTANGIBLE ASSETS
Long-lived assets, other than goodwill and other indefinite-lived intangibles, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows derived from such assets.
Definite-lived intangible assets primarily consist of non-compete agreements and customer relationships. For long-lived assets used in operations, impairment losses are only recorded if the asset's carrying amount is not recoverable through its undiscounted, probability-weighted future cash flows. The Company measures the impairment loss based on the difference between the carrying amount and the estimated fair value. When an impairment exists, the related assets are written down to fair value.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated on a straight-line basis over their estimated useful lives. Useful lives are: 3-7 years for vehicles; 5-7 years for equipment; 3-10 years for developed software; and 3 years for computers and office equipment. Maintenance and repairs are expensed as incurred and major improvements are capitalized. When assets are sold or retired, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in other income.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DEFERRED LOAN COSTS
Deferred loan costs are capitalized and amortized to interest expense using the effective interest method over the terms of the related debt agreements. The amount of amortization of deferred loan costs, which was recorded as interest expense, in the years ended December 31, 2014 and 2013 was $1,371 and $671, respectively. As a result of the conversion of a portion of the Company’s convertible debentures and a term loan at various dates during 2014, the Company recorded $722 of accelerated amortization of the deferred loan costs related to that debt for the year ended December 31, 2014.
CONCENTRATIONS
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and trade receivables. The Company maintains its cash balances with high-credit-quality financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. These deposits may be withdrawn upon demand and therefore bear minimal risk. The Company limits the amount of credit exposure through diversification and management regularly monitors the composition of its investment portfolio.
The Company provides credit to customers on an uncollateralized basis after evaluating client creditworthiness. The Company’s largest customer, Ericsson, Inc. and its affiliates, accounted for 15% and 41% of consolidated revenues for the years ended December 31, 2014 and 2013, respectively. In addition, amounts due from this customer represented 7% and 26% of trade accounts receivable as of December 31, 2014 and 2013, respectively. A significant reduction in business from this significant customer or its failure to pay outstanding trade accounts receivable could have a material adverse effect on the Company’s results of operations and financial condition.
The Company’s customers in its applications and infrastructure and professional services segments are located within the United States of America and Puerto Rico. Revenues generated within the United States of America accounted for approximately 96% and 92% of consolidated revenues for the years ended December 31, 2014 and 2013, respectively. Revenues generated from foreign sources accounted for approximately 4% and 8% of consolidated revenues for the years ended December 31, 2014 and 2013, respectively.
The Company has obligations contingent on the performance of its subsidiaries. These contingent obligations, payable to the former owners of the subsidiaries, are based on metrics that contain escalation clauses. The Company believes that the amounts recorded within the liabilities section of the consolidated balance sheets are indicative of fair value and are also considered the most likely payout of these obligations. If conditions were to change, these liabilities could potentially impact the Company’s results of operations, financial condition and future cash flows.
COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is subject to various contingencies. The Company records any contingencies in the consolidated financial statements when it is probable that a liability will be incurred and the amount of the loss is reasonably estimable, or otherwise disclosed, in accordance with ASC Topic 450, Contingencies ("ASC 450"). Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. In the event the Company determines that a loss is not probable, but is reasonably possible, and it becomes possible to develop what the Company believes to be a reasonable range of possible loss, then the Company will include disclosures related to such matter as appropriate and in compliance with ASC 450. To the extent there is a reasonable possibility that the losses could exceed the amounts already accrued, the Company will, when applicable, adjust the accrual in the period in which the determination is made, disclose an estimate of the additional loss or range of loss, indicate that the estimate is immaterial with respect to its financial statements as a whole or, if the amount of such adjustment cannot be reasonably estimated, disclose that an estimate cannot be made.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In March 2014, a complaint was filed in the United States District Court for the District of New Jersey against the Company, the Company’s Chairman of the Board and Chief Executive Officer, Mark Munro, The DreamTeamGroup and MissionIR, as purported securities advertisers and investor relations firms, and John Mylant, a purported investor and investment advisor. The complaint was purportedly filed on behalf of a class of certain persons who purchased the Company's common stock between November 5, 2013 and March 17, 2014. The complaint alleges violations by the defendants (other than Mark Munro) of Section 10(b) of the Exchange Act, and other related provisions in connection with certain alleged courses of conduct that were intended to deceive the plaintiff and the investing public and to cause the members of the purported class to purchase shares of the Company's common stock at artificially inflated prices based on untrue statements of a material fact or omissions to state material facts necessary to make the statements not misleading. The complaint also alleges that Mr. Munro and the Company violated Section 20 of the Exchange Act as controlling persons of the other defendants. The complaint seeks unspecified damages, attorney and expert fees, and other unspecified litigation costs.
In January 2015, a suit was filed in the United States District Court of the Southern District of New York against the Company, the Chairman of the Board and Chief Executive Officer, Mark Munro, the Chief Accounting Officer and former Chief Financial Officer, Dan Sullivan, alleging, among other claims, breach of contract due to the Company’s failure to pay certain post-closing purchase price payments to the sellers of IPC in connection with the Company’s purchase of IPC in January 2014, and that Messrs. Munro and Sullivan intentionally interfered with such contractual obligations.
The Company intends to dispute these claims and to defend these litigations vigorously. However, due to the inherent uncertainties of litigation, the ultimate outcome of these litigations is uncertain. An unfavorable outcome in either litigation could materially and adversely affect the Company's business, financial condition and results of operations.
Currently, there is no other material litigation pending against the Company other than as disclosed in the paragraphs above. From time to time, the Company may become a party to litigation and subject to claims incident to the ordinary course of the Company's business. Although the results of such litigation and claims in the ordinary course of business cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a material adverse effect on the Company's business, results of operations or financial condition. Regardless of outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.
DISTINGUISHMENT OF LIABILITIES FROM EQUITY
The Company relies on the guidance provided by ASC Topic 480, Distinguishing Liabilities from Equity, to classify certain redeemable and/or convertible instruments, such as the Company’s preferred stock. The Company first determines whether a financial instrument should be classified as a liability. The Company will determine the liability classification if the financial instrument is mandatorily redeemable, or if the financial instrument, other than outstanding shares, embodies a conditional obligation that the Company must or may settle by issuing a variable number of its equity shares.
Once the Company determines that a financial instrument should not be classified as a liability, the Company determines whether the financial instrument should be presented between the liability section and the equity section of the balance sheet (“temporary equity”). The Company will determine temporary equity classification if the redemption of the preferred stock or other financial instrument is outside the control of the Company (i.e. at the option of the holder). Otherwise, the Company accounts for the financial instrument as permanent equity.
Initial Measurement
The Company records its financial instruments classified as liability, temporary equity or permanent equity at issuance at the fair value, or cash received.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Subsequent Measurement
Financial instruments classified as liabilities
The Company records the fair value of its financial instruments classified as liabilities at each subsequent measurement date. The changes in fair value of its financial instruments classified as liabilities are recorded as other expense/income. The Company uses the Black Scholes pricing method, which is not materially different from a binomial lattice valuation methodology utilizing Level 3 inputs, to determine the fair value of derivative liabilities resulting from warrants and options. The Monte Carlo simulation is used to determine the fair value of derivatives for instruments with embedded conversion features.
INCOME TAXES
The Company accounts for income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established to reduce deferred tax assets when management estimates, based on available objective evidence, that it is more likely than not that the benefit will not be realized for the deferred tax assets. The Company, and its subsidiaries, conduct business, and file income, franchise or net worth tax returns, in thirty nine (39) states and the Commonwealth of Puerto Rico. The Company determines its filing obligations in a jurisdiction in accordance with existing statutory and case law.
Significant management judgment is required in determining the provision for income taxes, and in particular, any valuation allowance recorded against the Company’s deferred tax assets. Deferred tax assets are regularly reviewed for recoverability. The Company currently has significant deferred tax assets resulting from net operating loss carryforwards and deductible temporary differences, which should reduce taxable income in future periods. The realization of these assets is dependent on generating future taxable income.
In June 2006, the FASB issued ASC Topic 740, Income Taxes (“ASC Topic 740”) (formerly FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109) which prescribes a two-step process for the financial statement recognition and measurement of income tax positions taken or expected to be taken in an income tax return. The first step evaluates an income tax position in order to determine whether it is more likely than not that the position will be sustained upon examination, based on the technical merits of the position. The second step measures the benefit to be recognized in the financial statements for those income tax positions that meet the more likely than not recognition threshold. ASC Topic 740 also provides guidance on de-recognition, classification, recognition and classification of interest and penalties, accounting in interim periods, disclosure and transition. Penalties and interest, if incurred, would be recorded as a component of current income tax expense. As of December 31, 2014, and 2013, the Company has no accrued interest or penalties related to uncertain tax positions. The Company believes that any uncertain tax positions would not have a material impact on the results of operations.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with ASC Topic 718, Compensation-Stock Compensation ("ASC Topic 718"). Under the fair value recognition provisions of this topic, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense on a straight-line basis over the requisite service period, based on the terms of the awards. The Company adopted a formal stock option plan in December 2012 and it had not issued any options under the plan as of December 31, 2013. The Company issued options prior to the adoption of this plan, but the amount was not material. Historically, the Company has awarded stock grants to certain of its employees and consultants that did not contain any performance or service conditions. Compensation expense included in the Company’s consolidated statement of operations includes the fair value of the awards at the time of issuance. When common stock was issued, it was valued at the trading price on the date of issuance and was expensed as it was issued. All stock grants issued in 2013 were fully vested in 2013. The Company granted an aggregate of 1,791,979 shares in 2014, of which 1,189,987 shares were subject to a 3-year vesting term, 185,000 shares were subject to 1-year vesting, and 416,992 shares had no vesting terms.
2012 PERFORMANCE INCENTIVE PLAN and EMPLOYEE STOCK PURCHASE PLAN
On November 16, 2012, the Company adopted its 2012 Equity Incentive Plan (the "Equity Incentive Plan") and it’s Employee Stock Purchase Plan (the "Stock Purchase Plan"). Both plans were established to attract, motivate, retain and reward selected employees and other eligible persons. For the Equity Incentive Plan, employees, officers, directors and consultants who provide services to the Company or one of the Company’s subsidiaries may be selected to receive awards. A total of 2,325,000 shares of the Company’s common stock is authorized for issuance with respect to awards granted under the Equity Incentive Plan. The number of authorized shares under the Equity Incentive Plan will automatically increase on the first trading day in January of each year (commencing with January 2014) by an amount equal to lesser of (i) 4% of the total number of outstanding shares of the Company’s common stock on the last trading day in December in the prior year, (ii) 2,000,000 shares, or (iii) such lesser number as determined by the Company’s board of directors. Any shares subject to awards that are not paid, delivered or exercised before they expire or are canceled or terminated, or fail to vest, as well as shares used to pay the purchase or exercise price of awards or related tax withholding obligations, will become available for other award grants under the Equity Incentive Plan. During the year ended December 31, 2014, an aggregate of 1,957,353 shares were granted under the Equity Incentive Plan, and 1,101,396 shares authorized under the Equity Incentive Plan remained available for award purposes.
The Stock Purchase Plan is designed to allow the Company’s eligible employees and the eligible employees of the Company’s participating subsidiaries to purchase shares of the Company’s common stock, at semi-annual intervals, with their accumulated payroll deductions. A total of 500,000 shares of the Company’s common stock was initially available for issuance under the Stock Purchase Plan. The share limit will automatically increase on the first trading day in January of each year (commencing with January 2014) by an amount equal to lesser of (i) 1% of the total number of outstanding shares of the Company’s common stock on the last trading day in December in the prior year, (ii) 500,000 shares, or (iii) such lesser number as determined by the Company’s board of directors. As of December 31, 2014 and 2013, no shares had been purchased under the Stock Purchase Plan.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NET LOSS PER SHARE
The Company follows ASC 260, Earnings Per Share, which requires presentation of basic and diluted earnings per share (“EPS”) on the face of the income statement for all entities with complex capital structures, and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. In the accompanying financial statements, basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted EPS excluded all dilutive potential shares if their effect was anti-dilutive.
The following sets forth the computation of diluted EPS for the year ended December 31, 2014:
Basic net loss per share is based on the weighted average number of common and common-equivalent shares outstanding. Potential common shares includable in the computation of fully-diluted per share results are not presented for the years ended December 31, 2014 and 2013, respectively, in the consolidated financial statements as their effect would be anti-dilutive.
Basic loss per common share is computed based on the weighted average number of shares outstanding during the period. Diluted loss per share is computed in a manner similar to the basic loss per share, except the weighted-average number of shares outstanding is increased to include all common shares, including those with the potential to be issued by virtue of warrants, options, convertible debt and other such convertible instruments. Diluted loss per share contemplates a complete conversion to common shares of all convertible instruments only if they are dilutive in nature with regards to earnings per share.
The anti-dilutive shares of common stock outstanding for years ended December 31, 2014 and 2013 were as follows:
FAIR VALUE OF FINANCIAL INSTRUMENTS
ASC Topic 820 "Fair Value Measurements and Disclosures" ("ASC Topic 820") provides a framework for measuring fair value in accordance with generally accepted accounting principles.
ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).
The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under ASC Topic 820 are described as follows:
● Level 1- Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.
● Level 2- Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
● Level 3- Inputs that are unobservable for the asset or liability.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following section describes the valuation methodologies that the Company used to measure, for disclosure purposes, its financial instruments at fair value.
Debt
The fair value of the Company’s debt, which approximated the carrying value of the Company's debt, as of December 31, 2014 and December 31, 2013 was estimated at $57,921 and $31,600, respectively. Factors that the Company considered when estimating the fair value of its debt included market conditions, liquidity levels in the private placement market, variability in pricing from multiple lenders and term of debt. The level of the debt would be considered as level 2.
Contingent Consideration
The fair value of the Company’s contingent consideration is based on the Company’s evaluation as to the probability and amount of any earn-out that will be achieved based on expected future performance by the acquired entity. The Company utilizes a third-party valuation firm to assist in the calculation of the contingent consideration at the acquisition date. The Company evaluates the forecast of the acquired entity and the probability of earn-out provisions being achieved when it evaluates the contingent consideration at initial acquisition date and at each subsequent reporting period. The fair value of contingent consideration is measured at each reporting period and adjusted as necessary. The Company evaluates the terms in contingent consideration arrangements provided to former owners of acquired companies who become employees of the Company to determine if such amounts are part of the purchase price of the acquired entity or compensation.
Additional Disclosures Regarding Fair Value Measurements
The carrying value of cash, accounts receivable and accounts payable approximate their fair value due to the short-term maturity of those items.
Derivative Warrant Liabilities
The fair value of the derivative liabilities is classified as Level 3 within the Company’s fair value hierarchy. Please refer to Footnote 9 Derivative Instruments for a further discussion of the measurement of fair value of the derivatives and their underlying assumptions.
The fair value of the Company’s financial instruments carried at fair value at December 31, 2014 and 2013 were as follows:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following table provides a summary of changes in fair value of the Company’s Level 3 financial instruments for the years ended December 31, 2014 and 2013.
TREASURY STOCK
The Company records treasury stock at the cost to acquire it and includes treasury stock as a component of stockholders’ equity (deficit).
RECENT ACCOUNTING PRONOUNCEMENTS
On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which is effective for public entities for annual reporting periods beginning after December 15, 2016. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 shall be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is currently evaluating the impact of the pending adoption of ASU 2014-09 on the consolidated financial statements and has not yet determined the method by which the Company will adopt the standard in 2017.
In April 2014, the FASB issued ASU No. 2014-08, Reporting of Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). ASU 2014-08 provides a narrower definition of discontinued operations than under existing U.S. GAAP. ASU 2014-08 requires that only a disposal of a component of an entity, or a group of components of an entity, that represents a strategic shift that has, or will have, a major effect on the reporting entity’s operations and financial results should be reported in the financial statements as discontinued operations. ASU 2014-08 also provides guidance on the financial statement presentations and disclosures of discontinued operations. ASU 2014-08 is effective prospectively for disposals (or classifications as held for disposal) of components of an entity that occur in annual or interim periods beginning after December 15, 2014. The Company does not expect the adoption of ASU 2014-08 to have a material impact on the consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern-Disclosures of Uncertainties about an entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 provides new guidance related to management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards and to provide related footnote disclosures. This new guidance is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The requirements of ASU 2014-15 are not expected to have a significant impact on the consolidated financial statements.
RECLASSIFICATIONS
Certain 2013 activities and balances were reclassified to conform to classifications used in the current period.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
3. ACQUISITIONS AND DISPOSALS OF SUBSIDIARIES
Acquisition and Disposal of Environmental Remediation and Financial Services, LLC
On December 17, 2012, ADEX acquired 100% of the membership interests in ERFS, an environmental remediation company that provides in site remediation of oil, chemicals and ground/water. The purchase consideration for ERFS was $6,651, which was paid with 4,500 shares of Series I Preferred Stock, which shares were valued at $4,187. The seller of ERFS was entitled to redeem up to $750 of the Series I Preferred Stock on or after March 31, 2013. As additional consideration, the Company agreed to pay the ERFS seller 1.5 times EBITDA for the twelve-month period from January 1, 2013 through December 31, 2013, provided that the EBITDA for such twelve-month period exceeded the EBITDA for the twelve month period prior to closing by $10. This earn-out consideration was valued at $2,464. The Series I Preferred shares were classified within temporary equity because the redemption of those shares rested with the holders of those instruments. The goodwill was attributable to synergies and economies of scale provided to the Company. The acquisition was accounted for as a stock purchase. The goodwill was not tax deductible. The Company did not incur any acquisition-related costs for the year ended December 31, 2012.
During 2013, the Company’s management decided to exit its environmental remediation and disaster recovery services business conducted by ERFS (see Note 18, Discontinued Operations). The Series I Preferred Stock issued as part of the purchase price of ERFS, along with the contingent consideration payable to the sellers of ERFS, were received by the Company and retired as part of the proceeds of the sale of ERFS.
Acquisition of AW Solutions Inc.
On April 15, 2013, the Company acquired all of the outstanding capital stock of the AWS Entities. The AWS Entities are professional multi-service line, telecommunications infrastructure companies that provide outsourced services to the wireless and wireline industry. The purchase consideration for the AWS Entities was $8,760, which was paid with $500 in cash, common stock valued at $2,608, a 45-day promissory note valued at $2,108, a note in the principal amount of $1,034, which was equal to the net working capital of AWS on the date of acquisition, and contingent consideration, which was valued at $2,511 and was recorded as a liability at the date of acquisition. The contingent consideration payable was based on the EBITDA of the AWS Entities for the twelve months following the date of acquisition. The contingent consideration also consists of a formula tied to the EBITDA growth for the thirteenth through twenty-fourth months after the date of acquisition. The Company estimated the contingent consideration based on the expected growth of AWS. The Company had an independent valuation performed of the acquisition to determine the value of the contingent consideration and the value of the stock issued on the acquisition date. As the total consideration paid by the Company for AWS exceeded the net assets acquired, the Company recorded approximately $2,200 of goodwill. The goodwill is attributable to synergies and economies of scale provided to the Company. The goodwill is tax deductible. The amount of acquisition-related costs for the acquisition of AW Solutions was $125, which amount was recorded on the Company’s consolidated statement of operations as general and administrative expenses.
The final purchase consideration for the 2013 acquisition of the AWS Entities was calculated as follows:
The final purchase consideration was allocated to the assets acquired and liabilities assumed as follows:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Acquisition of IPC
On January 1, 2014, the Company acquired all of the outstanding capital stock of IPC. The purchase price for the acquisition was paid as follows:
● an aggregate of $12,510 was paid to two sellers;
● a convertible promissory note was issued to Mr. Jadevaia in the original principal amount of $6,255 (the “Jadevaia Note”);
● 45,676 shares of the Company’s common stock was issued to Mr. Jadevaia or his designee(s);
● 5,886 shares of the Company’s common stock was issued to each of Messrs. Nahabedian and Graf or their respective designee(s); and
● $942 and 47,080 shares of the Company’s common stock was placed in escrow to secure the sellers’ indemnification and certain other obligations under the purchase agreement.
As additional earn-out consideration, the Company was to pay an amount equal to (i) the product of 0.6 multiplied by the EBITDA of IPC for the 12-month period beginning on January 1, 2014 (the “Forward EBITDA”), plus (ii) in the event that the Forward EBITDA exceeded the closing trailing-twelve-month EBITDA by 5.0% or more, an amount equal to 2.0 multiplied by this difference, which amount was to be payable in cash or, at the Company's election, shares of the Company’s common stock. This amount was to be recorded as compensation in the period in which it was earned, as Mr. Jadevaia became the President of the Company upon completion of this transaction. For the year ended December 31, 2014, no contingent consideration was earned.
The Jadevaia Note accrues interest at the rate of 8% per annum, and all principal and interest accruing thereunder was due and payable on December 31, 2014. At the election of Mr. Jadevaia, the Jadevaia Note is convertible into shares of the Company's common stock at a conversion price of $16.99 per share (subject to equitable adjustments for stock dividends, stock splits, recapitalizations and other similar events). The Company can elect to force the conversion of the Jadevaia Note if the Company’s common stock is trading at a price greater than or equal to $16.99 for ten consecutive trading days.
On December 31, 2014, the Company and Mr. Jadevaia agreed to a modification of the Jadevaia Note. The terms of the note were extended to May 30, 2016 and, in consideration for this modification, the Company issued to Mr. Jadevaia 100,000 shares of common stock. At the time of modification, the Company recorded the stock payable as a current liability and related expense to loss on debt modification in the amount of $292 on the consolidated statement of operations.
Acquisition of RentVM
On February 3, 2014, the Company entered into a stock purchase agreement with RentVM pursuant to which the Company agreed to acquire all the outstanding capital stock of RentVM. In consideration for the acquisition, at the closing the Company issued 400,000 shares of its common stock, of which (i) an aggregate of 331,601 shares were issued to the sellers and (ii) 68,399 shares were placed in escrow. The escrowed shares will remain in escrow until such time as the Company files its Annual Report on Form 10-K for the fiscal year ending December 31, 2014. The escrowed shares will secure, among other things, the sellers’ indemnification obligations under the purchase agreement. Notwithstanding the foregoing, provided no claim for indemnity has been made, or if a claim has been made and there are sufficient escrowed shares remaining to satisfy such claim, the sellers may request a release of up to 25% of the remaining escrowed shares to cover personal tax liabilities associated with the acquisition. The escrowed shares will be released in the second quarter of 2015.
Up to and including the 90th calendar day following the closing date of the acquisition, the Company had the option to purchase from the sellers, on a pro rata basis, for an aggregate option purchase price of $1,000 in cash, a number of shares of the Company’s common stock equal to the quotient of $1,000 divided by $14.62, which was the closing price of the Company’s common stock on the trading day immediately preceding the date of the purchase agreement. The Company did not exercise this option.
Acquisition of VaultLogix
Effective as of October 9, 2014, the Company consummated the acquisition of all of the outstanding membership interests of VaultLogix and its affiliated entities for an aggregate purchase price of $36,796. The purchase price for the acquisition was payable to the sellers as follows: (i) $16,385 in cash, (ii) 1,008,690 shares of the Company’s common stock and (iii) $15,627 in unsecured convertible promissory notes, as further described below. The closing payments are subject to customary working capital adjustments.
The promissory notes accrue interest at a rate of 8% per annum, and all principal and interest accrued under the promissory notes is payable on October 9, 2017. The promissory notes are convertible into shares of the Company’s common stock at a conversion price equal to $6.37 per share. A portion of the principal amount of the promissory notes equal to twenty percent (20%) of the principal amount on the Closing Date will not be convertible until the fifteen-month (15) anniversary of the Closing Date.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
On a date when (i) the shares are freely tradeable without restriction or volume limitations under Rule 144, and (ii) the average closing price of the Company’s common stock is 105% or higher of the conversion price on the three (3) trading days immediately prior to such date, the Company may deliver notice to the holders of the promissory notes electing to convert some or all of the outstanding amounts owed under the promissory notes into common stock at the applicable conversion price. Additionally, if on or after the maturity date, (i) the Company is restricted or otherwise unable to pay in cash all outstanding amounts under the promissory notes, (ii) the promissory notes have not otherwise been paid in full within ten business days following the maturity date, or (iii) the Company is not at such time entitled to effect a forced conversion, then, in the event that both (i) and (iii) above apply, the Company, and in the event that both (ii) and (iii) above apply, the holders of the promissory notes, shall have the right to convert all outstanding amounts owing under the promissory notes into shares of the Company’s common stock at a conversion price equal to the average closing price of the Company’s common stock on the three trading days immediately preceding the date of such conversion. Refer to Note 8 Term Loans for additional detail.
Effective as of December 31, 2014, VaultLogix completed the purchase of Axim Cloud assets. In consideration for the acquisition, at the closing the Company made a payment of $1,500 in shares of common stock and recorded contingent consideration of $1,872. Based on the purchase consideration and assets acquired, the Company recorded the following intangible assets: customer list of $100 and non-compete of $302. Goodwill of $2,922 was also recorded in connection with the purchase. The Company is in the process of completing a valuation of the acquisition to determine the value of the intangible assets and goodwill. Once the valuation is completed, the Company will make any adjustments as necessary.
The purchase consideration for the 2014 acquisitions of IPC, RentVM and VaultLogix were calculated as follows:
The preliminary allocation of the purchase price for VaultLogix was based upon a valuation for which the estimates and assumptions are subject to change within the measurement period (up to one year from the acquisition date). The final allocation price could differ materially from the preliminary allocation. Any subsequent changes to the purchase price allocation that result in material changes to the Company’s consolidated financial results will be adjusted accordingly.
The purchase consideration was allocated to the assets acquired and liabilities assumed as follows:
IPC
The original deferred tax liability that was recorded in the first quarter of 2014 should have resulted in the reduction of the Company’s valuation allowance. The reduction in the valuation allowance was not recorded by the Company at that time. In the fourth quarter of 2014, the Company updated the allocation of purchase price to the assets and liabilities acquired and determined that a portion of its valuation allowance was no longer required and recorded a tax benefit of $3,195. In the Company’s March 31, 2015 Form 10Q, the amount will be reflected in the Company’s March 31, 2014 consolidated statement of operations.
RentVM
The original deferred tax liability that was recorded in the first quarter of 2014 should have resulted in the reduction of the Company’s valuation allowance. The reduction in the valuation allowance was not recorded by the Company at that time. In the fourth quarter of 2014, the Company updated the allocation of purchase price to the assets and liabilities acquired.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Unaudited pro forma results of operations data of the Company as if the acquisitions had occurred as of January 1, 2013 are as follows:
Pro forma data does not purport to be indicative of the results that would have been obtained had these events actually occurred at January 1, 2013 and is not intended to be a projection of future results.
The pro forma adjustments for the years ended December 31, 2014 and 2013 consisted of the amortization of intangible assets with an identifiable life, customer lists and non-compete agreements in the amount of $597 for the years ended December 31, 2014 and 2013. The Company also borrowed the cash portion of the purchase consideration and has recorded interest expense in the amount of $1,560 in the years ended December 31, 2014 and 2013. Refer to Note 8 Term Loans for additional information.
The amount of revenues and income of the acquired companies since the acquisition date included in the Company's consolidated statements of operations are as follows:
2014 Acquisitions
2013 Acquisitions
NOTES - CONTINGENT CONSIDERATION
The Company has issued contingent consideration in connection with the acquisitions the Company completed during the years ended December 31, 2013 and 2012. The following describes the contingent consideration arrangements.
Tropical: As additional consideration, the Company agreed to issue additional shares of common stock in the Company based on a formula tied to the future earnings of Tropical. The contingent consideration to be paid to the former owners of Tropical was as follows: 50% of the net income of Tropical for the 18 months following the acquisition, along with warrants with an exercise price of $150 per share for up to 1,000 shares of Company common stock for each $500 of EBITDA generated by Tropical in the two years after the date of acquisition. The Company determined the fair value of contingent consideration to be $15. The potential range of contingent consideration could have ranged from $0, in the event Tropical had zero or negative net income, to unlimited, as there was no cap on the amount that could have been earned. The Company recorded contingent consideration in the amount of $15 as a liability on its consolidated balance sheets. As of December 31, 2013, the Company determined that, based on the results of Tropical since the date of acquisition, no contingent consideration was payable, and the fair value of the contingent consideration was adjusted to $0.
RM Engineering: As additional consideration, the Company agreed to pay 50% of the net income of RM Engineering for the 18-month period following the closing, as well as cashless exercise warrants with an exercise price of $150 per share for up to 1,000 additional shares for each $500 in net income generated by RM Engineering during the 24-month period following closing. The Company determined the fair value of the contingent consideration likely to be paid at $126. The potential range of contingent consideration could have ranged from $0, in the event RM Engineering had zero or negative net income, to unlimited, as there is no cap on the amount that could have been earned. The Company recorded this $126 contingent consideration as a liability on its consolidated balance sheets. As of December 31, 2013, the Company determined that, based on the results of RM Engineering, no contingent consideration was payable, and the fair value of the contingent consideration was adjusted to $0.
ADEX: As additional consideration, the Company agreed to pay the ADEX sellers an amount of cash equal to the product of 0.75 (the “Multiplier”) multiplied by the adjusted EBITDA of the ADEX Entities for the twelve months beginning October 1, 2012, (the “Forward EBITDA”). If the Forward EBITDA was less than $2,731, the Multiplier was to be adjusted to 0.50, and if the Forward EBITDA was greater than $3,431, the Multiplier was to be adjusted to 1.0. The Company also agreed to pay the ADEX sellers an amount of cash equal to the amount, if any, by which the Forward EBITDA was greater than $3,081. In connection with these obligations, the Company reserved 2,000 shares of Series G Preferred Stock. These shares were redeemable in the event the Company defaulted on its obligation to make the required payments. The shares of Series G Preferred were to be automatically cancelled if required payments were made in cash by the Company. The Company valued the amount of contingent consideration likely to be paid at $2,123 as of the date of acquisition. On December 31, 2013, the Company recorded a gain on the change in contingent consideration of $345 based on an agreement reached between the Company and the former owners of ADEX that the amount of contingent consideration to be paid was $1,779. The $1,779 was recorded as a contingent consideration payable on the Company's consolidated balance sheet as of December 31, 2013. During the year ended December 31, 2014, contingent consideration of $1,779 related to the ADEX acquisition was settled in cash.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
T N S: Additional consideration was to be paid to the T N S sellers in the event certain operating results were achieved by T N S. The former owners of T N S, which were the holders of the Company’s Series F Preferred Stock could have demanded that an aggregate of 3,000 shares of Series F Preferred be redeemed beginning on November 27, 2012, with the redemption to occur within 20 days of such request. The holders also could have requested that an additional 575 shares of Series F Preferred be redeemed beginning on September 17, 2013 and that an additional 575 shares of Series F Preferred be redeemed beginning on September 17, 2014. In the event that certain operating results were achieved or not achieved by T N S, additional shares of Series F Preferred Stock could have been issued, or issued shares of Series F Preferred Stock could have been cancelled, based on an agreed upon formula. The Company valued the contingent consideration likely to be paid at $260 as of the date of acquisition. At September 30, 2013, the Company evaluated the contingent consideration and recorded a gain in change of contingent consideration of $575. In December 2013, the Company and the former owners of T N S agreed to release the Company and T N S from any and all further obligations in connection with the contingent considerations. As part of the agreement, the Company redeemed an additional 1,150 shares of Series F Preferred Stock related to the aforementioned agreement. In addition, the Company issued to the former owners of T N S 89,653 shares of common stock. This agreement resulted in a loss on change in contingent consideration of $2,336, which was recorded on the Company's statement of operations as a loss on change in fair value of contingent consideration.
AWS Entities: As additional consideration, the Company agreed to pay the AWS seller certain earn-out payments based on the first and second anniversary EBITDA of the AWS Entities.
First Anniversary: Following the first anniversary of the closing date, the Company calculated the EBITDA of the AWS Entities for the twelve-month period beginning on the closing date and ending on the first anniversary of the closing date. The Company was required to make an earn-out payment to the sellers based on such EBITDA as follows: (i) if such EBITDA was less than $2,000 no payment was required; (ii) if such EBITDA was equal to or greater than $2,000 and less than or equal to $3,000 then the First EBITDA Adjustment was to be equal to such EBITDA and was to be paid by the Company to the sellers in cash; (iii) if such EBITDA was greater than $3,000 and less than or equal to $4,000, then the First EBITDA Adjustment was to be equal to 1.5x such EBITDA and was to be paid by the Company to the sellers in cash; (iv) if such EBITDA was greater than $4,000 and less than or equal to $5,000, then the First EBITDA Adjustment was to be equal to 2.0x such EBITDA, of which 50% was to be paid by the Company to the sellers in cash and 50% was to be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the first anniversary of the closing date; or (v) if such EBITDA was greater than $5,000, then the First EBITDA Adjustment was to be equal to 2.25x such EBITDA, of which 50% was to be paid by the Company to the sellers in cash and 50% was to be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the first anniversary of the closing date.
Second Anniversary: Following the second anniversary of the closing date, the Company calculated the EBITDA of the AWS Entities for the twelve-month period beginning on the first anniversary of the closing date and ending on the second anniversary of the closing date. The Company was required to make an earn-out payment to the sellers based on such EBITDA as follows: (i) if such EBITDA was less than or equal to the First Anniversary EBITDA, then no payment was required; (ii) if such EBITDA exceeds the First Anniversary EBITDA (the “EBITDA Growth Amount”) by an amount less than $1,000, such EBITDA Adjustment was to be equal to 2.0x the EBITDA Growth Amount and was to be paid by Company to the sellers in cash; (iii) if the EBITDA Growth Amount was equal to or greater than $1,000 and less than $3,000, then such EBITDA Adjustment was to be equal to 2.25x the EBITDA Growth Amount, of which 88.88% was to be paid by Company to the sellers in cash and 11.12% was to be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the second anniversary of the closing date; or (iv) if the EBITDA Growth Amount was equal to or greater than $3,000, then such EBITDA Adjustment was to be equal to 2.5x the EBITDA Growth Amount, of which 80% was to be paid by Company to the sellers in cash and 20% was to be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the second anniversary of the closing date.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company determined the fair value of the contingent consideration to be $2,511 at the date of acquisition. As of December 31, 2013, the amount of contingent consideration had been recorded as $4,350, which resulted in a loss from change in fair value of contingent consideration of $1,839 that has been recorded on the Company's consolidated statement of operations as a loss on change in contingent consideration. The amount of contingent consideration increased based on a revised forecast for the remainder of the earn-out period.
During the year ended December 31, 2014, contingent consideration of $1,763 related to the AWS acquisition was settled by issuing common shares with a fair market value of $2,545. As of December 31, 2014, the Company determined that, based on the results of AWS since the date of acquisition, AWS would not meet all EBITDA adjustment amounts and, as a result, the fair value of the contingent consideration was adjusted to $500. The Company recorded this adjustment as a gain on fair value of contingent consideration of $2,087 in its consolidated statement of operations.
VaultLogix: As additional consideration, the Company agreed to provide the VaultLogix sellers certain price protection. If the closing price per share of the Company’s common stock 180 days after the closing is less than 90% of $16.50, as adjusted for any stock splits, dividends, recapitalizations, or similar transactions, then the Company will issue additional shares of common stock. Additionally, the adjusted closing price for purposes of the calculation will not be less than $12.50 per share. As such, the downsize protection of $870 was recorded as a liability on the Company’s balance sheet.
On December 1, 2014, VaultLogix acquired the assets of a third-party entity. As part of this acquisition, the Company agreed to (1) an additional payment equal to 2X the EBITDA increase for the twelve months beginning on January 1, 2015 and concluding March 31, 2015 and (2) an additional payment equal to 2.5X the EBITDA increase over the first year EBITDA calculated as of the March 31, 2015 for the period beginning on April 1, 2015 and concluding on March 31, 2016. The Company determined the fair value of the contingent consideration to be $1,873 at the date of acquisition, which also approximates the value of the contingent consideration as of December 31, 2014.
4. PROPERTY AND EQUIPMENT, NET
At December 31, 2014 and 2013, property and equipment consisted of the following:
On November 21, 2013, the Company sold its ERFS subsidiary. As a result of the transaction, the Company sold property and equipment related to ERFS with an original purchase price of $205 and accumulated depreciation of $52.
Depreciation expense for the years ended December 31, 2014 and 2013 was $640 and $154, respectively.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
5. GOODWILL AND INTANGIBLE ASSETS
Goodwill
The following table sets forth the changes in the Company's goodwill during the years ended December 31, 2014 and 2013 resulting from the above-described acquisitions by the Company of its operating segments.
Intangible Assets
The following table summarizes the Company’s intangible assets as of December 31, 2014 and 2013:
During the second quarter of 2014, the Company began experiencing declines in revenues within the professional services operating segment due to delays in work from a significant customer. The delays continued into the third quarter of 2014 when it became apparent that anticipated revenue and profitability trends within the Company’s professional services operating segment were not being achieved to the extent forecasted. The Company updated the forecast for the professional services segment, of which ADEX is a reporting unit, based on the most recent financial results and best estimates of future operations. The updated forecast reflects slower growth in revenues and lower margins for the professional services segment due to lower demand from customers.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
As of September 30, 2014, the Company performed the two-step goodwill and indefinite lived impairment process and determined that the professional services operating segment failed both tests. Based on the testing performed, the Company recorded a non-cash impairment charge of $3,761 related to the professional services reporting segment, of which $2,392 related to intangible assets and $1,369 related to goodwill.
The Company uses the straight-line method to determine the amortization expense for its definite lived intangible assets, which approximates amortization that would have been recognized if determined by an accelerated method. Amortization expense related to the purchased intangible assets was $3,500 and $966 for the years ended December 31, 2014 and 2013, respectively.
On November 21, 2013, the Company disposed of its ERFS subsidiary, which carried goodwill of $4,863 and intangible assets consisting of net customer relationships of $1,787 and trade names of $361.
The estimated future amortization expense for the next five years and thereafter is as follows:
6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
As of December 31, 2014 and 2013, accrued expenses consisted of the following:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. BANK DEBT
As of December 31, 2014 and 2013, bank debt consisted of the following:
Future maturities of bank debt are as follows:
At December 31, 2014 and 2013, there were no covenants related to the bank debt.
The interest expense associated with the bank debt during the years ended December 31, 2014 and 2013 amounted to $30 and $33, respectively. The weighted average interest rate on bank debt during the years ended December 31, 2014 and 2013 was 9.9% and 7.6%, respectively.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
8. TERM LOANS
At December 31, 2014 and 2013, term loans consisted of the following:
Future annual principal payments are as follows:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Term Loan - MidMarket Capital
On September 17, 2012, the Company entered into a Loan and Security Agreement with the lenders referred to therein, MidMarket Capital Partners, LLC, as agent for the lenders (the “Agent”), and certain subsidiaries of the Company as guarantors (the “MidMarket Loan Agreement”). Pursuant to the MidMarket Loan Agreement, on September 17, 2012 and November 13, 2012, the lenders thereunder provided the Company senior secured first lien term loans in an aggregate amount of $15,000 (the “MidMarket Loans”). Interest on the MidMarket Loans accrued at the rate of 12% per annum.
The MidMarket Loans were to mature on September 17, 2017, provided that if the Company failed to raise by March 14, 2014 at least $20,000 in connection with a public offering of voting equity securities of the Company, the MidMarket Loans were to mature on June 17, 2014. If the Company did not complete an acquisition of an additional operating business within 90 days of September 17, 2012, the Company was required to repay $750 of the MidMarket Loans. The Company completed the acquisition of ERFS on December 17, 2012, which satisfied this covenant.
On October 17, 2013, the Company entered into an amendment to the MidMarket Loan Agreement to provide that, (i) if prior to March 17, 2014, the Company failed to raise at least $5,000 in gross proceeds in an underwritten public offering of the Company’s equity securities, the maturity date of the original MidMarket Loans were to be accelerated to June 17, 2014, or (ii) if prior to March 17, 2014 the Company raised at least $5,000 but less than $20,000 in gross proceeds in an underwritten public offering of the Company’s equity securities, the maturity date of the original MidMarket Loans were to be accelerated to December 30, 2014.
In connection with the MidMarket Loans, deferred loan costs of $1,800 were recorded. These costs were being amortized over the life of the loan using the effective interest method.
Subject to certain exceptions, all obligations of the Company under the MidMarket Loans were unconditionally guaranteed by each of the Company’s domestic subsidiaries. In addition, the obligation of the Company and the subsidiary guarantors in respect of the MidMarket Loans was secured by a first priority security interest in substantially all of the assets of the Company and the subsidiary guarantors, subject to certain customary exceptions.
Pursuant to the MidMarket Loan Agreement, the Company issued warrants to the lenders, which entitle the lenders to purchase a number of shares of common stock equal to 10% of the fully-diluted shares of the common stock of the Company on the date on which the warrants first became exercisable, which was December 6, 2012. Refer to Note 9 Derivative Instruments for further detail on the MidMarket Loan Agreement Warrants.
On October 4, 2013, the Company entered into a Fourth Amendment and Consent (the “Fourth Amendment”), dated and effective as of September 30, 2013, to the Company’s Loan and Security Agreement, dated September 17, 2012, with MidMarket Capital Partners LLC, as agent for the lenders (“MidMarket”), as amended (the “MidMarket Loan Agreement”). Pursuant to the Fourth Amendment, MidMarket consented to the Company’s incurrence of indebtedness under the Company’s revolving credit facility with PNC Bank in an aggregate principal amount not to exceed $1,000 at any one time outstanding.
Further, the Fourth Amendment provides that, if the Company consummates a public offering of equity securities raising gross proceeds of not less than $5,000, the maturity date of the additional term loan under the MidMarket Loan Agreement in the principal amount of $2,000 (the “Additional Term Loan”) will be extended from November 13, 2013 to December 31, 2013; provided, however, that a payment of principal in the amount of $500 will be due and payable under the Additional Term Loan on November 13, 2013.
On October 17, 2013, the Company entered into a Fifth Amendment (the “Fifth Amendment”) to the Company’s Loan and Security Agreement, dated September 17, 2012, with MidMarket Capital Partners LLC, as agent for the lenders (“MidMarket”), as amended (the “MidMarket Loan Agreement”). Prior to the Fifth Amendment, the MidMarket Loan Agreement provided that the maturity date of the term loans under the MidMarket Loan Agreement in the original principal amount of $13,000 (the “Original Term Loans”) matured on September 17, 2017; provided, however, that if prior to March 17, 2014 the Company failed to raise at least $20,000 in gross proceeds in an underwritten public offering of the Company’s equity securities, the maturity date of the Original Term Loans would be accelerated to June 17, 2014. The Fifth Amendment amends the MidMarket Loan Agreement to provide that, (i) if prior to March 17, 2014, the Company failed to raise at least $5,000 in gross proceeds in an underwritten public offering of the Company’s equity securities, the maturity date of the Original Term Loans will be accelerated to June 17, 2014, or (ii) if prior to March 17, 2014 the Company raised at least $5,000 but less than $20,000 in gross proceeds in an underwritten public offering of the Company’s equity securities, the maturity date of the Original Term Loans will be accelerated to December 30, 2014.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
As of December 31, 2012, certain events of default had occurred and were continuing under the MidMarket Loan Agreement, including events of default relating to a number of financial covenants under the loan agreement. On March 22, 2013, the Company and its subsidiaries entered into an amendment to the MidMarket Loan Agreement pursuant to which, among other agreements, all of the existing events of default by the Company were waived and the financial covenants that gave rise to certain of the events of default were amended.
Pursuant to Assignment and Assumption Agreements, each dated as of March 12, 2014, the lenders under the MidMarket Loan Agreement assigned the MidMarket Loans to 31 Group LLC and Dominion Capital LLC (the “Assignees”). Pursuant to an Exchange Agreement, dated as of March 12, 2014, among the parties to the MidMarket Loan Agreement and the Assignees (the “Exchange Agreement”), the Assignees agreed to convert the outstanding principal amount of the MidMarket Loans into shares of the Company’s common stock at a conversion price of $10.50 per share. Pursuant to the Exchange Agreement, in full satisfaction of the MidMarket Loans, the Company (i) issued an aggregate of 1,180,361 shares of common stock, of which it has issued 561,197 and 519,164 shares of its common stock to Dominion Capital LLC and 31 Group LLC, respectively, and (ii) paid an aggregate of $277 in cash to the Assignees in respect of accrued but unpaid interest under the MidMarket Loans. The Exchange Agreement provided, however, that if 85% of the volume weighted average price of the Company’s common stock on April 14, 2014 was less than $10.50, the Company would issue an additional number of shares of the Company’s common stock such that the average conversion price of the MidMarket Loans was such lower price. On April 18, 2014, the Company amended the agreement to provide for the issuance of additional consideration to the Assignees in lieu of the issuance of additional shares to satisfy such adjustment requirement. On the date of the elimination of debt, the fair value of the Company’s common stock was $11.87, resulting in the total fair value of shares issued of $14,011. On that date, the principal amount of debt outstanding was $12,025, resulting in a loss on extinguishment of debt of $1,986. As a result of the extinguishment of the MidMarket Loans, the Company also recorded a loss on extinguishment of debt of $2,504 as a result of accelerated amortization of deferred financing costs and debt discounts. Please refer to Footnote 9 Derivative Instruments for further explanation.
On April 15, 2014, the Company entered into an amendment to the Exchange Agreement due to the decline in the trading price of the Company’s common stock, pursuant to which the Company amended the provision requiring it to issue additional shares of common stock by issuing (i) 363,853 shares of common stock and warrants to purchase 100,000 shares of common stock to Dominion Capital LLC, and (ii) 401,996 shares of common stock and warrants to purchase 125,000 shares of common stock to 31 Group LLC. The warrants issued pursuant to the amendment are exercisable at a price of $7.25 per share for a three-year period, provided that if the shares of common stock underlying the warrants are registered under the Securities Act of 1933, as amended, the exercise period of the warrants will be reduced to two years.
On December 31, 2014, the Company used the Black Scholes pricing method to determine the fair value of the derivative liability of the warrants on that date. Please refer to Footnote 9 Derivative Instruments for further explanation.
Interest expense on the MidMarket Loan was $291 and $2,395 in the years ended December 31, 2014 and 2013, respectively.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Term Loan - White Oak Global Advisors
On October 9, 2014, the Company’s wholly-owned subsidiary, VaultLogix, entered into a loan and security agreement with the lenders party thereto, White Oak Global Advisors, LLC, as Administrative Agent, Data Protection Services, L.L.C. (“DPS”), U.S. Data Security Acquisition, LLC (“USDSA”) and U.S. Data Security Corporation (“USDSC”) as guarantors, pursuant to which, VaultLogix received a term loan in an aggregate principal amount of $13,261. Interest on the term loan accrues at a rate per annum equal to the sum of (a) the greater of (i) the LIBOR Index Rate (as defined), as adjusted as of each Libor Index Adjustment Date (as defined) and (ii) 1.00% per annum; plus (b) 1100 basis points per annum. The LIBOR Index Rate was 0.6044 as of December 31, 2014 however this did not exceed the 12% stated rate as defined in item (ii) above.
The proceeds of the Term Loan were used to finance the Company’s acquisition of VaultLogix, DPS and USDSA, to repay certain outstanding indebtedness (including all indebtedness owed by VaultLogix to Hercules Technology II, L.P.) and to pay fees, costs and expenses.
In connection with the term loan, the Company entered into (i) a continuing guaranty in favor of the Agent, (ii) a pledge agreement, and (iii) a security agreement, pursuant to which the obligations of the Company in respect of the Term Loan are secured by a security interest in substantially all of the assets of VaultLogix, subject to certain customary exceptions.
Convertible Promissory Notes, Unsecured.
In June 2012, the Company issued an 8% convertible promissory note in the principal amount of $27,500 that bore interest at the rate of 8% per annum and matured in December 2012. This note was convertible into common stock of the Company, at the holder’s option, at a conversion price equal to 50% of the average of the three lowest closing prices of the common stock within the 10-day period prior to the conversion date. In January 2013, this note was converted in accordance with its terms into 7,207 shares of common stock.
Promissory Note, unsecured
In September 2012, the Company issued a promissory note in the principal amount of $530 to Wellington Shields & Co. This note bore interest at the lowest rate permitted by law unless the Company was in default on repayment, at which time the note was to bear interest at the rate of 18% per annum. This note was due in October 2012 and the Company was in default as of March 31, 2013 and accruing interest at the higher amount. The amount outstanding as of March 31, 2013 was $175. This note was paid in full as of May 2, 2013. The Company recorded other income of $80, as the debt was repaid for $95.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
18% Convertible Promissory Note
In July 2012, the Company issued an 18% convertible promissory note in the principal amount of $210 that matured in January 2013. The principal and interest on this note were convertible, at the holder’s option, into the Company’s common stock at a rate equal to 50% of the average of the three lowest closing prices of the common stock within the 10-day period prior to the conversion date. During 2012, the Company recognized interest expense of $11 on this note. During March 2013, the note was converted into 36,584 shares of common stock. Upon conversion, the beneficial conversion feature was recorded as interest expense in the amount of $281. The loss was not materially different than the incremental intrinsic value resulting from the resolution of the contingently adjustable conversion ratios and the corresponding adjustments to the conversion prices.
Acquisition Promissory Note
On December 29, 2011, the Company acquired substantially all of the assets and assumed certain liabilities of RM Engineering. Upon its acquisition of RM Engineering, the Company assumed unsecured, non-interest bearing acquisition promissory notes to former shareholders of RM Engineering due in March and June 2012. These notes were repaid in full in 2013.
Term Loan Maturing in January 2014
During April 2013, the Company entered into a purchase agreement (the "ICG Purchase Agreement") with ICG USA, LLC (“ICG”) pursuant to which the Company agreed to sell and ICG agreed to purchase, unsecured, convertible promissory notes in the aggregate principal amount of $1,725 for an aggregate purchase price of up to $1,500, at up to two separate closings. Pursuant to such agreement, on April 30, 2013, the Company issued to ICG a promissory note in the principal amount of $863 for a purchase price of $750, with the difference between the purchase price and the principal amount of the note representing an up-front interest payment in lieu of any additional interest on such note. This note matured on the tenth trading day following the earlier of (i) the closing by the Company of a public offering of equity securities resulting in gross proceeds of at least $20,000 or (ii) any capital raise by the Company of at least $3 million. If the Company did not complete a capital raise within 180 days of the date of funding (October 26, 2013), then the lender could have elected to be repaid on this note by either receiving 25% of the Company's future monthly cash flows until such time as the unpaid principal had been repaid, or converting the unpaid principal amount into shares of the Company’s common stock. At the end of the six-month period, if ICG elected to convert, this note was convertible into common shares at a price per share equal to 80% of the lessor of a) the average of the closing bid prices of the common stock for each of the ten trading days preceding the date of conversion, or b) the closing bid price of the Company’s common stock on the date of conversion, but in no event less than $11.60 per share. On November 5, 2013, the Company completed a capital raise of greater than $3,000 and, as a result, the note was no longer convertible into shares of the Company’s common stock.
Pursuant to the ICG Purchase Agreement, in August 2013, the Company issued to ICG a promissory note in the principal amount of $288 for a purchase price of $250, with the difference between the purchase price and the principal amount of the note representing an up-front interest payment in lieu of any additional interest on such note. This note matured on the thirtieth trading day following the earlier of the closing of any capital raise by the Company of at least $3,000 or October 26, 2013. If the Company did not complete a capital raise within 180 days of the date of funding (February 28, 2014), then the lender could have elected to be repaid on this note by either receiving 25% of the Company's future monthly cash flows until such time as the unpaid principal has been repaid, or converting the unpaid principal amount into shares of the Company’s common stock. At the end of the six month period, if ICG made the election to convert, this note was convertible into common stock at a price per share equal to 80% of the lessor of a) the average of the closing bid prices of the common stock for each of the ten trading days preceding the date of conversion, or b) the closing bid price of the Company’s common stock on the date of conversion, but in no event less than $11.60 per share. On November 5, 2013, the Company completed a capital raise of greater than $3,000, and the note was no longer convertible into shares of the Company’s common stock.
Pursuant to the ICG Purchase Agreement, in October 2013, the Company issued to an affiliate of ICG a promissory note in the principal amount of $575 for a purchase price of $500, with the difference between the purchase price and the principal amount of the note representing an up-front interest payment in lieu of any additional interest on the such note. This note matured in January 2014. At the time of this issuance, the outstanding notes held by ICG were assigned by ICG to such affiliate of ICG and the maturity date of such notes was extended to January 2014.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In March 2014, the Company and ICG agreed to convert the remaining unpaid principal amount of the three notes into common stock.
Pursuant to the ICG Purchase Agreement, in connection with the issuance of the notes, ICG was also issued two warrants to purchase a number of common shares equal to fifty percent (50%) of the number of shares into which the note may be converted on the date of issuance of the note. Refer to Note 9 Derivative Instruments for further information on the ICG warrants.
PNC Bank Revolving Credit Facility
On September 23, 2013, the Company entered into a revolving credit and security agreement dated as of September 20, 2013 (the "PNC Credit Agreement"), with PNC Bank, as agent and a lender, and each of the Company’s subsidiaries, as borrowers or guarantors. The PNC Credit Agreement provided the Company a revolving credit facility in the principal amount of up to $10,000, subject to a borrowing base (as further described below), that was secured by substantially all of the Company’s assets and the assets of the Company’s subsidiaries, including a pledge of the equity interests of the Company’s subsidiaries pursuant to a pledge agreement. The maturity date of the revolving credit facility was June 17, 2014.
The PNC Credit Agreement contained customary events of default and covenants, including, but not limited to, financial covenants requiring a minimum fixed charge coverage ratio and minimum earnings before interest, taxes, depreciation and amortization (EBITDA). In connection with the Company’s acquisition of IPC, the Company was required to have availability under the PNC loan of $3,000. In order to satisfy this requirement, the Company prepaid the loan in the amount of $108.
At December 31, 2013, the balance of the loan was a prepayment of $108, which was recorded as other current assets on the Company’s consolidated balance sheet.
The Company terminated the PNC Credit Agreement on April 4, 2014. In connection with the early termination of the PNC Credit Agreement, the Company paid to PNC Bank an early termination fee of approximately $300 which was recorded as interest expense on the consolidated statement of operations for the year ended December 31, 2014.
12% Convertible Debentures
In December 2013 the Company entered into a securities purchase agreement with various institutional investors pursuant to which the Company issued to such investors convertible debentures in the original aggregate principal amount of $11,625 (the "Convertible Debentures") and an aggregate of 36,567 shares of its common stock for an aggregate purchase amount of $11,625. The Convertible Debentures mature on June 13, 2015 and bear interest at the rate of 12% per annum and are payable in accordance with an amortization schedule, with monthly payments that began on July 13, 2014 and end on the final maturity date of June 13, 2015. At the Company’s election, subject to compliance with certain terms and conditions in the purchase agreement, the monthly amortization payments may be paid by the issuance of shares of the Company’s common stock at a price per share equal to the lesser of (i) the Conversion Price (as defined below) and (ii) 75% of the average of the VWAP (the daily volume weighted average price) of the Company’s common stock for the five-trading-day period ending on, and including, the trading day immediately preceding the trading day that is five days prior to the applicable monthly amortization date.
The Convertible Debentures are convertible into shares of the Company’s common stock at the election of the holder thereof at a conversion price (the “Conversion Price”) equal to the lesser of (i) $6.36, or (ii) 85% of the price per share of the Company’s common stock in the first underwritten public offering of not less than $10,000 of the Company’s equity securities (a “Qualified Offering”). The Conversion Price is subject to customary anti-dilution provisions. Notwithstanding the foregoing, the Convertible Debenture of a particular holder will not be convertible if such conversion would result in such holder owning more than 4.99% of the issued and outstanding shares of the Company’s common stock after such conversion.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company may redeem a Convertible Debenture, in whole or in part, for cash at a redemption price (the “Redemption Amount”) equal to 115% of the outstanding principal amount of the Convertible Debenture, plus all accrued and unpaid interest, plus an amount equal to the interest that would have accrued on the Convertible Debenture through the one year anniversary of the issuance date. Upon the occurrence of a Qualified Offering while the Convertible Debentures remain outstanding, (i) each holder of a Convertible Debenture has the option to force the redemption of a portion of such holder's Convertible Debenture for a redemption price equal to the Qualified Offering Amount (as defined below), and (ii) the Company has the option to force the redemption of a portion of a holder’s Convertible Debenture in an amount equal to or less than the Qualified Offering Amount. The “Qualified Offering Payment” means, with respect to each Convertible Debenture, an amount equal to the lesser of (i) 50% of the Redemption Amount and (ii) (a) 50% of the gross proceeds of the Qualified Offering multiplied by (b)(x) the Redemption Amount of such Convertible Debenture, divided by (y) the Redemption Amount of all Convertible Debentures issued pursuant to the purchase agreement.
The Company could have elected to force the holder of a Convertible Debentures to convert all, but not less than all, amounts outstanding under the Convertible Debenture into shares of the Company’s common stock at the applicable Conversion Price; provided, that the Company could only have elected such forced conversion if certain conditions were met, including the condition that the Company’s common stock was trading at 150% or higher of the applicable Conversion Price for 30 consecutive trading days with an average daily trading volume of not less than $1,000 of shares per day. As the conditions were not met, the Company did not force any conversions.
Upon the occurrence of an event of default (as defined in the Convertible Debentures), the outstanding principal amount of the Convertible Debentures, plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the holder’s election, immediately due and payable in cash at the Mandatory Default Amount. The “Mandatory Default Amount” means the sum of (a) the greater of (i) the outstanding principal amount of the Convertible Debenture, divided by the Conversion Price on the date the Mandatory Default Amount is either (A) demanded (if demand or notice is required to create an event of default) or otherwise due or (B) paid in full, whichever has a lower Conversion Price, multiplied by the VWAP of the Company’s common stock on the date the Mandatory Default Amount is either (x) demanded or otherwise due or (y) paid in full, whichever has a higher VWAP, or (ii) 115% of the outstanding principal amount of the Convertible Debenture, plus 100% of accrued and unpaid interest hereon, and (b) all other amounts, costs, expenses and liquidated damages due in respect of the Convertible Debenture. After the occurrence of an event of default that results in the acceleration of the Convertible Debentures, the interest rate on the Convertible Debentures shall accrue at an interest rate equal to the lesser of 18% per annum or the maximum rate permitted under applicable law. Additionally, upon the occurrence of an event of default, at the holder’s election each Convertible Debenture shall become convertible into shares of the Company’s common stock at the lesser of (i) the Conversion Price, and (ii) 70% of the average VWAP of the Company’s common stock for the five trading days in the preceding twenty trading days that have the lowest VWAP during such period.
The Company recorded a debt discount in the amount of $382 in connection with the 36,567 shares of the Company's common stock issued pursuant to the purchase agreement, which amount is being amortized over the life of the Convertible Debentures. The Company also recorded a debt discount and a related derivative liability in the amount of $6,620 in connection with the embedded features of the Convertible Debentures, which amount is being amortized over the life of the Convertible Debentures. Refer to Note 9 Derivative Instruments for further detail on the derivative liability. Principal of $2,331 and $11,625 remained outstanding as of December 31, 2014 and 2013, respectively.
Promissory Notes to the Mark Munro 1996 Charitable Remainder UniTrust
On May 7, 2014, the Company issued a promissory note to the Mark Munro 1996 Charitable Remainder UniTrust in the principal amount of $300 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
Revolving Line of Credit
On July 3, 2014, the Company obtained an unsecured $3,000 interim revolving line of credit from the Mark Munro 1996 Charitable Remainder UniTrust to provide working capital as well as cash to make the Company’s upcoming amortization payments pursuant to the Company’s Convertible Debentures. The line has a maturity date of March 31, 2016, and bears interest at the rate of 1.5% per month on funds drawn.
As of December 31, 2014, there was no amount outstanding under the related party revolving line of credit.
Demand Promissory Note
The Company entered into a securities purchase agreement, effective as of November 17, 2014, with an investor whereby the Company issued to the investor a demand promissory note, dated November 17, 2014, in the original principal amount of $1,000, with interest accruing at the rate of 12% per annum. The note matures on the earlier of: (x) November 10, 2015 or (y) upon demand by the investor, which such demand may be made any time 150 days following the issuance of the Note upon 30 days’ written notice to the Company; provided, that $60 of interest is guaranteed by the Company regardless of when the note is repaid. The Company may redeem the note at any time prior to the maturity date for an amount equal to (i) 100% of the outstanding principal amount, plus (ii) a redemption premium equal to an additional 10% of the outstanding principal amount, plus (iii) any accrued and unpaid interest on the note. The redemption premium can be paid in cash or common stock at the option of the Company. If common stock of the Company is used to pay the redemption premium, then such shares shall be delivered by the third business day following the maturity date, or date of demand, as applicable, at a mutually agreed upon conversion price by both parties.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Aegis Capital Corp. served as the placement agent in connection with this private placement and, in exchange for its services, earned a placement agent fee equal to 3.5% of the proceeds from the private placement. The total fee of $86 was recorded within additional paid in capital on the consolidated balance sheet as of December 31, 2014.
31 Group Convertible Note
In July 2014, the Company issued to 31 Group, LLC a convertible note in the aggregate original principal amount of $1,500, convertible at $6.37 per share, with a term of one year and an interest rate of 12% per annum, and a three-year warrant to purchase up to 58,870 shares of common stock at an exercise price of $7.25 per share. The maturity date of the convertible note could have been extended at the option of the holder through the date that is 20 business days after the consummation of a fundamental transaction (as defined in the convertible note agreement) in the event that a fundamental transaction was publicly announced or a fundamental transaction notice (as defined in the convertible note agreement) was delivered prior to the maturity date. As the Company did not repay the convertible note in full on or prior to the 45th day after the date the convertible note was issued, 31 Group, LLC was granted a security interest in all assets of the Company in September 2014.
The Company was entitled to redeem the Convertible Note, in whole or in part, for cash at a redemption price equal to 107% of the then-outstanding principal amount of the Convertible Note plus all accrued and unpaid interest. The Company evaluated the convertible feature and determined that the value was de minimis and as such, the Company did not bifurcate the convertible feature.
On December 31, 2014, the Company entered into a Bridge Financing Agreement with GPB Life Science Holdings, LLC of which a portion of the proceeds were used to repay the convertible note of the 31 Group, LLC. Refer to the Bridge Financing - GPB Life Science Holdings, LLC section of this note for further detail.
Refer to Note 9 Derivative Instruments for further detail on the warrants issued in conjunction with the 31 Group convertible note.
Bridge Financing - GPB Life Science Holdings, LLC
The Company entered into a bridge financing agreement, effective as of December 3, 2014, with GPB Life Science Holdings, LLC, whereby the Company issued to the investor for gross proceeds of $2,375 (i) a senior secured note, dated December 3, 2014, in the aggregate principal amount of $2,500 with interest accruing at the rate of 12% per annum and (ii) a four-year warrant, dated December 3, 2014, exercisable for up to 250,000 shares of the Company’s common stock at an exercise price of $5.00 per share, subject to adjustment as set forth therein. The note matures upon the earlier of: (x) the date one hundred and eighty (180) days from December 3, 2014 or (y) the date of a Major Transaction (as defined in the purchase agreement). In addition, upon maturity of the note, the Company must pay the investor additional interest in cash, which interest accrues over the term of the Note at the rate of 4% per annum. The note is secured by (i) a first priority security interest in and to all Accounts Receivable (as defined in the purchase agreement) of the Company and its subsidiaries, except those of VaultLogix, and (ii) a first priority security interest and lien on all Collateral (as defined in the purchase agreement) of the Company and its subsidiaries, which lien and security interest will only go into effect at such time as White Oak Global Advisors, LLC (“White Oak”) releases (or is deemed to have released pursuant to the applicable documents between it and the Company), its liens and security interest on any collateral of the Company and the Company’s obligation to grant, pledge or otherwise assign a lien in favor of White Oak is terminated (pursuant to the applicable documents between White Oak and the Company).
Refer to Note 9 Derivative Instruments for further detail on the warrants issued as part of the bridge financing agreement.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
9. DERIVATIVE INSTRUMENTS
The Company evaluates and accounts for derivatives conversion options embedded in its convertible and freestanding instruments in accordance with ASC Topic 815, Accounting for Derivative Instruments and Hedging Activities ("ASC Topic 815").
MidMarket Warrants
The Company issued warrants to the lenders under the MidMarket Loan Agreement in 2012. These warrants were outstanding at December 31, 2014 and 2013.
The terms of the warrants issued pursuant to the MidMarket Loan Agreement in 2012 originally provided, among other things, that the number of shares of common stock issuable upon exercise of such warrants amounted to 11.5% of the Company’s fully-diluted outstanding common stock and common stock equivalents, whether the common stock equivalents were fully vested and exercisable or not, and that the initial exercise price of such warrants was $5.00 per share of common stock, subject to adjustment. Pursuant to an amendment to the MidMarket Loan Agreement, on March 22, 2013, the number of shares for which the warrants are exercisable was fixed at 234,233 shares. On September 17, 2012, when the warrants were issued, the Company recorded a derivative liability in the amount of $194. The amount was recorded as a debt discount and is being amortized over the original life of the MidMarket Loans. The amount of the derivative liability was computed by using the Black-Scholes option pricing model to determine the value of the warrants issued. In accordance with ASC Topic 480, the warrants are classified as liabilities because there is a put feature that requires the Company to repurchase any shares of common stock issued upon exercise of the warrants. The derivative liability associated with this debt is revalued each reporting period and the increase or decrease is recorded to the consolidated statement of operations under the caption “change in fair value of derivative instruments.” At each reporting date, the Company performs an analysis of the fair value of the warrants using the Black-Scholes pricing model and adjusts the fair value accordingly.
On December 31, 2014 and 2013, the Company used the Black-Scholes pricing method to determine the fair value of the warrants on those dates, and determined the fair value was $212 and $3,280, respectively. The Company recorded the change in the fair value of the derivative liability as a gain in fair value of derivative liability for the year ended December 31, 2014 of $3,168 and a loss on change in fair value of derivative liability in the year ended December 31, 2013 of $3,246.
The MidMarket warrants were set to expire on September 17, 2014, the second anniversary date of the warrants. However, during 2014 the Company failed to comply with the Minimum Adjusted EBITDA provisions set forth within the original warrant agreement. As such, the expiration date of the warrants was extended to September 17, 2016.
On April 15, 2014, the Company entered into an amendment to the Exchange Agreement, due to the decline in the trading price of the Company’s common stock, pursuant to which the Company amended the provision requiring it to issue additional shares of common stock by issuing (i) 363,853 shares of common stock and warrants to purchase 100,000 shares of common stock to Dominion Capital LLC, and (ii) 401,996 shares of common stock and warrants to purchase 125,000 shares of common stock to 31 Group LLC. The warrants are exercisable at a price of $7.25 per share for a three-year period, provided that if the shares of common stock underlying the warrants are registered under the Securities Act, the exercise period of the warrants will be reduced to two years. On April 15, 2014, the day the warrants were issued, the Company recorded a derivative liability in the amount of $416. The amount was recorded as a loss on extinguishment of debt. The amount of the derivative liability was computed by using the Black-Scholes pricing model to determine the value of the warrants issued. On December 31, 2014, the Company used the Black-Scholes option pricing model to determine the fair value of the warrants and derived an implied fair value of $74, which is included in derivative financial instruments at estimated fair value on the consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability as a gain of $342 in the consolidated statement of operations in change in fair value of derivative instruments.
The fair value of the MidMarket Loan Agreement warrant derivative at each measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The fair value of the MidMarket Exchange Agreement warrant derivative at the measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies:
Series E Warrants
The Company issued warrants associated with the issuance of its Series E Preferred Stock in 2012 and 2013.
The terms of the warrants issued to the holders of Series E Preferred Stock provided that, among other things, the number of shares of common stock issuable upon exercise of such warrants amounted to 4.99% of the Company’s fully-diluted outstanding common shares and common share equivalents, whether the common share equivalents were fully vested and exercisable or not, and that the exercise price of such warrants was $500 per share of common stock, subject to adjustment.
The warrants provided for variability involving the effective amount of common share equivalents issued in future equity offerings of equity-linked financial instruments. Additionally, the warrants did not contain an exercise contingency. Accordingly, the settlement of the warrants would not have equaled the difference between the fair value of a fixed number of shares of the Company’s common stock and a fixed stock price. Accordingly, such warrants were not indexed to the Company’s stock price. The Company accounted for such variability associated with its warrants as derivative liabilities.
In December 2013, the Company agreed with the holders of the Company’s Series E Preferred Stock to issue a fixed number of shares of common stock to satisfy these warrants. The Company obtained approval and agreement of such stockholders at December 31, 2013; however, the shares of common stock were not issued until January 2014, which resulted in a liability of $978, based on a Black-Scholes calculation, as of December 31, 2013. The Company recorded a gain on the derivative liability of $78 related to the issuance of shares in January 2014 that was recorded in the consolidated statement of operations in change in fair value of derivative instruments.
The fair value of the Series E warrants derivative at each measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies:
ICG warrants
Pursuant to the ICG Purchase Agreement, in connection with the issuance of the notes, ICG was also issued two warrants to purchase a number of common shares equal to fifty percent (50%) of the number of shares into which the note may be converted on the date of issuance of the note. The warrants are exercisable at an exercise price equal to the lesser of a) 120% of the price per share at which the Company sells its common stock in a public offering or b) the exercise price of any warrants issued to investors in an offering of the Company’s securities resulting in gross proceeds of at least $3,000, provided, however, that if no such offering closed by October 30, 2013, then the exercise price for the warrant would be equal to 120% of the closing price of the Company’s common stock on October 30, 2013. The Company completed an offering of its common stock on November 5, 2013. The exercise price of the warrants was fixed at $4.80. The warrants meet the criteria in accordance with ASC 815 to be classified as liabilities as the number of shares to be issued upon conversion of the warrants and the strike price of the warrants is variable. On April 26, 2013, the date on which the warrants were issued, the Company recorded a derivative liability in the amount of $140. The amount was recorded as a debt discount and was being amortized over the life of the related term loan. The Company recorded the change in the fair value of the derivative liability as a gain on change in fair value of derivative liability of $130 for the year ended December 31, 2013.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company issued warrants to its lender, ICG, in April 2013. On April 26, 2013, the date on which the warrants were issued, the Company recorded a derivative liability in the amount of $140. The amount was recorded as a debt discount and is being amortized over the life of the related loan. The amount of the derivative liability was computed by using the binomial method to determine the value of the warrants issued. The binomial method evaluated possible scenarios for the price of the Company’s common stock and other factors that would impact the anti-dilution provisions of the warrants. At April 26, 2013, the number of shares of common stock issuable upon exercise of the warrants was 37,177.
The Company issued additional warrants to its lender, ICG, in August 2013. On August 28, 2013, the date on which the warrants were issued, the Company recorded a derivative liability in the amount of $35. The amount was recorded as a debt discount and is being amortized over the life of the related loan. The amount of the derivative liability was computed by using the binomial method to determine the value of the warrants issued. The binomial method evaluated possible scenarios for the price of the Company’s common stock and other factors which would impact the anti-dilution provisions of the warrants. At August 28, 2013, the number of shares of common stock issuable upon exercise of the warrants was 12,392.
The Company issued additional warrants to its lender, ICG, in October 2013. On October 30, 2013, the date on which the warrants were issued, the Company recorded a derivative liability in the amount of $19. The amount was recorded as a debt discount and is being amortized over the life of the related loan. The amount of the derivative liability was computed by using the binomial method to determine the value of the warrants issued. The binomial method evaluated possible scenarios for the price of the Company’s common stock and other factors which would impact the anti-dilution provisions of the warrants. At October 30, 2013, the number of shares of common stock issuable upon exercise of the warrants was 22,308.
In November 2013, ICG exercised all of its warrants and the Company recorded a change in fair value of the derivative liability of $952 for the year ended December 31, 2013.
12% Convertible Debentures Convertible Feature
The Company recorded a debt discount in the amount of $382 in connection with the 36,567 shares of the Company’s common stock issued pursuant to the purchase agreement, which amount is being amortized over the life of the Convertible Debentures. The Company also recorded a debt discount in the amount of $6,620, which amount is being amortized over the life of the Convertible Debentures. The Company used a Monte Carlo simulation on the date of issuance to determine the fair value of the embedded conversion feature. The Company recorded interest expense of $3,236 related to the amortization of the debt discount for the year ended December 31, 2014.
Due to the conversion of $7,008 aggregate principal amount of Convertible Debentures during the first three quarters of 2014, the Company adjusted the balance of the derivative liability related to the embedded conversion feature of the Convertible Debentures in the amount of $2,510. Upon conversion, the principle amount of the debt and equity-linked derivative liability were removed at their respective carrying amounts, after a final adjustment of the embedded derivatives to fair value of $943, and the shares of common stock were issued at their then-current fair value, with the difference recorded as a loss on extinguishment of the two separate liabilities in the amount of $569.
On December 31, 2014, the Company used a Monte Carlo simulation to determine the fair value of the embedded conversion feature of the Convertible Debentures and, on that date, determined the fair value of the embedded conversion feature to be $180. The Company recorded the change in the fair value of the derivative liability as a gain in the consolidated statements of operations of $15,063.
The fair value of the embedded conversion feature of the Convertible Debentures at December 31, 2014 was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Forward Investments, LLC Convertible Feature
On February 4, 2014 and March 28, 2014, Forward Investments, LLC made convertible loans to the Company for working capital purposes in the amounts of $1,800 and $1,200, respectively. Such loans are evidenced by convertible promissory notes that bear interest at the rate of 2% and 10% per annum, mature on June 30, 2015 and are convertible into shares of the Company’s common stock at an initial conversion price of $6.36 per share.
The fair value of the embedded conversion feature at the date of issuance was $8,860. The Company recorded a debt discount of $6,475 and a loss on debt discount of $2,385. The debt discount is being amortized over the life of the loans. The Company used a Monte Carlo simulation on the date of issuance to determine the fair value of the embedded conversion feature.
On October 22, 2014, the two convertible loan agreements were modified to reduce the initial conversion price of $6.36 to $3.93, subject to the 12% debentures not being outstanding. As a result, the Company used a Monte Carlo simulation to determine the fair value on the date of modification. The fair value of the conversion feature of the Forward Investments, LLC loan on the date of modification was $910. The Company recorded the change in the fair value of the derivative liability as a loss on debt modification of $310.
On December 31, 2014, the fair value of the conversion feature of the Forward Investments, LLC loans was $800, which is included in derivative financial instrument at estimated fair value on the consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability as a gain in the consolidated statements of operations of $8,370.
The fair value of the Forward Investments, LLC derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:
Group Promissory Note Warrants
On July 1, 2014, the Company issued 58,870 warrants associated with its issuance to 31 Group LLC of convertible promissory notes. Upon issuance, the Company recorded a derivative liability and a related debt discount in the amount of $184. The debt discount was being amortized over the original life of the convertible promissory notes and was completely amortized as a result of the payoff of the 31 Group debt. On December 31, 2014, the Company used the Black-Scholes option pricing model to determine the fair value of the warrants and derived an implied fair value of $43, which is included in derivative financial instruments at estimated fair value on the consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability as a gain in the consolidated statements of operations of $141.
The fair value of the 31 Group Promissory Note warrant derivative at the measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies:
Group, LLC October Warrants
Pursuant to the securities purchase agreement entered into with 31 Group LLC dated October 8, 2014, the Company issued a warrant, initially exercisable for up to 300,000 shares of common stock at an exercise price of $5.00 per share. The warrant expires on the date that is the earlier of (i) the later of (x) the fifteenth (15th) Trading Day after the date a registration statement registering all of the shares of the Company’s common stock underlying the warrants is declared effective by the SEC and (y) December 31, 2014, and (ii) such earlier date as set forth in a written agreement of the Company and 31 Group LLC; provided, that any such date shall be extended as set forth in the warrant. On October 8, 2014, when the warrant was issued, the Company recorded a derivative liability in the amount of $90. The amount of the derivative liability was computed by using the Black-Scholes pricing model to determine the value of the warrants issued. On December 31, 2014, the Company used the Black-Scholes option pricing method to determine the fair value of the warrants and derived an implied fair value of $18, which is included in derivative financial instruments at estimated fair value on the consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability as a gain in the consolidated statements of operations of $71.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The fair value of the 31 Group securities purchase agreement warrants derivative at the measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies:
Bridge Financing Agreement Warrants
On December 3, 2014, the Company entered into a bridge financing agreement with GPB Life Science Holdings LLC, a third-party lender. Pursuant to the agreement, the Company issued a warrant entitling the lender to purchase 250,000 shares of common stock. The warrant is exercisable at a fixed price of $5.00 and expires 180 days from the original issue date. On December 1, 2014, when the warrant was issued, the Company recorded a derivative liability in the amount of $421. The amount was recorded as a debt discount and is being amortized over the original life of the related loan. On December 31, 2014, the Company used the Black-Scholes option pricing model to determine the fair value of the warrants and derived an implied fair value of $340, which is included in derivative financial instruments at estimated fair value on the consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability as a gain consolidated statements of operations of $81.
On December 24, 2014, the Company entered into a second bridge financing agreement with GPB Life Science Holdings LLC. Pursuant to the second agreement, the Company issued a warrant entitling the lender to purchase 150,000 shares of common stock. The warrant is exercisable at a fixed price of $5.00 and expires 180 days from the original issue date. On December 24, 2014, when the warrant was issued, the Company recorded a derivative liability in the amount of $215. The amount was recorded as a debt discount and is being amortized over the original life of the related loan. The amount of the derivative liability was computed by using the Black-Scholes pricing model to determine the value of the warrants issued. On December 31, 2014, the Company used the Black-Scholes option pricing method to determine the fair value of the warrants and derived an implied fair value of $206, which is included in derivative financial instruments at estimated fair value on the consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability as a gain in the consolidated statements of operations of $9.
The fair value of the GPB Life Science Holdings LLC warrants derivative at the measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies:
Option Shares
On October 15, 2014, the Company granted to an employee pursuant to the InterCloud Systems, Inc. 2012 Performance Incentive Plan an option to purchase 150,000 shares of common stock at an exercise price of $3.72 per share. The option vested immediately and expires on the tenth anniversary of the grant dated. The amount of the liability was computed by using the Black-Scholes pricing model and the fair value of the option liability recorded in the consolidated balance sheet at December 31, 2014 is $474.
On October 15, 2014, the Company granted to an employee pursuant to the InterCloud Systems, Inc. 2012 Performance Incentive Plan an option to purchase 25,000 shares of common stock at an exercise price of $3.72 per share. The option vests over three years with 33 1/3 percent vesting on the first anniversary of the grant date and on each of the next two anniversaries of the Grant Date. This option expires on the fifth anniversary of the grant date. The amount of the liability was computed by using the Black-Scholes pricing model and the fair value of the option liability recorded in the consolidated balance sheet at December 31, 2014 is $62.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
10. INCOME TAXES
The benefit from income taxes for the years ended December 31, 2014 and 2013 was as follows:
The Company’s income taxes was calculated on the basis of $1,180 of foreign net income.
The Company’s effective tax rate for the years ended December 31, 2014 and 2013 differed from the U.S. federal statutory rate as follows:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The tax effects of temporary differences and carryforwards that gave rise to significant portions of the deferred tax assets and liabilities were as follows:
The Company performs an analysis each year to determine whether the expected future income will more likely than not be sufficient to realize the deferred tax assets. The Company's recent operating results and projections of future income weighed heavily in the Company's overall assessment. Prior to 2012, there were no provisions (or benefits) for income taxes because the Company had sustained cumulative losses since the commencement of operations. In 2013, a benefit from income taxes of $588 from continuing operations was recorded. The tax benefit in 2013 was primarily a result of the release of the valuation allowance as a result of the recognition of offsetting deferred tax liabilities.
During 2014, in conjunction with the accounting associated with the acquisitions as described in Note 3, Acquisitions and Disposals of Subsidiaries, the Company recorded a net deferred tax liability related to the book and tax basis difference of the underlying assets acquired. The net deferred tax liability served as reversible temporary differences that would give rise to future taxable income and, accordingly, would serve as a source of income that permits the recognition of certain existing deferred tax assets of the Company. During the fourth quarter of 2014, management determined that it is more likely than not that a portion of its valuation allowance was no longer required due to the deferred tax liabilities recorded resulting from these acquisitions. As a result of the release of the valuation allowance, the Company recorded a tax benefit of $3,693 in the consolidated statement of operations for the year ended December 31, 2014 offset by certain current taxes of $524, resulting in a net tax benefit of $3,169.
As of December 31, 2014 and 2013, the Company had federal net operating loss carryforwards (“NOL’s”) of approximately $44,715 and $9,873, respectively, and state NOL’s of approximately $32,889 and $9,307, respectively, that will be available to reduce future taxable income, if any. These NOL’s begin to expire in 2025. In addition, as of December 31, 2014 and 2013, the Company had federal tax credit carryforwards of $791 and $318, respectively, available to reduce future taxes. These credits begin to expire in 2022.
Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, provide for annual limitations on the utilization of net operating loss and credit carryforwards if the Company were to undergo an ownership change, as defined in Section 382 of the Code. In general, an ownership change occurs whenever the percentage of the shares of a corporation owned, directly or indirectly, by 5-percent shareholders, as defined in Section 382 of the Code, increases by more than 50 percentage points over the lowest percentage of the shares of such corporation owned, directly or indirectly, by such 5-percent shareholders at any time over the preceding three years. In the event such ownership change occurs, the annual limitation may result in the expiration of the net operating losses prior to full utilization. The Company has completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since the Company became a “loss corporation” under the Code. As disclosed the Company has taken these limitations into account in determining its available NOL’s.
During 2012, the Company acquired ownership of three entities that had historically used the cash method of accounting for tax purposes. Section 446 of the Internal Revenue Code of 1986, as amended, requires that the Company prepare its tax returns using the accrual method of accounting. As a result of this change from cash to accrual accounting for income tax purposes, the Company will recognize $1,193 of income during 2015. During 2012 and 2013, the Company acquired 100% of a Puerto Rican limited liability company, thereby subjecting the Company to Puerto Rico income taxes on any Puerto Rico-sourced taxable income. Such taxes paid are considered foreign taxes that may be credited against federal income taxes payable in future years.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company applies the standard relating to accounting (ASC 740-10) for uncertainty in income taxes, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company is required to recognize in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. There were no significant unrecognized tax benefits recorded as of December 31, 2014, and there was no change to the unrecognized tax benefits during 2014 and 2013.
The Company does not have any tax positions for which it is reasonably possible the total amount of gross unrecognized tax benefits will increase or decrease through December 31, 2015. The unrecognized tax benefits may increase or change during the next year for items that arise in the ordinary course of business.
The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters as a component of income tax expense. As of December 31, 2014 and 2013, there was no accrued interest and penalties related to uncertain tax positions.
The Company is subject to U.S. federal income taxes and to income taxes in various states in the United States. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. Due to the Company's net operating loss carryforwards, all years remain open to examination by the major domestic taxing jurisdictions to which the Company is subject. In addition, all of the net operating loss and credit carryforwards that may be used in future years are still subject to adjustment. The Company is not currently under examination by any tax jurisdiction.
11. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration of credit risk consist of cash in financial institutions. The Company maintains deposits in federally-insured financial institutions. Cash held with financial institutions may exceed the amount of insurance provided on such deposits; however, management believes the Company is not exposed to significant credit risk due to the financial position of the financial institutions in which those deposits are held.
The Company grants credit under normal payment terms, generally without collateral, to its customers. These customers primarily consist of telephone companies, cable television multiple system operators and electric and gas utilities. With respect to a portion of the services provided to these customers, the Company has certain statutory lien rights that may in certain circumstances enhance the Company’s collection efforts. Adverse changes in overall business and economic factors may impact the Company’s customers and increase credit risks. These risks may be heightened as a result of the current economic developments and market volatility. In the past, some of the Company’s customers have experienced significant financial difficulties and likewise, some may experience financial difficulties in the future. These difficulties expose the Company to increased risks related to the collectability of amounts due for services performed. The Company believes that none of its significant customers were experiencing financial difficulties that would impact the collectability of the Company’s trade accounts receivable as of December 31, 2014 and 2013.
As of, and for the years ended, December 31, 2014 and 2013, concentrations of significant customers within the professional services segment were as follows:
Geographic Concentration Risk
Substantially all of the Company’s customers are located within the United States and Puerto Rico.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
12. COMMITMENTS AND CONTINGENCIES
The Company leases certain of its properties under leases that expire on various dates through 2019. Some of these agreements include escalation clauses and provide for renewal options ranging from one to five years.
Rent expense incurred under the Company’s operating leases amounted to $792 and $464 during the years ended December 31, 2014 and 2013, respectively.
The future minimum obligation during each year through 2019 under the leases with non-cancelable terms in excess of one year is as follows:
13. STOCKHOLDERS’ EQUITY (DEFICIT)
Common Stock:
Reverse stock splits
On December 7, 2012, the Company’s stockholders approved a reverse stock split of its common stock at a ratio of 1-for-125. The reverse stock split became effective on January 14, 2013. On May 15, 2013, the Company’s stockholders approved up to a 1-for-4 reverse stock split. The reverse stock split became effective on August 1, 2013. All applicable share and per share amounts have been retroactively adjusted to reflect the reverse stock splits.
Public Offering
On November 5, 2013, the Company completed an offering of its common stock in which the Company sold 1,250,000 shares of common stock at a price of $4.00 per share. In connection with the offering, 625,000 warrants to purchase 625,000 shares of common stock were also sold at $0.01 per warrant. The net proceeds to the Company from the offering after underwriting discounts and expenses was $4,550. Of the 625,000 warrants sold, 111,095 were exercised as of December 31, 2014.
Basis for determining fair value of shares issued
The Company determines the value at which to record common stock issued in connection with acquisitions, debt conversions and settlements, loan modifications and employee and non-employee compensation arrangements, using the market price of the common stock on the date of issuance.
Issuance of shares of common stock to third parties for services and non-employees
During 2013, the Company issued 23,879 shares of the Company’s common stock to consultants in exchange for consulting services relating to corporate matters. The shares were valued at an average fair value of $8.85 per share and were immediately vested. The Company recorded $211 to salaries and wage expense.
During February 2014, the Company issued 7,500 shares of its common stock to a consultant in exchange for consulting services relating to corporate matters. The shares were valued at fair value at $13.41 per share and were immediately vested. The Company recorded $101 to salaries and wages expense.
During March 2014, the Company issued 69,458 shares of its common stock to a consultant in exchange for consulting services relating to corporate matters. The shares were valued at fair value at $11.87 per share and were immediately vested. The Company recorded $82 to salaries and wages expense.
During April 2014, the Company issued 9,677 shares of its common stock to consultants in exchange for consulting services relating to corporate matters. The shares were valued at fair value at $5.04 and $5.99 per share, respectively and were immediately vested. The Company recorded $50 to salaries and wages expense.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
During July 2014, the Company issued 7,500 shares of its common stock to consultants in exchange for consulting services relating to corporate matters. The shares were valued at fair value at $5.43 per share and were immediately vested. The Company recorded $41 to salaries and wages expense.
During August 2014, the Company issued 40,241 shares of its common stock to non-employees. The shares were valued at fair value at $4.89 per share and were immediately vested. The Company recorded $197 to salaries and wages expense.
During November 2014, the Company issued 12,000 shares of its common stock to non-employees. The shares were valued at fair value at $3.15 per share and were immediately vested. The Company recorded $38 to salaries and wages expense.
Issuance of shares of common stock to employees, directors, and officers
During 2013, the Company issued 5,000 shares of the Company’s common stock to two employees for services rendered. The shares were valued at $11.52 per share for a value of $58. The shares were immediately vested.
During 2013, the Company issued 149,700 shares of the Company’s common stock to six employees and two directors or services rendered. The shares were valued at $10.51 per share for a value of $1,573. The shares were immediately vested.
During April, May and June 2014, the Company issued an aggregate of 1,105,597 shares of its common stock to various employees and directors for services rendered. The shares were valued between $5.04 to $5.99 per share. The Company recorded $1,963 to stock compensation expense.
During July and August 2014, the Company issued an aggregate of 524,551 shares of its common stock to various employees and directors for services rendered. The shares were valued between $4.89 to $5.43 per share. The Company recorded $954 to stock compensation expense.
During November 2014, the Company issued an aggregate of 15,455 shares of its common stock to various employees and directors for services rendered. The shares were valued at $3.15 per share. The Company recorded $34 to stock compensation expense.
Issuance of shares pursuant to convertible notes payable
During 2013, the Company issued 7,206 shares of the Company’s common stock to a third-party lender in connection with the conversion of notes payable aggregating $28. Upon conversion, $144 was recorded as interest expense related to the beneficial conversion feature.
During 2013, the Company issued 36,584 shares of the Company’s common stock to a third-party lender in connection with the conversion of notes payable aggregating $210. Upon conversion, $281 was recorded as interest expense related to the beneficial conversion feature.
On December 13, 2013, the Company entered into a securities purchase agreement with certain institutional investors pursuant to which the Company issued to such investors 12% convertible debentures. During December 2013, 36,567 shares of common stock were issued as a debt discount in the amount of $382 as part of the debenture issuance.
In April 2013, the Company entered into an agreement for the acquisition of AW Solutions. As part of the acquisition, the Company issued a note in the amount of $2,108 to the former owners of AW Solutions. On December 31, 2013, the Company settled the remaining principal and interest on the note with the issuance of 152,562 shares of common stock. The shares were issued with a fair value of $18.36 per share, for a total fair value of $2,801, which resulted in a loss on extinguishment of debt of $992.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Issuance of shares of common stock pursuant to extinguishment of the MidMarket Term Loan
During March 2014, the Company issued 1,080,361 shares of its common stock to a third-party lender pursuant to the extinguishment of notes payable aggregating $12,025. The shares were issued with a fair value of $11.87 per share, for a total fair value of $12,824, which resulted in a loss on extinguishment of debt of $799.
During April 2014, the Company issued 100,000 shares of its common stock to a third-party lender pursuant to the extinguishment of notes payable aggregating $1,187. The shares were issued with a fair value of $11.87 per share, for a total fair value of $1,187.
During April 2014, the Company issued 401,996 and 363,853 shares of its common stock to two third-party lenders pursuant to the extinguishment of notes payable aggregating $4,097. The shares were issued with a fair value of $5.35 per share, for a total fair value of $4,097, which was recorded as loss on extinguishment of debt on the consolidated statement of operations.
Issuance of shares of common stock pursuant to conversion of the 12% Convertible Debentures
During February 2014, the Company issued 176,100 shares of its common stock to a third-party lender pursuant to the conversion of notes payable aggregating $1,000 and accrued interest of $120. The shares were issued at $6.36 per share, the conversion price of the notes payable, for a total value of $2,218.
During March 2014, the Company issued 35,220 shares of its common stock to a third-party lender pursuant to the conversion of notes payable aggregating $200 and accrued interest of $24. The shares were issued at $6.36 per share, the conversion price of the notes payable, for a total value of $224.
During June 2014, the Company issued an aggregate of 290,565 shares of its common stock to three third-party lenders pursuant to the conversion of notes payable aggregating $1,650 and accrued interest of $99. The shares were issued at $6.92 per share, the conversion price of the notes payable, for a total value of $2,011.
During June 2014, the Company issued 35,220 shares of its common stock to a third-party lender pursuant to the conversion of notes payable aggregating $200 and accrued interest of $12. The shares were issued at $6.78 per share, the conversion price of the notes payable, for a total value of $239.
During June 2014, the Company issued 17,610 shares of its common stock to a third-party lender pursuant to the conversion of notes payable aggregating $100 and accrued interest of $6. The shares were issued at $6.65 per share, the conversion price of the notes payable, for a total value of $117.
During June 2014, the Company issued an aggregate of 128,303 shares of its common stock to two third-party lenders pursuant to the conversion of notes payable aggregating $702 and accrued interest of $75. The shares were issued at $6.67 per share, the conversion price of the notes payable, for a total value of $856.
During June 2014, the Company issued an aggregate of 20,755 shares of its common stock to two third-party lenders pursuant to the conversion of notes payable aggregating $92 and accrued interest of $35. The shares were issued at $6.97 per share, the conversion price of the notes payable, for a total value of $145.
During June 2014, the Company issued an aggregate of 89,649 shares of its common stock to five third-party lenders pursuant to the conversion of notes payable aggregating $461 and accrued interest of $84. The shares were issued at $6.59 per share, the conversion price of the notes payable, for a total value of $591.
During July 2014, the Company issued an aggregate of 44,025 shares of its common stock to seven third-party lenders pursuant to the conversion of notes payable aggregating $250 and accrued interest of $17. The shares were issued at $6.22 per share, the conversion price of the notes payable, for a total value of $274.
During July 2014, the Company issued an aggregate of 36,164 shares of its common stock to seven third-party lenders pursuant to the conversion of notes payable aggregating $200 and accrued interest of $14. The shares were issued at $6.25 per share, the conversion price of the notes payable, for a total value of $226.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
During July 2014, the Company issued an aggregate of 23,585 shares of its common stock to seven third-party lenders pursuant to the conversion of notes payable aggregating $132 and accrued interest of $9. The shares were issued at $5.99 per share, the conversion price of the notes payable, for a total value of $141.
During July 2014, the Company issued an aggregate of 12,561 shares of its common stock to seven third-party lenders pursuant to the conversion of notes payable aggregating $42 and accrued interest of $3. The shares were issued at $6.17 per share, the conversion price of the notes payable, for a total value of $78.
During July 2014, the Company issued an aggregate of 146,083 shares of its common stock to two third-party lenders pursuant to the conversion of notes payable aggregating $833 and accrued interest of $61. The shares were issued at $5.66 per share, the conversion price of the notes payable, for a total value of $827.
During July 2014, the Company issued an aggregate of 189,990 shares of its common stock to seven third-party lenders pursuant to the conversion of notes payable aggregating $1,146 and accrued interest of $63. The shares were issued at $5.54 per share, the conversion price of the notes payable, for a total value of $1,052.
Issuance of shares to satisfy obligations pursuant to warrants
On April 26, 2013, August 28, 2013 and October 30, 2013, the Company issued warrants to ICG USA, LLC and Venture Champion Asia Limited in connection with loans received from those entities in April, August and October 2013. These warrants were fully exercised with the issuance of 138,396 shares of common stock.
During January 2014, the Company issued an aggregate of 53,259 shares of common stock to the holders of the Series E warrants in exchange for such warrants. The common stock was valued at $16.90 per share. The total value of the shares issued was $900.
On various dates during the quarter ending March 31, 2014, the Company issued an aggregate of 111,095 shares of common stock with a fair value of $555 related to the exercise of warrants issued in a public offering.
Issuance of shares pursuant to penalty to waive covenant
During 2013, the Company issued an aggregate of 20,375 shares of the Company’s common stock in connection with a loan modification of the MidMarket Loan. The shares were valued at a price of $12.20 per share. The aggregate consideration for the issuance of the shares of common stock amounted to $249, which amount was recorded as interest expense in the consolidated statement of operations.
Issuance of shares pursuant to preferred dividends
During 2013, the Company issued 112,256 shares of the Company’s common stock in satisfaction of accrued preferred stock dividends in an amount equal to $959.
Issuance of shares pursuant to conversion of preferred stock
During 2013, the Company issued 39,487 shares of common stock upon the conversion of 566 shares ($566) of Series D Preferred Stock.
During 2013, the Company issued 40,000 shares of common stock upon the conversion of 2,000,000 shares of Series A Preferred Stock. Of such shares, 8,000, shares of common stock were issued to Lawrence Sands, the Company’s then Senior Vice President and Corporate Secretary, and 16,000 shares of common stock were issued to each of Billy Caudill and Gideon Taylor, each of whom was a former officer and director of the Company.
In 2013, the Company issued 3,352 shares of common stock upon the conversion of 42 shares ($40) of Series D Preferred Stock.
In 2013, the Company issued 2,452,742 shares of common stock upon the conversion of 37,500 shares ($2,217) of Series B Preferred Stock.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In 2013, the Company issued 1,262,440 shares of common stock upon the conversion of 1,500 shares ($1,500) of Series C Preferred Stock.
In 2013, the Company issued 534,819 shares of common stock upon the conversion of 3,350 shares ($3,350) of Series E Preferred Stock.
In 2013, the Company issued 483,015 shares of common stock upon the conversion of 1,425 shares ($1,425) of Series H Preferred Stock.
Issuance of shares pursuant to settlement of TNS contingent consideration and settlement of Series F Preferred Stock
On December 21, 2013, the Company entered into agreement with TNS sellers to satisfy all the Company’s outstanding obligations related to the TNS acquisition agreement. Based on the terms of that agreement, the Company settled all remaining obligations to the TNS sellers by converting the 1,150 shares of Series F Preferred Stock owned by such sellers, along with the settlement of the common shares with a put option, issued additional shares to settle contingent consideration and the shares to be issued in connection with the Company’s public offering, which aggregated to 466,702 shares of the Company’s common stock. At the time of settlement, there was no contingent consideration outstanding. The shares issued to settle the contingent consideration arrangement resulted in a loss of $2,200.
Issuance of shares pursuant to exercise of stock options
During 2013, the Company issued 5,000 shares of common stock upon the exercise of common stock options.
Issuance of shares pursuant to promissory notes
In March 2014, the Company issued an aggregate of 216,876 shares of its common stock with an average fair value of $7.95 per share, to a third-party lender in satisfaction of notes payable aggregating $1,725. The shares were issued at $1,725, per the terms of the notes payable.
Issuance of shares pursuant to initial investment in non-controlling interest
During April 2014, the Company issued 25,000 shares of its common stock to an officer in consideration of an acquisition of a 40% ownership interest in Nottingham Enterprises. The shares were issued with a fair value at $5.99 per share.
Issuance of shares for payment of related-party interest
During June 2014, the Company issued an aggregate of 8,934 shares of its common stock to four related parties for payment of accrued interest aggregating to $53. The shares were issued at $5.97 per share.
During July 2014, the Company issued an aggregate of 101,440 shares of its common stock to seven related parties for payment of accrued interest aggregating to $551. The shares were issued at $5.43 per share.
During November 2014, the Company issued an aggregate of 17,478 shares of its common stock to four related parties for payment of accrued interest aggregating to $58. The shares were issued at $3.15 per share.
Issuance of shares pursuant to completed acquisition
During 2013, the Company issued 203,735 shares of common stock, valued at $12.80 per share, in connection with the Company’s acquisition of AWS. The shares were valued in the aggregate at $2,608.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
During January 2014, the Company issued 57,448 shares of common stock, valued at $16.99 per share, pursuant to its completed acquisition of IPC. These shares were valued at $976.
During January 2014, the Company issued 47,080 shares of common stock, in escrow, valued at $10.00 per share, pursuant to its completed acquisition of IPC. These shares were valued at $471.
During February 2014, the Company issued 400,000 shares of common stock, valued at $13.20 per share, pursuant to its completed acquisition of RentVM. These shares were valued at $5,280.
During April 2014, the Company issued 91,241 shares of common stock, valued at $5.99 per share, pursuant to its completed acquisition of the assets from a non-affiliated entity. These shares were valued at $546.
During October 2014, the Company issued 1,008,690 shares of common stock, valued at $3.90 per share, pursuant to its completed acquisition of VaultLogix. These shares were valued at $3,934.
During December 2014, the Company issued 443,524 shares of common stock, valued at $3.36 per share, pursuant to VaultLogix’s acquisition of certain assets from a non-affiliated entity. These shares were valued at $1,490.
During December 2014, the Company issued 234,159 shares of common stock, valued at $2.92 per share, pursuant to AWS’s acquisition of certain assets from a non-affiliated entity. These shares were valued at $684.
Issuance of shares pursuant to completed business combination
During January 2014, the Company issued 50,861 shares of common stock, valued at $16.00 per share, in connection with promissory notes issued to AWS. The total value of the stock issued was $814. The Company agreed with the note holders to convert the debt into shares of common stock at a price less than market price, which resulted in a loss due to the settlement of a working capital note payable that was recorded in the consolidated statement of operations as loss on extinguishment of debt of $306.
Issuance of shares pursuant to AWS earn out
During August 2014, the Company issued 490,445 shares issued to the former owners of AW Solutions in settlement of the earn-out provision included in the purchase agreement. The shares were issued at $5.19 per share, which was the conversion price of the notes payable, for a total value of $2,624 and a related loss in contingent consideration of $860 was recorded in the consolidated statements of operations for the year ended December 31, 2014. In addition the Company recorded a gain of $79 which is recorded within loss on extinguishment of debt in the consolidated statements of operations for the year ended December 31, 2014.
Issuance of shares pursuant to earn out of AWS asset purchase
During November 2014, the Company issued 16,896 shares of common stock for the future contingent consideration owed to the owners of an AWS asset purchase. The shares were issued at $3.15 per share and were valued at $53.
Issuance of shares upon Settlement of debt
During November 2014, the Company issued 125,000 shares of common stock to related parties for the cancellation of debt. The shares were issued between $3.13 per share and $3.15 per share and were valued at $393.
Issuance of shares pursuant to private placement
During October 2014, the Company completed two private placements of its common stock in which the Company sold 868,838 shares of common stock at a price of $5.00 per share. The cash proceeds received by the Company in connection with the private placements was $4,284 less transaction fees for a total value of $4,073.
Purchase of Treasury Shares
During December 2014, the Company repurchased 850 shares from two employees who terminated employment for a nominal amount of cash.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Preferred Stock
The Company evaluated and concluded that its Series B, C, E, F, G and H Preferred Stock did not meet the criteria in ASC 480-10 and thus were not considered liabilities. The Company evaluated and concluded that the embedded conversion feature in its Series B, C, E, G and H Preferred Stock did not meet the criteria of ASC 815-10-25-1 and did not need to be bifurcated. In accordance with ASR 268 and ASC 480-10-S99, these equity securities were required to be classified outside of permanent equity because they were redeemable for cash. These instruments are no longer outstanding.
The Company evaluated and concluded that its Series D Preferred Stock did not meet any the criteria in ASC 480-10 and thus was not considered a liability. The Company evaluated and concluded that the embedded conversion feature in the Series D Preferred Stock did not meet the criteria of ASC 815-10-25-1 and did not need to be bifurcated. In accordance with ASR 268 and ASC 480-10-S99, the shares of Series D Preferred Stock were required to be classified outside of permanent equity because such shares were redeemable for cash. These shares are no longer outstanding.
The Company evaluated and concluded that its Series I Preferred Stock did not meet any the criteria in ASC 480-10 and thus was not considered a liability. The Company evaluated and concluded that the embedded conversion feature in the Series I Preferred Stock did not meet the criteria of ASC 815-10-25-1 and did not need to be bifurcated. In accordance with ASR 268 and ASC-480-10, the shares of Series I Preferred Stock were required to be classified outside of permanent equity because such shares were redeemable for cash. These shares are no longer outstanding.
Series A
On June 1, 2011, the Company designated 20,000,000 of its 50,000,000 authorized shares of preferred stock, par value of $0.0001 per share, as Series A Preferred Stock (the “Series A Preferred Stock”). The Series A Preferred Stock had no dividend rights and was convertible into shares of common stock of the Company at a conversion ratio of .08 shares of common stock for every one share of Series A Preferred Stock. The Series A Preferred Stock was redeemable at a price of $0.0001 per share and entitled the holder to voting rights at a ratio of .08 votes for every one share of Series A Preferred Stock.
On June 1, 2011, the Company’s Board of Directors authorized the issuance of 2,000,000 shares of the Series A Preferred Stock to three of the Company’s principal officers valued at the fair market value of $1.00 per share and recorded in the accompanying financials statements as stock compensation expense. The carrying amount of the Series A Preferred Stock was based on the par value of the Series A Preferred stock of $0.001 per share, or $200, the difference of $2,000 between the fair value of the Series A Preferred Stock at date of issuance and the carrying value of $200, was recorded as additional paid in capital.
As of December 31, 2012, the Series A Preferred Stock was convertible into 40,000 shares of common stock. This conversion was based on a conversion ratio of .08 shares of common stock for each share of Series A Preferred Stock. On February 7, 2013, holders converted all outstanding shares of Series A Preferred Stock into 40,000 shares of common stock.
Series B
On June 28, 2011, the Company designated 60,000 of its authorized shares of preferred stock as Series B Preferred Stock (the “Series B Preferred Stock”). The Series B Preferred Stock had no dividend rights and each share of Series B Preferred Stock was convertible into such number of shares of common stock of the Company as is equal to 0.00134% of the Company’s total common stock outstanding on a fully-diluted basis. The Series B Preferred Stock was redeemable, at the option of the holder, at a price of $1,000 per share, and entitled the holders to one vote for each share of common stock to be received on an as if converted basis. In June 2011, the Company sold and received subscriptions for the sale of 15,000 shares of Series B Preferred Stock at $1,000 per share from three individuals and a trust. One of the individuals is, and the trust is a related party to, the current chief executive officer of the Company. During 2012, the Company sold, and received subscriptions from four individuals for the purchase of, 16,021 shares of Series B Preferred stock for cash consideration in the aggregate amount of $1,585. Three individuals also converted a principal amount of debt and accrued interest thereon in the aggregate amount of $617 into 6,479 shares of Series B Preferred Stock. On June 25, 2013, holders converted all 37,500 outstanding shares of Series B Preferred stock into 2,452,742 shares of common stock.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Series C
On December 23, 2011, the Company designated 1,500 shares of the authorized shares of preferred stock as Series C Preferred Stock (the “Series C Preferred Stock”). Series C Preferred Stock had a stated value of $1,000 per share, and entitled holders to receive cumulative dividends at the rate of 10% of the stated value per annum, payable quarterly. Holders of Series C Preferred Stock have a two-year option to convert their shares of Series C Preferred Stock to common stock at a rate per share equal to 0.025% of the issued and outstanding common stock at the time of the conversion. On June 25, 2013, holders converted all 1,500 outstanding shares of Series C Preferred stock into 1,262,440 shares of common stock.
Series D
On December 31, 2011, the Company designated 1,000 shares of its authorized shares of preferred stock as Series D Preferred Stock (the “Series D Preferred Stock”). The Series D Preferred Stock had an initial stated value of $1,000 per share and entitled holders to receive cumulative dividends at the annual rate of 10% of the stated value per share, payable quarterly in cash or shares of common stock, at the election of the Company, beginning on March 31, 2012. The Series D Preferred Stock was non-voting, non-redeemable and was convertible at any time the market capitalization of the Company’s common stock exceeded $15,000 or the shares of common stock were trading at a per share price in excess of $43.75 per share for a 10-day trading period. The number of shares of common stock issuable upon conversion was calculated by dividing the stated amount of the Series D Preferred Stock by the closing price of the common stock on the last business date preceding written notice by the Company to the holders of the Series D Preferred Stock of the Company’s decision to convert such shares. On December 31, 2011, the Company’s Board of Directors authorized the issuance of 408 shares of Series D Preferred Stock to one of the Company’s former principal officers in settlement of a note payable due the officer aggregating $406, including unpaid interest. On January 30, 2013, holders converted 566 shares of Series D Preferred Stock into 39,487 shares of common stock. On May 12, 2013, holders converted all 42 remaining outstanding shares of Series D Preferred Stock into 3,352 shares of common stock.
Series E
On September 17, 2012, the Company designated 3,500 shares of its authorized shares of preferred stock as Series E Preferred Stock (the “Series E Preferred Stock”). Series E Preferred Stock had a stated value of $1,000 per share, and was entitled to cumulative dividends at a rate of 12% per annum, payable quarterly, beginning on September 30, 2012. The dividends were payable in cash or shares of the Company’s common stock, at the Company’s option. Holders of Series E Preferred Stock had a one-year option to convert their shares of Series E Preferred Stock to common stock of the Company. In aggregate, the shares of Series E Preferred Stock were convertible into a number of shares of common stock amounting to 9.8% of the fully-diluted capitalization of the Company. The shares of Series E Preferred Stock were redeemable at $1,000 per share, at the option of the holder. On August 6, 2013, holders converted all 3,350 outstanding shares of Series E Preferred Stock into 534,819 shares of common stock.
Series F
On September 17, 2012, the Company designated 4,800 shares of its authorized shares of preferred stock as Series F Preferred Stock (the “Series F Preferred Stock”). Series F Preferred Stock had an initial stated value of $1,000 per share, and entitled the holders to receive cumulative dividends at the rate of 12% per annum, payable quarterly, beginning on September 30, 2012. The dividends were payable in cash or shares of the Company’s common stock, at the Company’s option. Holders of Series F Preferred Stock had an option to convert their shares of Series F Preferred Stock to common stock on the fourth day after the Company’s associated registration statement under the Securities Act of 1933, as amended, is declared effective by the Securities and Exchange Commission and for a period of one year thereafter. The shares of Series F Preferred Stock were convertible at the lesser of (i) the last quoted price of the common stock on the third day following the effective date of the associated registration statement or (ii) the average of the last reported sale price of the common stock for each of the three trading days prior to the date of conversion. The shares of Series F Preferred Stock were redeemable at $1,000 per share, at the option of the holder. During 2013, the holders liquidated 3,000 shares of Series F Preferred Stock for cash considerations. On December 24, 2013, Company and the holders executed a settlement agreement and the holders converted the remaining 1,150 shares of Series F Preferred Stock into 377,049 shares of common stock. The Series F Preferred Stock was converted using a conversion price of $3.05 per share, and the fair value of the Company's common stock on the date of conversion was $10.50. The former owners of Series F Preferred Stock also settled the put option shares and received the shares to be issued as part of the Company's public stock offering. As a result of the settlement agreement Company recorded a loss on settlement of contingent consideration of $2,200.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Series G
On September 17, 2012, the Company designated 2,000 shares of its authorized preferred stock as Series G Preferred Stock (the “Series G Preferred Stock”). Series G Preferred Stock had an initial stated value of $1,000 per share, and entitled the holders to receive cumulative dividends at a rate of 12% per annum, payable quarterly, beginning on September 30, 2012. The dividends were payable in cash or shares of the Company’s common stock, at the Company’s option. Holders of Series G Preferred Stock had an option to convert their shares of Series G Preferred Stock into the Company’s common stock upon the occurrence of a default of payment of an earn-out or working capital loan in connection with the Company’s acquisition of the ADEX Entities and after the associated registration statement is declared effective by the Securities and Exchange Commission. The shares of Series G Preferred Stock were convertible at the rate equal to the earn-out or working capital loan payment that is under default divided by $1,000 and by the lesser of (i) the last quoted price of the common stock on third day following the effective date of the associated registration statements or (ii) the average of the last reported sale price of the common stock for each of the three trading days prior to the date of conversion. The shares of Series G Preferred Stock were redeemable at the amount of earn out or working capital loan upon the occurrence of default, at their then carrying value, at the option of the holder. The Series G Preferred Stock was cancelled in February 2014 upon the settlement of the ADEX contingent consideration.
Series H
On October 25, 2012, the Company designated 2,000 shares of its authorized preferred stock as Series H Preferred Stock (the “Series H Preferred Stock”). Series H Preferred Stock had an initial stated value of $1,000 per share, and entitled the holders to receive cumulative dividends at a rate of 10% per month, up to 150%. The dividends were payable in cash or shares of the Company’s common stock, at the Company’s option, upon conversion or redemption. Holders of Series H Preferred Stock had a one-year option to convert their shares of Series H Preferred Stock to common stock, beginning 90 days after the date of issuance. In the aggregate, the shares of Series H Preferred Stock were convertible into a number of shares of common stock amounting to 4.49% of the fully-diluted capitalization of the Company. The shares of Series H Preferred Stock were redeemable at $1,000 per share, at the option of the holder, beginning 180 days after the date of their issuance. The Company could have delayed the payment of the redemption amount by paying interest thereon at the rate of 2% per month until paid. During the fourth quarter of 2012, the Company received subscription agreements and cash and issued 1,425 shares of Series H Preferred Stock for an aggregate purchase price of $1,425. On December 31, 2013, holders converted all 1,425 outstanding shares of Series H Preferred Stock into 483,015 shares of common stock. In connection with the conversion, the Company received a commission in the amount of $1,824, which is included in other income on the consolidated statements of operations, from an investor who purchased all of the outstanding shares of Series H Preferred Stock from the holders and then converted the total amount of outstanding shares of Series H Preferred Stock.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Series I
On November 30, 2012, the Company designated 4,500 shares of its authorized preferred stock as Series I Preferred Stock (the “Series I Preferred Stock”). Series I Preferred Stock had an initial stated value of $1,000 per share. Holders of Series I Preferred Stock had an option to convert their shares of Series I Preferred Stock to common stock on the earlier of the 30th day after the associated registration statement is declared effective by the Securities and Exchange Commission or 120 days after the date of their issuance. The shares of Series I Preferred Stock were convertible into common stock at the rate equal to the average of the last reported sale price of the common stock for each of the three trading days prior to the date of conversion. The shares of Series I Preferred Stock were redeemable at $1,000 per share, at the option of the holder, beginning on the 31st day after the associated registration statement is declared effective by the Securities and Exchange Commission and until the Company had redeemed up to $750 of Series I Preferred Stock. On November 21, 2013, the Company acquired and cancelled the 4,500 shares of Series I Preferred Stock as part of the sale of its ERFS subsidiary. As of that date, there were no remaining shares of Series I Preferred Stock outstanding.
A summary of the transactions related to the Company’s preferred stock classified as temporary equity during 2013 is as follows:
14. PREFERRED DIVIDENDS
The Company calculated the dividends on the preferred stock for the years ended December 31, 2013 as follows:
* The stated dividend rate was 10%; however, if the dividends were not paid, the dividend rate became 12%.
** Dividends accrued on the Series H Preferred Stock at the rate of 10% per month for a maximum amount of dividends equal to 150% of the stated amount.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
15. STOCK-BASED COMPENSATION
Restricted Stock
The following table summarizes the Company’s restricted stock unit activity for the year ended December 31, 2014.
For the twelve months ended December 31, 2014 and 2013, the Company incurred $4,165 and $2,508, respectively, in stock compensation expense from the issuance of common stock to employees and consultants. In the fourth quarter of 2014, the Company recorded additional compensation expense of $158 related to second quarter 2014 share issuances and $600 related to the third quarter 2014 share issuances.
Options
The fair values of stock option grants during the year ended December 31, 2014 was calculated on the date of the grant using the Black-Scholes option pricing model. There were no options granted during the year ended December 31, 2013. Compensation expense is recognized over the period of service, generally the vesting period (see Note 2 Summary of Significant Accounting Policies). During the year ended December 31, 2014, 175,000 options were granted by the Company. The following assumptions were used in the Black-Scholes options pricing model to estimate the fair value of stock options for the year ended December 31, 2014:
The following table summarizes the Company’s stock option activity and related information for the year ended December 31, 2014.
The aggregate intrinsic value for outstanding options is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock as of December 31, 2014 of $2.92.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
16. RELATED PARTIES
At December 31, 2014 and 2013, the Company had outstanding the following loans from related parties:
Future maturities of related party debt are as follows:
The interest expense associated with the related-party notes payable in the years ended December 31, 2014 and 2013 amounted to $1,743 and $1,046, respectively.
Subsequent to December 31, 2014, the Company restructured certain related-party loans. Refer to Note 19 Subsequent Events for further detail.
Related Party Promissory Note Payable
On July 5, 2011, the Company entered into a definitive master funding agreement with MMD Genesis LLC (“MMD Genesis”), a company the three principals of which are the Company’s Chairman of the Board and Chief Executive Officer, Mark Munro, one of the Company’s directors, Mark F. Durfee, and Douglas Shooker, the principal of Forward Investments LLC, the beneficial owner of more than 5% of the Company’s common stock. Pursuant to the master funding agreement, MMD Genesis has made loans to us from time to time to fund certain of the Company’s working capital requirements and a portion of the cash purchase prices of the Company’s business acquisitions. All such loans originally bore interest at the rate of 2.5% per month and matured on June 30, 2014. At December 31, 2013, the Company had outstanding loans from MMD Genesis in the aggregate principal amount of $3,925, respectively, were outstanding.
On January 1, 2014, the outstanding principal amount of the loans from MMD Genesis in the amount of $3,925, and accrued interest thereon in the amount of $964, was restructured and, in lieu thereof, the Company issued to the principals of MMD Genesis LLC or their designees the following notes:
● a note issued to Mark Munro 1996 Charitable Remainder UniTrust in the principal amount of $275 that bears interest at the rate of 12% per annum and matures on March 31, 2016. As of December 31, 2014 the Mark Munro 1996 Charitable Remainder UniTrust is no longer a related party;
● a note issued to CamaPlan FBO Mark Munro IRA in the principal amount of $347 that bears interest at the rate of 12% per annum and matures on March 31, 2016;
● a note issued to 1112 Third Avenue Corp., a company controlled by Mark Munro, in the principal amount of $375 that bears interest at the rate of 12% per annum and matures on March 31, 2016;
● a note issued to Mark Munro in the principal amount of $737 that bears interest at the rate of 12% per annum and matures on March 31, 2016;
● a note issued to Pascack Road, LLC, a company controlled by Mark Durfee, in the principal amount of $1,575 that bears interest at the rate of 12% per annum and matures on March 31, 2016;
● a note issued to Forward Investments, LLC in the principal amount of $650 that bears interest at the rate of 10% per annum, matures on June 30, 2015 and is convertible into shares of the Company’s common stock at an initial conversion price of $6.36 per share; and
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
● a note issued to Forward Investments, LLC in the principal amount of $2,825 that bears interest at the rate of 2% per annum, matures on June 30, 2015 and is convertible into shares of the Company’s common stock at an initial conversion price of $6.36 per share, and reflects certain penalties and consulting fees of $1,000 which were incurred and outstanding as of December 31, 2013.
On February 4, 2014 and March 28, 2014, Forward Investments, LLC made loans to the Company for working capital purposes in the amounts of $1,800 and $1,200, respectively. Such loans are evidenced by promissory notes that bear interest at the rate of 10% per annum, mature on June 30, 2015 and are convertible into shares of the Company’s common stock at an initial conversion price of $6.36 per share.
Series E Preferred Stock Financing
Between September 2012 and January 2013, the Company sold an aggregate of 2,725 shares of its Series E Preferred Stock at $1,000 per share for an aggregate purchase price of $2,725. These sales were made to “accredited investors” within the meaning of the Securities Act, including certain of the Company’s affiliates. Charles K. Miller, a director of the Company, purchased 25 shares for a purchase price of $25. A company owned by the Company’s Chief Executive Officer, Mark Munro, purchased 25 shares for a purchase price of $25.
Related Party Promissory Notes to CamaPlan FBO Mark Munro IRA
On July 8, 2014, the Company issued a promissory note to the CamaPlan FBO Mark Munro IRA in the principal amount of $200 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
Related Party Promissory Notes to Mark Munro
On September 2, 2014, the Company issued a promissory note to Mark Munro in the principal amount of $100 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
On September 9, 2014, the Company issued a promissory note to Mark Munro in the principal amount of $150 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
On September 24, 2014, the Company issued a promissory note to Mark Munro in the principal amount of $250 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
Related Party Promissory Notes to Pascack Road, LLC
On June 20, 2014, the Company issued a promissory note to Pascack Road, LLC in the principal amount of $300 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
On July 11, 2014, the Company issued a promissory note to Pascack Road, LLC in the principal amount of $200 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
On September 2, 2014, the Company issued a promissory note to Pascack Road, LLC in the principal amount of $100 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
On September 8, 2014, the Company issued a promissory note to Pascack Road, LLC in the principal amount of $150 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
On September 29, 2014, the Company issued a promissory note to Pascack Road, LLC in the principal amount of $575 that bears interest at the rate of 18% per annum and matures on March 31, 2016.
Related Party Promissory Notes to Forward Investments, LLC
On June 19, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $500 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
On July 11, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $200 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
On August 12, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $600 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
On September 2, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $100 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
On September 8, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $150 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
On September 26, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $250 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
On September 29, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $395 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
On October 24, 2014, the Company issued a promissory note to Forward Investments, LLC in the principal amount of $400 that bears interest at the rate of 18% per annum and matures on June 30, 2015.
Forward Investments Working Capital Loan
On February 4, 2014 and March 28, 2014, Forward Investments, LLC made loans to the Company for working capital purposes in the amounts of $1,800 and $1,200, respectively. Such loans are evidenced by promissory notes that bear interest at the rate of 10% per annum, mature on June 30, 2015 and are convertible into shares of the Company’s common stock at an initial conversion price of $6.36 per share.
Due to the embedded conversion feature of the Forward Investments, LLC loans, the Company deemed this feature to be a derivative and recorded a debt discount in the amount of $8,860, which is being amortized over the life of the loans using the effective interest method. Refer to Note 9 Derivative Instruments for further detail on the Forward Investments derivative.
Revolving Line of Credit
On July 3, 2014, the Company obtained an unsecured $3,000 interim revolving line of credit from MMD Genesis LLC, CamaPlan FBO Mark Munro IRA, Mark Munro, Pascack Road, LLC, and Forward Investments, LLC, all of which are related parties, to provide working capital as well as cash to make the Company’s upcoming amortization payments pursuant to the Company’s Convertible Debentures. The line has a maturity date of March 31, 2016, and bears interest at the rate of 1.5% per month on funds drawn.
As of December 31, 2014, there was no amount outstanding under the related party revolving line of credit.
Convertible Promissory Note to Scott Davis
On July 1, 2014, the Company issued an unsecured $250 convertible promissory note to Scott Davis, who is a related party. The note bears interest at the rate of 8% per annum, matures on January 1, 2015 and is convertible into shares of the Company’s common stock at an initial conversion price of $6.59. The note is currently outstanding and payable on demand. The Company evaluated the convertible feature and determined that the value was de minimis and as such, the Company did not bifurcate the convertible feature.
17. SEGMENT INFORMATION
The Company has acquired four companies since January 1, 2013. With each acquisition, the Company evaluated the newly-acquired company’s sources of revenues and costs of revenues. The Company evaluated its acquisitions and their impact upon the segments structure as of December 31, 2013. The Company had determined that its two operating segments were specialty contracting services and telecommunications staffing services. Due to continued expansion in 2014, the Company evaluated its recent acquisitions and their impact upon the existing segment structure. The Company determined that it has three reportable segments are applications and infrastructure (formally known as specialty contracting services), professional services (formally known as telecommunications staffing services) and cloud and managed services, which is comprised of the cloud services operating segment and professional services operating segment.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company identified its operating segments based on the services provided by its various operations and the financial information used by its chief operating decision maker to make decisions regarding the allocation of resources to and the financial performance of the operating segments. The reporting segments represent an aggregation of individual operating segments with similar economic characteristics. The applications and infrastructure operating segment is an aggregation of the component operations of Tropical, RM Leasing, T N S and AWS. The professional services operating segment is an aggregation of the operations of the ADEX entities. The managed services operating segment is primarily comprised of the operations of IPC and RentVM the cloud services operating segment is comprised of the operations of VaultLogix. The Company will evaluate the Cloud and Managed Services reporting segment in 2015 to determine if it should be segregated into two reporting segments. For the period from the date of its acquisition through December 31, 2014 the results of operations of the cloud services operating segment are considered immaterial to the Company’s financial statements.
In addition to the operating segments, the Company has determined that certain costs related to the general operations of the Company cannot be reasonably allocated to each individual segment. These costs are not part of the factors that the chief operating decision maker uses to calculate gross margin. As such, the Company has chosen to present those costs within a general “Corporate” line item for presentation purposes.
The information presented below presents various segment information as it would have been stated if the Company operated as three distinct reporting segments as of December 31, 2014 and 2013.
Segment information relating to the Company's results of continuing operations was as follows:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
For the year ended December 31, 2014, revenues from the largest customer of the applications and infrastructure, professional services and cloud and managed services segments was $5,001, $12,357 and $2,786, respectively, which represented 6.25%, 15.44% and 3.48%, respectively, of the Company’s consolidated revenue.
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
18. DISCONTINUED OPERATIONS
During 2013, the Company’s management decided to exit its environmental remediation and disaster recovery services business. On November 21, 2013, the Company’s wholly-owned subsidiary, ADEX, completed its disposal of its wholly-owned subsidiary, ERFS. The Company completed the sale of ERFS for $297 in cash, payment of certain operating expenses related to the sale, repurchase and cancellation of 4,500 shares of Series I Preferred Stock, and cancellation of certain contingent considerations related to the acquisition of ERFS in December 2012.
In connection with such sale, ERFS was removed as a guarantor and party under the MidMarket Loan Agreement and the loan agreement with PNC Bank, N.A., and was released from any obligations with respect thereto.
The following table shows the major classes assets and liabilities of the Company’s discontinued operations at December 31, 2013.
The following shows the calculation of the net gain on discontinued operations attributable to affiliate:
INTERCLOUD SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
19. SUBSEQUENT EVENTS
On February 25, 2015, the Company restructured the terms of certain related-party promissory notes and term loans issued to Mark Munro, the Company’s Chairman and Chief Executive Officer, Cama Plan FBO Mark Munro IRA, 1112 Third Ave. Corp., the Mark Munro 1996 Charitable Remainder Trust and Pascack Road, LLC in order to extend the maturity dates thereof and to reduce the interest rate accruing thereon. The following notes were restructured as follows:
●notes issued to Mark Munro in the aggregate principal amount of $1,337 had the interest rates reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;
●notes issued to CamaPlan FBO Mark Munro IRA in the aggregate principal amount of $597 had the interest rates reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;
●a note issued to 1112 Third Avenue Corp. in the principal amount of $375 had the interest rate reduced from 12% to 3% per annum and the maturity date extended from March 31, 2016 to January 1, 2018;
●notes issued to Mark Munro 1996 Charitable Remainder UniTrust in the aggregate principal amount of $575 had the interest rates reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018; and
●notes issued to Pascack Road, LLC in the aggregate principal amount of $2,650 had the interest rate reduced from 12% and 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018.
In consideration for such restructuring, the Company issued to Mark Munro 159,300 shares of unregistered common stock, the CamaPlan FBO Mark Munro IRA 81,290 shares of unregistered common stock, 1112 Third Avenue Corp. 87,500 shares of unregistered common stock, the Mark Munro 1996 Charitable Remainder UniTrust 89,900 shares of unregistered common stock and Pascack Road, LLC 381,100 shares of unregistered common stock.
On March 2, 2015, the Company issued a convertible promissory note to NGNWare, LLC (“NGNWare”) in the principal amount of $1,000 with a term of one year and an interest rate of 12%. The Company may elect to convert the outstanding principal balance and related accrued interest receivable under the convertible promissory note to a number of membership units of equity interests in NGNWare.
On March 4, 2015, the Company restructured the terms of certain promissory notes issued by it to a related party investor, Forward Investments, LLC, in order to extend the maturity dates thereof, reduce the seniority and reduce the interest rate accruing thereon. The following notes were restructured as follows:
● notes issued to Forward Investments, LLC in the aggregate principal amount of $3,650 that bear interest at the rate of 10% per annum, had the maturity date extended from June 30, 2015, to July 1, 2016;
● notes issued to Forward Investments, LLC in the principal amount of $2,825 that bears interest at the rate of 2% per annum, had the maturity date extended from June 30, 2015, to July 1, 2016; and
● notes issued to Forward Investments, LLC in the aggregate principal amount of $2,645 were converted from senior notes to junior notes, had the interest rate reduced from 18% to 3% per annum, had the maturity date extended by approximately three years to January 1, 2018, and now are convertible at an initial conversion price of $6.36 per share, subject to further adjustment as set forth therein.
In connection with such restructuring, Forward Investments, LLC agreed to lend to the Company an amount substantially similar to the accrued interest the Company owed to Forward Investments, LLC on the restructured notes. In consideration for such restructuring and additional payments made by Forward Investments, LLC to the Company, the Company issued to Forward Investments, LLC an additional convertible note equal to $1,730 with an interest rate of 3% per annum, a maturity date of January 1, 2018, and an initial conversion price of $6.36 per share, subject to further adjustment as set forth therein, and provided Forward Investments, LLC the option to lend the Company an additional $8 million in the form of convertible notes similar to the existing convertible notes of the Company issued to Forward Investments, LLC.
On March 23, 2015, the Company signed a definitive agreement for a new $15,000 senior credit facility with Faunus Group International, Inc. The senior credit facility is secured by the Company’s consolidated accounts receivable.