UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

☒   ANNUAL REPORT PURSUANT TO SECTION 13 OR 151(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2017

 

or

 

☐   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _________ to _________ 

 

Commission file number: 000-32037

 

InterCloud Systems, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   65-0963722

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

1030 Broad Street

Suite 102

Shrewsbury, NJ 07702

(Address of Principal Executive Offices) (Zip Code)

 

Registrant’s telephone number:  (561) 988-1988

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class   Name of Each Exchange on Which Registered
Common Stock, $0.0001 par value   None

Warrant to purchase Common Stock

(expiring on November 4, 2018)

   

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  ☐   No  ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.   Yes  ☐   No  ☒

 

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

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

 

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

 

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

Smaller reporting company

Emerging growth company


 

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

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and ask price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $14,229,585 as of June 30, 2017, based on the $11.76 closing price per share of the Company’s common stock on such date.

 

The number of outstanding shares of the registrant’s common stock on March 31, 2018 was 16,211,816. 

 

 

 

 

 

 

FORM 10-K ANNUAL REPORT

FISCAL YEAR ENDED DECEMBER 31, 2017

 

TABLE OF CONTENTS

 

      PAGE
        
PART I   1
Item 1. Business. 1
Item 1A. Risk Factors. 5
Item 1B. Unresolved Staff Comments. 20
Item 2. Properties. 20
Item 3. Legal Proceedings. 21
Item 4. Mine Safety Disclosures. 21
       
PART II    22
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 22
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 25
Item 7A. Quantitative and Qualitative Disclosures about Market Risk. 43
Item 8. Financial Statements and Supplementary Data. 43
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 43
Item 9A. Controls and Procedures. 43
Item 9B. Other Information. 44
       
PART III    45
Item 10. Directors, Executive Officers and Corporate Governance. 45
Item 11. Executive Compensation. 48
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters. 53
Item 13. Certain Relationships and Related Transactions, and Director Independence. 54
Item 14. Principal Accountant Fees and Services. 55
       
PART IV    55
Item 15. Exhibits, Financial Statement Schedules. 55
       
SIGNATURES 56
EXHIBIT INDEX 57
FINANCIAL STATEMENTS F-1

 

 i 

 

 

FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements. Forward-looking statements include all statements that do not directly or exclusively relate to historical facts. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “forecasts,” “predicts,” “potential,” or the negative of those terms, and similar expressions and comparable terminology. These include, but are not limited to, statements relating to future events or our future financial and operating results, plans, objectives, expectations and intentions. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these expectations may not be achieved. Forward-looking statements represent our intentions, plans, expectations, assumptions and beliefs about future events and are subject to known and unknown risks, uncertainties and other factors outside of our control that could cause our actual results, performance or achievements to differ materially from those expressed or implied by these forward-looking statements. Actual results may differ materially from those anticipated or implied in the forward-looking statements.

 

You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. You should also consider carefully the statements under Item 1A. Risk Factors appearing in this report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements. Such risks and uncertainties include:

 

  our ability to successfully execute our business strategies;

 

  changes in aggregate capital spending, cyclicality and other economic conditions, and domestic and international demand in the industries we serve;

 

  our ability to adopt and master new technologies and adjust certain fixed costs and expenses to adapt to our industry’s and customers’ evolving demands;
     
  our ability to obtain additional financing in sufficient amounts or on acceptable terms when required;

 

  our ability to adequately expand our sales force and attract and retain key personnel and skilled labor;

 

  shifts in geographic concentration of our customers, supplies and labor pools and seasonal fluctuations in demand for our services;

 

  our dependence on third-party subcontractors to perform some of the work on our contracts;

 

  our competitors developing the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services;

 

  our material weaknesses in internal control over financial reporting and our ability to maintain effective controls over financial reporting in the future;

 

  our ability to comply with certain financial covenants of our debt obligations;

 

  the impact of new or changed laws, regulations or other industry standards that could adversely affect our ability to conduct our business;

 

  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;
     
  we may incur goodwill and intangible asset impairment charges, which could harm our profitability; and

 

  we have substantial doubt about our ability to continue as a going concern.

 

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These forward-looking statements also should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. All written and oral forward looking statements made in connection with this report that are attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given these uncertainties, you are cautioned not to place undue reliance on any forward-looking statements and you should carefully review this report in its entirety. These forward-looking statements speak only as of the date of this report, and you should not rely on these statements without also considering the risks and uncertainties associated with these statements and our business.

 

Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events, except as required by applicable law or regulation.

 

OTHER PERTINENT INFORMATION

 

Unless specifically set forth to the contrary, when used in this report the terms “we”, “our”, the “Company” and similar terms refer to InterCloud Systems, Inc., a Delaware corporation, and its consolidated subsidiaries.

 

The information that appears on our web site at www.InterCloudsys.com is not part of this report. 

 

 iii 

 

 

PART I

 

ITEM 1. BUSINESS

 

Overview

 

InterCloud Systems, Inc. is a provider of networking orchestration and automation for the Internet of things (IOT), software-defined networking (SDN) and network function virtualization (NFV) environments to the telecommunications service provider (carrier) and corporate enterprise markets. Our managed services solutions offer enterprise and service-provider customers the opportunity to adopt an operational expense model by outsourcing cloud deployment and management to our company rather than the capital expense model that has dominated in recent decades in IT infrastructure management. Our professional services group offers SDN solutions to enterprise and service provider customers, including application development teams, analytics and project management. Our applications and infrastructure division offers enterprise and service provider customers specialty contracting services, including engineering, design, installation and maintenance services of some of the most advanced small cell, Wi-Fi and distributed antenna system (DAS) networks.

 

We provide the following categories of offerings to our customers:

 

  Applications and Infrastructure. We provide an array of applications and services throughout North America and internationally.  We also offer structured cabling and other field installations. In addition, we design, engineer, install and maintain various types of Wi-Fi and DAS networks for Enterprise and Government accounts primarily. Our services and applications teams support the deployment of new networks and technologies.

 

  Professional Services.  Our professional services is now focused on the design and deployment of SDN and software-defined wide area networking (SD-WAN) solutions for enterprise and carrier accounts. Our software development teams customize SDN solutions from our Netlayer.io platform. These teams can be deployed remotely or on site at the customer’s request.

  

Our Operating Units

 

Through a series of asset sales, we have narrowed our service offerings and geographic reach over the past two years. Our company is comprised of the following operating units: 

 

  T N S, Inc. T N S, Inc. (“T N S”) is a Chicago-based structured cabling and Next-Generation DAS design and installation firm that supports voice, data, video, security and multimedia systems within commercial office buildings, multi-building campus environments, high-rise buildings, data centers and other structures. T N S extends our geographic reach to the Midwest area and our client reach to end-users, such as multinational corporations, universities, school districts and other large organizations that have significant ongoing next generation network needs.

 

  Rives-Monteiro Engineering LLC and Rives-Monteiro Leasing, LLC. Rives-Monteiro Engineering, LLC (“RM Engineering”) is a cable firm based in Tuscaloosa, Alabama that performs engineering services in the Southeastern United States and internationally, and Rives-Monteiro Leasing, LLC (“RM Leasing”, and together with RM Engineering, “Rives-Monteiro”), is an equipment provider for cable-engineering services firms. RM Engineering provides services to customers located in the United States and Latin America.

 

  SDN Systems, LLC. SDN Systems, LLC (“SDNS”) sells its software solutions under the brand of Netlayer.io. This is an SDN Orchestration platform with various other network capabilities such as analytics, machine learning functions and SD-WAN.

 

 1 

 

 

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. 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.

 

Spending on public cloud services is expected to increase sharply this year and through 2019, according to analysts with International Data Corporation, a leading global market intelligence firm (“IDC”) and Gartner, Inc., a leading IT research and advisory company (“Gartner”). 

 

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

 

NFV and SDN are the popular software-based approaches that service providers are using to design, deploy and manage their networks and services. NFV is a telecom led initiative seeking to utilize standard IT virtualization technology to consolidate many telecom network equipment types onto industry standard high volume servers, switches and storage. Many industry leaders believe NFV will likely transform the entire telecom infrastructure ecosystem. In its report entitled “Network Functions Virtualization (NFV) Market: Business Case, Market Analysis and Forecasts 2015 – 2020”, published in November 2014, Mind Commerce, a business intelligence and technology insight company, estimated that the overall global market for NFV will grow at a compound annual growth rate, or CAGR, of 83.1% between 2015 and 2020, and that NFV revenues will reach $ 8.7 billion by the end of 2020.

 

Signals and Systems Telecom, a Dubai-based market intelligence and consulting firm for the worldwide telecommunications industry (“SNS Telecom”), projects exponential growth in service provider SDN and NFV investments. In its report titled ‘The SDN, NFV & Network Virtualization Ecosystem: 2015 – 2030 – Opportunities, Challenges, Strategies & Forecasts,’ SNS Telecom projects that this industry will log a 54% CAGR from 2015 to 2020, and will account for US$20 billion in revenue by 2020.

 

The SNS Telecom report states that enterprises are already aware of the several advantages offered by SDN and NFV. The deployment of these technologies is seen to be the highest in datacenter operations, telecommunications services, and enterprise IT. One aspect that makes SDN, NFV, and network virtualization much sought after is the ability of these technologies to help enterprises cope with the mounting demand for higher mobile traffic capacity. While doing so, these technologies bring down capital expenses and operating expenses, which can otherwise burden service providers. Most importantly, virtualization enables service providers to reduce their dependence on expensive and high-maintenance hardware platforms. 

 

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Our Competitive Strengths

 

We believe our market advantages center around our IOT platform NFVGrid and services portfolio such as SD-WAN. Our software allows enterprise and carrier accounts to take advantage of deploying virtual network functions with service chaining for multi-vendor deployments, VNF monitoring, VNF and full network analytics, the ability to turn up a VNF or turn them off if necessary. SDN and NFV have just begun to be adopted in carrier and enterprise networks after years of planning and testing. InterCloud has a competitive advantage because our NFVGrid platform has the next-generation automation necessary to lead clients through this latest technology transformation. 

 

  Service Provider Relationships. We have established relationships with many leading wireless and wireline telecommunications providers, cable broadband MSOs, OEMs and others.

  

  Software Platform OEM Licensing. We believe we have a distinct advantage in the marketplace with our SD-WAN OEM License Platform. Our offering allows Tier 2 and Tier 3 Unified Communications and VOIP customers to white label and customize a integrated SD-WAN solution into their existing software platforms. Our software development teams can customize unique functionality for carriers.

  

  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.
     
  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

 

Our growth strategy has changed dramatically over the past two years. We have streamlined our management, sales, and marketing staff and sold off business units to become more singularly focused for the future. Our growth strategy is to drive a prepackaged SD-WAN solution for MSP’s and Tier 2 and Tier 3 carriers that do not have the capital to build their own. This will be done through direct sales with a small team focused on providing this market with the most cost effective solution with a robust feature set. 

 

  Expand Our Cloud-Based Service Offerings. Our Software Development team has continued to expand our SDN solution set over the past several years. Recent developments include the roll out of an SD-WAN offering for MSP’s and Tier 2 and Tier 3 carriers.

 

  Selectively Expand Our Organic Growth Initiatives. Our customers include enterprise, government accounts with a focus on expanding our Tier 2 and Tier 3 carrier client base. We are actively recruiting a small sales team for the target markets mentioned above. In addition we plan on continuing to sell to enterprise clients in need of next generation WiFi and DAS technology solutions. This has been a strong  contributor to our annual cash flow and we will continue to focus on this growth market as well.

 

Our Services

 

We are a provider of networking orchestration and automation solutions for IOT, SDN and NFV and its corresponding professional services. In addition, we offer next-gen WiFi and DAS technology solutions. We provide cloud-based platforms, professional services, applications and infrastructure to both the telecommunications industry and corporate enterprises. We divide our service offerings into the following categories of services: 

 

  Applications and Infrastructure. We provide an array of applications and services throughout North America and internationally, including SDN training, SDN software development and integration, VNF validation in a multi-vendor environment. We also offer structured cabling and other field installations. In addition, we design, engineer, install and maintain various types of Wi-Fi and DAS networks to enterprise customers. Our services and applications teams support the deployment of new networks and technologies, as well as expand and maintain existing networks.

 

   

Network Function Virtualization. In order to enter the SDN and NFV market we developed and launched NFVGrid, an NFV orchestration platform, as part of our Network-as-a-Service (NaaS) offering. This software platform helps to manage VNFs, instantiating, monitoring, repairing them and handling billing for the services.

 

In addition, we also released our multi-vendor VNF validation services. Through third-party VNF validation, service providers know in advance that virtual network functions are working together in a specific, dynamic, environment. Since each VNF validation is as unique as the network itself, we have created three levels of validation services that are available through annual contracts. No matter how intricate a network is, we offer the level of service needed. We offer:

 

  Silver validation. This first tier of qualification says that a NFV successfully operates in the Cloud/SDN environment, which includes the validation of basic NFV functionality running on fully virtualized SDN-enabled Cloud platform.

  

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  Gold validation. This tier of qualification includes everything in the Silver Validation, plus guaranteed performance testing of scalability (both up and down) to address the demand volatility that CSPs face. Gold validation is done in compliance with OPNFV testing requirements.
     
  Platinum validation. This is the highest level of validation. It includes everything in the Gold Validation and guarantees that the NFV will remain functional as software and hardware continue to update or change.
     
    Most recently, we launched the first version of our SD-WAN (Software Defined Wide Area Networking) platform. This is a robust platform allowing enterprise and small business customers to build highly-secure multi-location private networks from the cloud and eliminate expensive private telecom circuits and eliminate services such as multiprotocol label switching (MPLS). The use case summary is below:

  

  - Fully automated management of remote locations with no IT personnel.

 

  - MPLS is not required. Encryption is provided by IP-Tunnels.

 

  - No special hardware is required.

 

  - All networking functions are run virtually.

 

  - No truck rolls are involved and services can be turned on and off automatically.

 

  - Customer premises equipment (CPE) functions have instant expansion with added security through deep packet analytics.

  

Customers

 

Our customers include many Fortune 1000 enterprises as well as local government accounts. 

 

Our top four customers, Uline, Ericsson, Inc., AT&T Inc., and Frontier Communications, accounted for approximately 48% of our total revenues from continuing operations in the year ended December 31, 2017. Our top four customers, Crown Castle, Uline, Ericsson, Inc., and Verizon, accounted for approximately 35% of our total revenues from continuing operations in the year ended December 31, 2016. Uline, Ericsson, Inc., and AT&T Inc. were the only customers to account for 10% or more of our revenues for the year ended December 31, 2017, accounting for approximately 17%, 11%, and 11% of our total revenues, respectively. No customer accounted for 10% or more of our revenues for the year ended December 31, 2016.

 

As a result of the sale of ADEX, Ericsson, Inc., AT&T Inc., and Frontier Communications will not be customers of our company going forward.

 

Competition

 

We provide cloud 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., CenturyLink Technology Solutions (formerly Savvis), Dimension Data, Dycom Industries, 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.

 

Employees

 

As of December 31, 2017, we had 241 full-time employees, of whom 23 were in administration and corporate management, 5 were accounting personnel, 3 were sales personnel and 210 were technical and project managerial personnel.

 

ADEX, which we sold during February 2018, accounted for 228 full-time employees as of December 31, 2017.

 

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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 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 $16.4 million and $12.5 million in the years ended December 31, 2017 and 2016, respectively. In addition, we incurred a net loss attributable to common stockholders of $44.3 million and $26.5 million in the years ended December 31, 2017 and 2016, 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. 

 

If we are unable to sustain or increase our revenue levels, we may never achieve or sustain profitability.

 

Our total revenues from continuing operations decreased to $34.5 million in the year ended December 31, 2017 from $59.1 million in the year ended December 31, 2016, respectively. The ADEX Entities, which we sold during February 2018, accounted for $20.5 million and $21.5 million of revenue in the years ended December 31, 2017 and 2016, 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 revenue levels, particularly if we are unable to develop and market our applications and infrastructure, increase our sales to existing customers or develop new customers. However, even if our revenues 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.

 

 5 

 

 

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, 2017, we had total indebtedness of approximately $12.4 million, consisting of $12.2 million of convertible debentures and notes payable, $0.1 million of related-party indebtedness, and $0.1 million of bank debt. 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 our ability to access the public equity and debt markets, financial market conditions, the value of our assets and our performance at the time we need capital.

 

Our limited operating history as an integrated company may make it difficult for investors to evaluate our business, financial condition, results of operations and divestitures, and prospects, and also impairs our ability to accurately forecast our future performance.

  

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. It may 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.

 

Risks Related to Our Business

  

If we do not continue to innovate and provide services that are useful to our business customers, we may not remain competitive, and our revenues and operating results could suffer.

 

The market for our cloud services, professional consulting and staffing services is characterized by changing technology, changes in customer needs and frequent new service and product introductions, and we may be required to select one emerging technology over another. Our future success will depend, in part, on our ability to use leading technologies effectively, to continue to develop our technical expertise, to enhance our existing services and to develop new services that meet changing customer needs on a timely and cost-effective basis. We may not be able to adapt quickly enough to changing technology, customer requirements and industry standards. In addition, the development and offering of new services in response to new technologies or consumer demands may require us to increase our capital expenditures significantly. Moreover, new technologies may be protected by patents or other intellectual property laws and therefore may be available only to our competitors and not to us. Any of these factors could adversely affect our revenues and profitability. We cannot assure you that we will be able to successfully identify, develop, and market new products or product enhancements that meet or exceed evolving industry requirements or achieve market acceptance. If we do not successfully identify, develop, and market new products or product enhancements, it could have a material and adverse effect on our results of operations. 

 

Our engagements typically require longer implementations and other professional services engagements.

 

Our implementations generally involve an extensive period of delivery of professional services, including the configuration of the solutions, together with customer training and consultation. In addition, existing customers for other professional services projects often retain us for those projects beyond an initial implementation. A successful implementation or other professional services project requires a close working relationship between us, the customer and often third-party consultants and systems integrators who assist in the process. These factors may increase the costs associated with completion of any given sale, increase the risks of collection of amounts due during implementations or other professional services projects, and increase risks of delay of such projects. Delays in the completion of an implementation or any other professional services project may require that the revenues associated with such implementation or project be recognized over a longer period than originally anticipated, or may result in disputes with customers, third-party consultants or systems integrators regarding performance as originally anticipated. Such delays in the implementation may cause material fluctuations in our operating results. In addition, customers may defer implementation projects or portions of such projects and such deferrals could have a material adverse effect on our business and results of operations.

 

 6 

 

 

Our future success is substantially dependent on third-party relationships.

 

An element of our strategy is to establish and maintain alliances with other companies, such as system integrators, resellers, consultants, and suppliers of products and services for maintenance, repair and operations. These relationships enhance our status in the marketplace, which generates new business opportunities and marketing channels and, in certain cases, additional revenue and profitability. To effectively generate revenue out of these relationships, each party must coordinate and support the sales and marketing efforts of the other, often including making a sizable investment in such sales and marketing activity. Our inability to establish and maintain effective alliances with other companies could impact our success in the marketplace, which could materially and adversely impact our results of operations. In addition, as we cannot control the actions of these third-party alliances, if these companies suffer business downturns or fail to meet their objectives, we may experience a resulting diminished revenue and decline in 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.

 

 7 

 

 

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. Uline, Ericsson, Inc., and AT&T Inc. accounted for approximately 17%, 11%, and 11%, respectively, of our revenues from continuing operations in the year ended December 31, 2017. No customer accounted for 10% or more of our total revenues for the year ended December 31, 2016. Our top four customers, Uline, Ericsson, Inc., AT&T Inc., and Frontier Communications, accounted for approximately 48% of our total revenues from continuing operations in the year ended December 31, 2017. As a result of the sale of ADEX, Ericsson, Inc., AT&T Inc., and Frontier Communications will not be customers of our company going forward. Our top four customers, Crown Castle, Uline, Ericsson, Inc., and Verizon, accounted for approximately 35% of our total revenues from continuing operations in the year ended December 31, 2016. 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 could become 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 economic downturns 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. The increase in demand for consulting technology integration and managed services has increased our need for employees with specialized skills or significant experience in these areas. Our ability to attract and retain reliable and skilled personnel 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.

 

 8 

 

 

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.

 

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, 2017 and 2016, we derived approximately 35% and 30%, 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.

 

 9 

 

 

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.

 

 10 

 

 

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 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. 

 

 11 

 

 

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.

 

Breaches of data security could adversely impact our business.

 

Our business involves the storage and transmission of proprietary information and sensitive or confidential data, including personal information of coworkers, customers and others. In addition, we operate data centers for our customers which host their technology infrastructure and may store and transmit both business-critical data and confidential information. In connection with our services business, our coworkers also have access to our customers’ confidential data and other information. We have privacy and data security policies in place that are designed to prevent security breaches; however, as newer technologies evolve, we could be exposed to increased risk of breaches in security. Breaches in security could expose us, our customers or other individuals to a risk of public disclosure, loss or misuse of this information, resulting in legal claims or proceedings, liability or regulatory penalties under laws protecting the privacy of personal information, as well as the loss of existing or potential customers and damage to our brand and reputation. In addition, the cost and operational consequences of implementing further data protection measures could be significant. Such breaches, costs and consequences could adversely affect our business, results of operations or cash flows.

 

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.

 

 12 

 

 

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 Amazon.com, Inc., CenturyLink Technology Solutions (formerly Savvis), Dimension Data, Dycom Industries, Inc., Hewlett Packard Company, Rackspace Hosting, Inc., SoftLayer Technologies, Inc., Tech Mahindra Limited, TeleTech Holdings, 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.

 

 13 

 

 

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. 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.

 

Other Risks Relating to Our Company and Results of Operations

 

We have doubt about our ability to continue as a going concern.

 

                We believe there is substantial doubt about our ability to continue as a going concern. As a result, it may be more difficult for us to attract investors. If we are not able to continue our business as a going concern, we have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or part of their investment.

 

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:

 

  our sale or other disposition of certain subsidiaries over the past two years and the possibility that we may sell or acquire additional businesses in the future;
     
  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

 

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:

  

  provisions for uncollectible receivables and customer claims and recoveries of costs from subcontractors, suppliers and others;

 

 14 

 

  

  valuation of assets acquired and liabilities assumed in connection with business combinations;

 

  accruals for estimated liabilities, including litigation and insurance reserves; and
     
  goodwill and intangible asset impairment assessment.

 

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.

 

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.

 

The Internal Revenue Service has completed its examination of our 2013 U.S. corporation income tax return. We have agreed to certain adjustments proposed by the IRS and are appealing others. Separately, the IRS has questioned our classification of certain individuals as independent contractors rather than employees. We estimate our potential liability to be $165 but the liability, if any, upon final disposition of these matters is uncertain.

 

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, 2017, our management team identified material weaknesses relating to (i) our inability to complete our implementation of comprehensive entity level 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. During 2016, we took steps to help remediate these material weaknesses, including hiring additional accounting staff who have a background and knowledge in the application of U.S. GAAP and performing a comprehensive review of our internal control over financial reporting. During 2017, many of these new personnel departed our company, including our Chief Financial Officer, as we divested our company of many of our subsidiaries. As a result, we do not have an adequate accounting staff. 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.

 

 15 

 

 

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 July 2013, a complaint was filed against our company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida titled The Farkas Group, Inc., The Atlas Group of Companies, LLC and Michael D. Farkas v. InterCloud Systems, Inc. (Case No. 502013CA01133XXXMB) for breach of contract and unjust enrichment. In the complaint, the plaintiffs allege that we have breached contractual agreements between our company and plaintiffs pertaining to certain indebtedness amounting to approximately $116,000 allegedly owed by us to the plaintiffs and our agreement to convert such indebtedness into shares of our common stock. The plaintiff alleges that they are entitled to receive in the aggregate 5,426 shares of our company’s common stock or aggregate damages reflecting the trading value at the high price for the common stock. We have asserted as a defense that such indebtedness, together with any right to convert such indebtedness into shares of common stock, was cancelled pursuant to the terms of a Stock Purchase Agreement dated as of July 2, 2009 between our company and the plaintiffs. The Farkas Group was a control person of our company during the period that it was a public “shell” company and facilitated the transfer of control of our company to our former chief executive officer, Gideon Taylor. This matter is presently set on the court’s non-jury trial docket. We intend to continue to vigorously defend this lawsuit.

 

As disclosed below in Item 3, Litigation, on May 15, 2017, a complaint was filed against us in the Supreme Court of the State of New York, County of New York titled Grant Thornton LLP v. InterCloud Systems, Inc., Case No. 652619/2017, for breach of contract, quantum meruit and unjust enrichment. In the complaint, the plaintiff alleges that we breached an agreement with the plaintiff by failing to pay the fees of the plaintiff of approximately $769 and to reimburse the plaintiff for its related expenses for a proposed audit of our financial statements for the year ended December 31, 2015. We intend to vigorously defend this action, and have commenced a separate action against Grant Thornton LLP in the Supreme Court of the State of New York, County of New York titled InterCloud Systems, Inc. v. Grant Thornton LLP, Case No. 65424/2017 for breach of contract and fraudulent inducement relating to the engagement letter between us and Grant Thornton LLP and to recover the fees the Company paid to Grant Thornton LLP, as well as other damages.

 

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 more actions will prevail no matter how vigorously we defend ourselves, which could result in significant compensatory damages on the part of our company. 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 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. 

 

 16 

 

  

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 SEC;

 

  market conditions for providers of services to telecommunications, utilities and managed 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.

 

 17 

 

 

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, 2017, we had 9,338,286 shares of common stock issued and 9,337,948 shares outstanding, of which 41,239 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, 2017, we also had outstanding $11.4 million aggregate principal amount of convertible notes that were convertible into 13,742,977 shares of common stock on that date. However, we cannot currently determine the total number of shares of our common stock that may be issued upon the conversion or repayment of our convertible notes 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 our convertible notes 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 our convertible notes in shares of our common stock. See Note 11, Term Loans, and Note 19, Related Parties, to the notes to our consolidated financial statements in this report. For conversions completed between January 1 and March 31, 2018, see Note 22, Subsequent Events, to the notes to our consolidated financial statements in this report. As of December 31, 2017, there were also outstanding warrants to purchase an aggregate of 33,339 shares of our common stock at a weighted-average exercise price of $61.34 per share, all of which warrants were exercisable as of such date, and outstanding options to purchase an aggregate of 417 shares of common stock at an exercise price of $1,488.00 per share, of which 417 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. 

 

We may have insufficient authorized capital stock to issue common stock to all of the holders of our outstanding warrants and other convertible securities and may be required to reverse split our outstanding shares of common stock or to request our stockholders to authorize additional shares of common stock in connection with the exercise or conversion of such outstanding securities or subsequent equity finance transactions.

 

We are authorized to issue 1,000,000,000 shares of common stock, of which 9,337,948 shares were outstanding on December 31, 2017 and, primarily as a result of the conversion of convertible debt securities since December 31, 2017, 16,211,816 shares were issued and outstanding on March 31, 2018. At March 31, 2018, we had reserved 5,496,448 shares of common stock for issuance upon conversion of certain of our outstanding convertible debt securities and warrants. In addition, at such date, we had outstanding $10,146,840 aggregate principal amount of additional convertible debt securities for which we are not required to reserve a specific number of shares of common stock for conversions but that is convertible into an undeterminable number of shares of common stock based upon a discount to the then-current market price of our common stock. If all of these securities were converted or exercised, the total number of shares of our common stock that we would be required to issue would greatly exceed the number of our remaining authorized but unissued shares of common stock. 

 

As a result of such potential shortfall in the number of our authorized shares of common stock, it is likely that we will have insufficient shares of common stock available to issue in connection with the conversion or exercise of our outstanding options, warrants and convertible debt securities or any future equity finance transaction we may seek to undertake. Accordingly, we may be required to take steps at an annual or special meeting of stockholders to seek approval of an increase in the number of our authorized shares of common stock. However, we cannot assure you that our stockholders would authorize an increase in the number of shares of our common stock. Alternatively, we may be required to reverse split our outstanding shares of common stock to create additional authorized but unissued shares. Our failure to have a sufficient number of authorized shares of common stock for issuance upon future exercise or conversion of our outstanding options, warrants and convertible debt securities could create an event of default under such securities, which could adversely affect our business, financial condition, results of operations and prospects.

 

 18 

 

 

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:

 

  provide that the aggregate voting power of our Series J preferred stock is equal to 51% of the total voting power of our company;
     
  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.

 

 19 

 

 

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, Series J preferred stock, and Series M preferred 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 on our common stock 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. UNRESOLVED STAFF COMMENTS.

 

None.

 

ITEM 2. PROPERTIES.

 

Our principal executive offices are located in Shrewsbury, New Jersey in segregated offices comprising an aggregate of approximately 3,784 square feet. We are occupying our offices under a 60-month lease that expires in September 2020 and provides for monthly lease payments of $7,568 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.

 

Location    Owned or Leased    User    Size (Sq Ft)
Tuscaloosa, AL    Leased (1)    Rives-Monteiro Engineering, LLC   5,000
Des Plaines, IL    Leased (2)    T N S, Inc.   1,500

 

(1) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,500.
   
(2) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,133.

 

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ITEM 3. LEGAL PROCEEDINGS.

 

Pending Litigation

 

Breach of Contract Action. In July 2013, a complaint was filed against the Company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida titled The Farkas Group, Inc., The Atlas Group of Companies, LLC and Michael D. Farkas v. InterCloud Systems, Inc. (Case No. 502013CA01133XXXMB) for breach of contract and unjust enrichment. In the complaint, the plaintiffs allege that the Company has breached contractual agreements between the Company and plaintiffs pertaining to certain indebtedness amounting to approximately $116,000 allegedly owed by the Company to the plaintiffs and the Company’s agreement to convert such indebtedness into shares of the Company’s common stock. The plaintiff alleges that they are entitled to receive in the aggregate 5,426 shares of the Company’s common stock or aggregate damages reflecting the trading value at the high price for the common stock. The Company has asserted as a defense that such indebtedness, together with any right to convert such indebtedness into shares of common stock, was cancelled pursuant to the terms of a Stock Purchase Agreement dated as of July 2, 2009 between the Company and the plaintiffs. The Farkas Group was a control person of the Company during the period that it was a public “shell” company and facilitated the transfer of control of the Company to its former chief executive officer, Gideon Taylor. This matter is presently set on the court’s non-jury trial docket. The Company intends to continue to vigorously defend this lawsuit.

 

On May 15, 2017, a complaint was filed against the Company in the Supreme Court of the State of New York, County of New York titled Grant Thornton LLP v. InterCloud Systems, Inc., Case No. 652619/2017, for breach of contract, quantum meruit and unjust enrichment. In the complaint, the plaintiff alleges that the Company breached an agreement with the plaintiff by failing to pay the fees of the plaintiff of approximately $769,000 and to reimburse the plaintiff for its related expenses for a proposed audit of the Company’s financial statements for the year ended December 31, 2015. The Company intends to vigorously defend this action, and has commenced a separate action against Grant Thornton LLP in the Supreme Court of the State of New York, County of New York titled InterCloud Systems, Inc. v. Grant Thornton LLP, Case No. 65424/2017 for breach of contract and fraudulent inducement relating to the engagement letter between the Company and Grant Thornton LLP and to recover the fees the Company paid to Grant Thornton LLP, as well as other damages.

 

Other

 

Currently, there is no 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, 2017, no accruals for loss contingencies have been recorded as the outcomes of these cases are neither probable nor reasonably estimable.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not Applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

Market Information

 

Our common stock trades under the symbol “ICLD”. Prior to October 6, 2016, our common stock traded on the Nasdaq Capital Market. From October 6, 2016 through February 12, 2018, our common stock traded on the OTCQB Venture Market. Effective February 13, 2018, our common stock began trading in the over-the-counter markets and was reported on the OTC Pink Current Information, The following table sets forth, for the periods indicated, the high and low sales price of our common stock as reported on the Nasdaq Capital Market prior to October 6, 2016, and the high and low bid price of our common stock thereafter through December 31, 2017. The quotations on the OTCQB Venture Market and in the over-the-counter markets reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not necessarily represent actual transactions. Prices below reflect all reverse stock splits made effective during the two year period.

 

Fiscal Year Ended December 31, 2016  High   Low 
First Quarter  $468.00   $168.68 
Second Quarter  $456.00   $260.00 
Third Quarter  $300.00   $34.00 
Fourth Quarter  $48.00   $10.80 
           
Fiscal Year Ended December 31, 2017          
First Quarter  $39.40   $4.00 
Second Quarter  $19.56   $5.64 
Third Quarter  $15.20   $0.90 
Fourth Quarter  $1.17   $0.17 

  

Holders

 

At February 28, 2018, we had approximately 389 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 and 2015 Performance Incentive Plan as of December 31, 2017, which were our only equity compensation plans at such date.

 

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   (a)   (b)   (c) 
Plan Category  Number of Securities to be Issued Upon Exercise of Outstanding Options   Weighted- Average Exercise Price of Outstanding Options   Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column(a)) 
Equity compensation plans approved by security holders   418   $1,488.00    24,656 

 

Unregistered Sales of Equity Securities

 

In the fourth quarter of 2017, we issued securities in the following transactions, each of which was exempt from the registration requirements of the Securities Act. Except for the shares of our common stock that were issued upon the conversion of our convertible debt securities or the grants of shares of common stock under our 2012 Performance Incentive Plan, all of the below-referenced securities were issued pursuant to the exemption from registration under Section 4(2) of the Securities Act and are deemed to be restricted securities for purposes of the Securities Act. There were no underwriters or placement agents employed in connection with any of these transactions. Use of the exemption provided in Section 4(2) for transactions not involving a public offering is based on the following facts:

 

  Neither we nor any person acting on our behalf solicited any offer to buy or sell securities by any form of general solicitation or advertising.
     
  The recipients were either accredited or otherwise sophisticated individuals who had such knowledge and experience in business matters that they were capable of evaluating the merits and risks of the prospective investment in our securities.
     
  The recipients had access to business and financial information concerning our company.
     
  All securities issued were issued with a restrictive legend and may only be disposed of pursuant to an effective registration or exemption from registration in compliance with federal and state securities laws.

 

The shares of our common stock that were issued upon the conversion of our convertible debt securities were issued pursuant to the exemption from registration under Section 3(a)(9) of the Securities Act and are deemed to be restricted securities for purposes of the Securities Act.

 

All dollar amounts presented below are in thousands, except share and per share data.

 

In October 2017, we issued an aggregate of 63,691 shares of common stock to Dominion Capital LLC upon the conversion of $20 of principal and accrued interest of a note outstanding. The shares were issued at an average of $0.31 per share, per the terms of the notes payable.

 

In October 2017, we issued 25,792 shares of common stock to Smithline upon the conversion of $19 of principal amount and $1 of accrued interest of a note outstanding. The shares were issued at an average of $0.75 per share, per the terms of the note payable.

 

In October 2017, we issued 529,959 shares of common stock to Forward Investments, LLC upon conversion of $331 principal amount of promissory notes outstanding. The shares were issued at an average of $0.62 per share, per the terms of the notes payable.

 

In October 2017, we issued 129,840 shares of common stock to RDW upon the conversion of $103 principal amount of a note outstanding. The shares were issued at $0.79 per share, per the terms of the note payable.

 

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In October 2017, we issued 289,322 shares of common stock to RDW upon the conversion of $133 principal amount of a note outstanding. The shares were issued at an average of $0.46 per share, per the terms of the note payable.

 

In October 2017, we issued 172,552 shares of common stock to JGB Waltham upon the cashless exercise of $500 of an outstanding warrant. The shares were issued at an exercise price of $0.66 per share.

 

In November 2017, we issued an aggregate of 212,718 shares of common stock to Dominion Capital LLC upon the conversion of $57 of principal and accrued interest of a note outstanding. The shares were issued at an average of $0.27 per share, per the terms of the notes payable.

 

In November 2017, we issued 63,282 shares of common stock to JGB Waltham pursuant to conversion of $20 principal amount related to the outstanding February 2016 senior secured convertible debenture. The shares were issued at an average of $0.32 per share, per the terms of the note payable.

 

In November 2017, we issued 917,475 shares of common stock to Forward Investments, LLC upon conversion of $327 principal amount of promissory notes outstanding. The shares were issued at an average of $0.36 per share, per the terms of the notes payable. 

 

In November 2017, we issued 1,285,559 shares of common stock to RDW upon the conversion of $354 principal amount of a note outstanding. The shares were issued at $0.28 per share, per the terms of the note payable.

 

In November 2017, we issued 334,671 shares of common stock to RDW upon the conversion of $133 principal amount of a note outstanding. The shares were issued at an average of $0.40 per share, per the terms of the note payable.

 

In December 2017, we issued 224,747 shares of common stock to JGB Waltham pursuant to conversion of $40 principal amount related to the outstanding February 2016 senior secured convertible debenture. The shares were issued at an average of $0.18 per share, per the terms of the note payable.

 

In December 2017, we issued 255,141 shares of common stock to RDW upon the conversion of $51 principal amount of a note outstanding. The shares were issued at $0.20 per share, per the terms of the note payable.

 

In December 2017, we issued 781,513 shares of common stock to RDW upon the conversion of $120 principal amount of a note outstanding. The shares were issued at an average of $0.15 per share, per the terms of the note payable. 

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following tables set forth selected consolidated financial data for our company for the years ended December 31, 2017 and 2016 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.

 

   For the years ended 
   December 31, 
   2017   2016 
Statement of Operations Data:        
         
Revenues  $34,520   $59,110 
Gross profit   7,028    14,108 
Operating expenses   23,451    26,625 
Loss from operations   (16,423)   (12,517)
Total other expense   (27,582)   (8,076)
Loss from continuing operations before benefit from income taxes   (44,005)   (20,593)
(Benefit from) provision for income taxes   (672)   207 
Loss from discontinued operations, net of tax   (1,559)   (5,672)
Net loss attributable to common stockholders   (44,336)   (26,483)
Net loss per share, basic and diluted  $(14.55)  $(25.23)
Weighted average shares outstanding, basic and diluted   3,046,643    1,049,866 

 

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   As of December 31, 
   2017   2016 
Balance Sheet Data:        
         
Cash  $681   $1,781 
Accounts receivable, net   6,234    9,856 
Total current assets   13,297    18,389 
Goodwill and intangible assets, net   2,659    24,942 
Total assets   16,456    54,569 
           
Total current liabilities   33,803    57,802 
Long-term liabilities   20,969    12,810 
Temporary equity   887    - 
Stockholders' (deficit) equity   (39,203)   (16,043)

 

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 legacy managed services, cloud managed services and professional services. We believe our market advantages center around our next-generation virtualized network orchestration software platform and services portfolio. As a next-generation network services provider, we add value by enabling customers to dynamically spool up their growing number of applications on VM’s and with virtualized network functions while helping to contain costs. Customers now demand a partner that can provide end-to-end IT solutions, that offers the customer the ability 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.

    

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.

 

Our past 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.

 

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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 Corporation, ADEX Puerto Rico, LLC, and TNS, Inc., and in April 2013, we acquired AW Solutions.

 

In January 2014, we acquired the operations of Integration Partners – NY Corporation (“IPC”), thereby entering the telecommunications hardware and software resale sector as well as expanding our services by adding a hardware and software maintenance division. The assets of IPC were subsequently sold in November 2017. In February 2014, we acquired the operations of RentVM Inc., which allowed us entry into the cloud computing sector and expanded the range of products and services provided to our customers. In October 2014, we acquired the operations of VaultLogix, LLC (“VaultLogix”), a cloud-based data backup and storage company which we subsequently sold in February 2016. The sale of VaultLogix eliminated the cloud-based data backup revenue but it did not eliminate our other cloud managed services in the portfolio. Cloud computing is defined as “compute, network and storage” offered in a managed service environment. Cloud is a very broad industry term and can cause some confusion at times. We still offer cloud services, not cloud data back-up services, and we plan on continuing to develop special cloud based use cases around security applications with our orchestration and automation software platform.

   

During 2016, we experienced continued operating losses in our former managed services segment due to investments we made in our cloud-based products. As a result, during 2016, we recorded intangible asset impairment expense of $3.5 million and goodwill impairment expense of $1.1 million. As a result of the sale of the assets of IPC during 2017, these impairment charges are recorded in loss on discontinued operations in the consolidated statement of operations for the year ended December 31, 2016.

 

We finalized the sale of VaultLogix and its subsidiaries, Data Protection Services and US Date, to a third party in February 2016 and, as a result, we recorded intangible asset impairment expense of $0.4 million and goodwill impairment expense of $11.2 million. As a result of the sale, the intangible asset and goodwill impairment expenses related to these entities were recorded in loss on discontinued operations for the year ending December 31, 2015. 

 

Our revenue decreased from $59.1 million for the year ended December 31, 2016 to $34.5 million for the year ended December 31, 2017. The ADEX Entities, which we sold during February 2018, accounted for $20.5 million and $21.5 million of revenue in the years ended December 31, 2017 and 2016, respectively. Our net loss attributable to common stockholders increased from $26.5 million for the year ended December 31, 2016 to $44.3 million for the year ended December 31, 2017. As of December 31, 2017, our stockholders’ deficit was $39.2 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 master service agreements, and typically have multiple agreements with each of our customers. Master service agreements generally contain customer-specified service requirements, such as discreet 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.

 

The following table summarizes our revenues from multi-year master service agreements and other long-term contracts, as a percentage of contract revenues:

 

   Year Ended December 31, 
   2017   2016 
Multi-year master service agreements and long-term contracts   35%   30%

 

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 the percentage of revenues from multi-year master service agreements is due to increases in revenue of our professional services segment, which does not derive revenues from multi-year master service agreements.

 

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A significant portion of our revenue typically came from one large customer within our professional services segment. As a result of the sale of the ADEX Entities, we will not be operating within the professional services segment going forward. During 2017, a significant portion of our revenue also came from a large customer in our applications and infrastructure segment. The following table reflects the percentage of total revenue from our only customers that contributed at least 10% to our total revenue in either of the years ended December 31, 2017 or 2016:

 

   Year ended December 31, 
   2017   2016 
Uline   17%   * 
Ericsson, Inc.   11%   * 
AT&T Inc.   11%   * 

 

 

* Represented less than 10% of the total revenues during the period.

 

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.in a outsourced managed service environment 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 solutions represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting outsourced 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.

  

Our Ability to Expand and Diversify Our Customer Base.

 

Our customers for specialty contracting services consisted of leading telephone, wireless, cable television and data companies. With the sale of our ADEX subsidiary in February 2018, we will generate no revenue from our professional services segment going forward. Ericsson Inc. was 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 changed as we have diversified our customer base and revenue streams. The percentage of our revenue attributable to our top 10 customers, as well as our only customers that contributed at least 10% of our revenue in at least one of the years specified in the following table, were as follows:

 

   Year ended December 31, 
   2017   2016 
Top 10 customers, aggregate   74%   61%
Customer:          
Uline   17%   * 
Ericsson, Inc.   11%   * 
AT&T Inc.   11%   * 

 

 

* Represented less than 10% of the total revenues during the period.

 

Business Unit Transitions.

 

Since January 1, 2012, we have acquired seven material companies and sold three material companies. We acquired these businesses to either enhance certain of our existing business units or allow 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 were able to cross-sell our other services. AW Solutions was sold in April 2017 (refer to Note 5, Acquisitions and Disposals of Subsidiaries, of the notes to our audited consolidated financial statements enclosed elsewhere in this report for further detail).

 

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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.

 

We expect the companies we acquire 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, 2017 and 2016.

 

   Year ended December 31, 
   2017   2016 
Revenue from:          
Applications and infrastructure  $12,009   $22,173 
Professional services  $22,511   $36,937 
As a percentage of total revenue:          
Applications and infrastructure   35%   38%
Professional services   65%   62%

 

In February 2018, we sold the subsidiaries that operated in our professional services segment.

 

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 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, 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, 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.

 

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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 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.

 

During 2017, our revenues were generated from two reportable segments, applications and infrastructure and professional 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, the AWS Entities (which we sold in April 2017), Tropical (which we sold in April 2017 in connection with the sale of the AWS Entities), and RM Engineering. Applications and infrastructure service revenue is derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. The contracts of TNS 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.

  

The AWS Entities, which we sold in April 2017, and which included 8760 Enterprises from September 14, 2016 through December 31, 2016, generally recognized revenue using the percentage of completion method. Revenues and fees under the contracts of these entities were recognized utilizing the units-of-delivery method, which used measures such as task completion within an overall contract. The units-of-delivery approach is an output method used in situations where it is more representative of progress on a contract than an input method, such as the efforts-expended approach. Provisions for estimated losses on uncompleted contracts, if any, were made in the period in which such losses were determined. Changes in job performance conditions and final contract settlements could have resulted in revisions to costs and income, which were recognized in the period in which revisions were determined.

 

The AWS Entities also generated revenue from service contracts with certain customers. These contracts were accounted for under the proportional performance method. Under this method, revenue was recognized in proportion to the value provided to the customer for each project as of each reporting date.

 

The revenues of our professional services segment, which was comprised of our ADEX subsidiaries (which we sold in February 2018) and SDNE (which we sold in May 2017), were 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 provided that payments made for our services might have been based on either (i) direct labor hours at fixed hourly rates or (ii) fixed-price contracts. The services provided under these contracts were generally provided within one month. Occasionally, the services might have been provided over a period of up to four months. If it was anticipated that the services would span a period exceeding one month, depending on the contract terms, we provided 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, 2017 and 2016.

 

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ADEX’s former Highwire division (“Highwire”), which we sold in February 2017, generated revenue through its telecommunications engineering group, which contracted with telecommunications infrastructure manufacturers to install the manufacturer’s products for end users. This division of ADEX recognized revenue using the proportional performance method. Under this method, revenue was recognized as projects within contracts were completed as of each reporting date.

 

Our applications and infrastructure segment 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 revenues of our managed services segment were derived primarily from the operations of IPC. The Company sold the assets of IPC during November 2017, and the results of operations for IPC are now included within discontinued operations. Our IPC subsidiary was a value-added reseller, the revenues of which were 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 were higher education organizations, governmental agencies and commercial customers. IPC also provided maintenance and support, resold maintenance and support and provided professional services. For certain maintenance contracts, IPC assumed responsibility for fulfilling the support to customers and recognized the associated revenue either on a ratable basis over the life of the contract or, if a customer purchased a time and materials maintenance program, as maintenance was provided to the customer. Revenue for the sale of third-party maintenance contracts was recognized net of the related cost of revenue. In a maintenance contract, all services were provided by our third-party providers and as a result, we concluded that we were acting as an agent and recognized revenue on a net basis at the date of sale with revenue being equal to the gross margin on the transaction. As IPC was under no obligation to perform additional services, revenue was recognized at the time of sale as opposed to over the life of the maintenance agreement.

 

For multiple-element arrangements, IPC recognized revenue in accordance with ASC 605-25, “Arrangements with Multiple Deliverables”. Under the relative fair value method, the total revenue was allocated among the elements based upon the relative fair value of each element as determined through the fair value hierarchy. Revenue was generally allocated in an arrangement using the estimated selling price of deliverables if it did not have vendor-specific objective evidence or third-party evidence of selling price.

 

Our former VaultLogix subsidiary, which was sold in February 2016, provided cloud-based on-line data backup services to its customers. Certain customers paid for their services before service began. Revenue for these customers was deferred until the services were performed. For all services, VaultLogix recognized revenue when services were provided, evidence of an arrangement existed, fees were fixed or determinable and collection was reasonably assured.

 

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, 2017 and 2016.

 

Goodwill and Intangible Assets

 

Goodwill and intangible assets were generated through the acquisitions made during 2012 through 2016. As the total consideration paid exceeded the value of the net assets acquired, we recorded goodwill for each of the completed acquisitions. At the date of the acquisition, we performed a valuation to determine the value of the intangible assets, along with the allocation of assets and liabilities acquired.

 

We test our goodwill and indefinite-lived intangible assets for impairment at least annually (at October 1) and whenever events or circumstances change that indicate impairment may have occurred.

 

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Derivative Financial Instruments

 

We record financial instruments classified as liabilities, temporary equity or permanent equity at issuance at the fair value, or cash received.

 

We record the fair value of our financial instruments classified as liabilities at each subsequent measurement date. The changes in fair value of our financial instruments classified as liabilities are recorded as other expense/income. We utilize a binomial lattice 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. The Monte Carlo simulation is used to determine the fair value of derivatives for instruments with embedded conversion features.

  

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 2017 and 2016. Our policy going forward will be to issue awards under our 2015 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 of 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, 2017 and 2016. Some of the factors that influenced the market price of our stock during those periods included: 

 

  acquisitions and disposals;
     
  increasing indebtedness to fund such acquisitions;
     
  historical operating results; and
     
  commencement of certain litigations against our company and its management.

 

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. 

 

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The following tables summarize our stock-based compensation for the years ended December 31, 2017 and 2016. 

 

   Year Ended December 31, 2017  
Date  Vesting Terms   Shares of Common Stock    Closing Stock Price on Grant Date    Fair Value
Per Share
    Fair Value of Instrument Granted
(in thousands)
 
                        
1/6/2017  No Vesting   1,250   $10.00   $10.00   $13 
1/6/2017  Three years   125    10.00    10.00    1 
1/27/2017  6 month Vesting   6,250    7.00    7.00    44 
1/27/2017  Three years   6,625    7.00    7.00    46 

 

   Year Ended December 31, 2016  
Date  Vesting Terms  Shares of Common Stock   Closing Stock Price on Grant Date   Fair Value
Per Share
   Fair Value of Instrument Granted 
                    
7/5/2016  6 months   501   $271.64   $271.64   $136,062 
7/5/2016  Three years   169    271.64    271.64    45,839 
7/20/2016  Vest 6/30/2017   1,031    231.20    231.20    238,425 
7/20/2016  Three years   500    231.20    231.20    115,600 
7/20/2016  No Vesting   143    231.20    231.20    33,028 
7/20/2016  Vest 1/1/2017   250    231.20    231.20    57,800 
7/20/2016  6 month Vesting   1,785    231.20    231.20    412,692 
7/27/2016  Vest 12/31/2017   188    202.00    202.00    37,875 
7/27/2016  6 month Vesting   162    202.00    202.00    32,731 

 

Components of Results of Operations

 

Revenue.

 

   Year ended December 31, 
   2017   2016 
Revenue from:          
Applications and infrastructure  $12,009   $22,173 
Professional services  $22,511   $36,937 
As a percentage of total revenue:          
Applications and infrastructure   35%   38%
Professional services   65%   62%

 

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.

 

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.

 

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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. We cannot accurately predict what our expenses for legal and professional fees will be. We have taken steps to reduce these costs, however, litigation could cause an increase in these fees. 

 

Goodwill and Indefinite Lived Intangible Assets.

 

Goodwill was generated through the acquisitions we have made since 2012. 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 7 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 reporting unit level, which is consistent with our operating segments. During 2017, our two reportable segments were applications and infrastructure and professional services. Professional services was comprised of the ADEX entities (which we sold in February 2018) and SDNE (which we sold in May 2017), and the applications and infrastructure is comprised of TNS, AW Solutions (which we sold in April 2017), Tropical (which we sold in April 2017 in connection with the sale of AW Solutions), and RM Engineering. These reporting units were aggregated to form two operating segments and two reportable segments for financial reporting and for the evaluation of goodwill for impairment. As our business evolves and we acquire or dispose of additional businesses, 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 October 1) 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.

 

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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.

 

We evaluated the recoverability of our long-lived assets in the applications and infrastructure and professional services reporting segments 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. As of January 1, 2017, step two was no longer required.

 

In order to determine the fair value of the customer relationships, we utilize 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. Non-compete agreements are evaluated based on the probability of competition and the revenue that can potentially be generated from the agreements. The fair value of a corporate trade name is 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 is 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 market conditions in order to determine a reasonable royalty rate to estimate the fair value of the corporate trade name. 

 

The first step of the goodwill impairment test is to identify potential impairment by comparing the fair value of a reporting unit with its net book value (or carrying amount), including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of the reporting unit exceeded its fair value, the second step of the goodwill impairment test, which is no longer required, was performed to measure the amount of the impairment loss, if any. The second step of the goodwill impairment test compared the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeded the implied fair value of that goodwill, an impairment loss was recognized in an amount equal to that excess. The implied fair value of goodwill was determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit was allocated to all of the assets and liabilities of that reporting unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.

 

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Fair Value of Embedded Derivatives.

 

We used a binomial lattice model as of December 31, 2017 and December 31, 2016 to determine the fair value of the derivative liability related to our outstanding warrants and the put and effective price of future equity offerings of equity-linked financial instruments. Based on our analysis, we derived the fair value of warrants using the common stock price, the exercise price of the warrants, the risk-free interest rate, the historical volatility, and our dividend yield. 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 Note 9 of the Notes to our consolidated financial statements included in this report).

 

We have convertible debentures outstanding with institutional investors. The convertible debentures held by these investors are convertible at a discount to the average closing stock price on the days prior to the conversion. Between July 7, 2016 and December 31, 2016, these institutional investors converted $5,008 of debentures into 189,204 shares of common stock. During the year ended December 31, 2017, these institutional investors converted $10,974 of debentures in 8,771,528 shares of common stock. These debentures are discussed in more detail at Note 11, Term Loans, in our historical financial statements.

  

The aggregate fair value of our derivative liabilities (both current and non-current liabilities) as of December 31, 2017 and 2016 amounted to $20.0 million and $3.1 million, respectively. 

  

Income Taxes.

 

In the years ended December 31, 2017 and 2016, we booked a current provision for state, local and foreign income taxes due of $0.1 million and $0.1 million, respectively. Certain states do not recognize net operating loss carryforwards, and we have operations in some of those states. For the year ended December 31, 2017, we booked a benefit for deferred federal and state income taxes of $0.8 million and a total benefit for income taxes of $0.7 million. For the year ended December 31, 2016, we booked a provision for deferred federal and state income taxes of $0.1 million and a total provision for income taxes of $0.2 million. As of December 31, 2017 and 2016, we had federal net operating loss carryforwards (NOLs) of $19.4 million and $11.4 million, respectively, which will be available to reduce future taxable income and expense through 2036. 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 and other receivables. 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. 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, 2017.

 

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. We no longer had any contingent consideration to include on our consolidated balance sheet as of December 31, 2017.

 

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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

 

Management believes that we will continue to incur losses for the immediate future. Therefore, we may need either additional equity or debt financing until we can achieve profitability and positive cash flows from operating activities, if ever. These conditions raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments relating to the recovery of assets or the classification of liabilities that may be necessary should we be unable to continue as a going concern. For the year ended December 31, 2017, we generated gross profits from operations, and we are trying to achieve positive cash flows from operations in future periods.

 

The following table shows our results of operations for the years ended December 31, 2017 and 2016. 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, 
   2017   2016 
Statement of Operations Data:        
         
Service revenue  $34,520   $59,110 
Cost of revenue   27,492    45,002 
Gross profit   7,028    14,108 
           
Operating expenses:          
Depreciation and amortization   559    1,326 
Salaries and wages   6,412    13,856 
General and administrative   6,966    11,443 
Goodwill impairment charges   7,992    - 
Intangible assets impairment charges   1,522    - 
Total operating expenses   23,451    26,625 
           
Loss from operations   (16,423)   (12,517)
           
Total other expense   (27,582)   (8,076)
Loss from continuing operations before (benefit from) provision for income taxes   (44,005)   (20,593)
           
(Benefit from) provision for income taxes   (672)   207 
           
Net loss from continuing operations   (43,333)   (20,800)
           
Loss from discontinued operations, net of tax   (1,559)   (5,672)
           
Net loss   (44,892)   (26,472)
           
Net (income) loss attributable to non-controlling interest   (556)   11 
           
Net loss attributable to InterCloud Systems, Inc. common stockholders  $(44,336)  $(26,483)

 

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Year ended December 31, 2017 compared to year ended December 31, 2016

 

Revenue.

 

   Year ended December 31,   Change 
   2017   2016   Dollars   Percentage 
Applications and infrastructure  $12,009   $22,173   $(10,164)   -46%
Professional services   22,511    36,937    (14,426)   -39%
Total  $34,520   $59,110   $(24,590)   -42%

 

Total revenue for the year ended December 31, 2017 was $34.5 million, which represented a decrease of $24.6 million, or 42%, compared to total revenue of $59.1 million for the year ended December 31, 2016. The decrease primarily resulted from the sale of SDNE in May 2017, which generated $1.7 million in revenue in 2017 compared to $4.7 million in revenue in 2016, along with the sale of our Highwire division in January 2017, which generated $0.4 million in revenue in 2017 compared to $11.0 million in revenue in 2016, and the sale of AWS in April 2017, which generated $3.2 million in revenue in 2017 compared to $11.7 million in revenue in 2016. Total revenue from subsidiaries sold in 2017 decreased $22.1 million compared to 2016. Revenue from our ADEX subsidiary, which we sold during February 2018, decreased $1.7 million in 2017 from 2016 due to a decrease in revenue from a large customer. During the years ended December 31, 2017 and 2016, our former ADEX subsidiary accounted for approximately $20.5 million and $21.5 million of our revenues, respectively, accounting for 59% and 36% of our revenues for those periods, respectively.

 

During 2017, 65% of our revenue was derived from our professional services segment, and 35% from our applications and infrastructure segment. As a result of the sale of our ADEX subsidiary in February 2018, we expect significantly all of our revenues to come from our applications and infrastructure segment in 2018. During 2016, 62% of our revenue was derived from our professional services segment and 38% from our applications and infrastructure segment. 

 

Cost of revenue and gross margin.

 

   Year ended December 31,   Change 
   2017   2016   Dollars   Percentage 
Applications and infrastructure                    
Cost of revenue  $8,598   $18,540   $(9,942)   -54%
Gross margin  $3,411   $3,633   $(222)   -6%
Gross profit percentage   28%   16%          
                     
Professional services                    
Cost of revenue  $18,894   $26,462   $(7,568)   -29%
Gross margin  $3,617   $10,475   $(6,858)   -65%
Gross profit percentage   16%   28%          
                     
Total                    
Cost of revenue  $27,492   $45,002   $(17,510)   -39%
Gross margin  $7,028   $14,108   $(7,080)   -50%
Gross profit percentage   20%   24%          

 

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Cost of revenue for the years ended December 31, 2017 and 2016 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 decreased by $17.5 million, or 39%, for the year ended December 31, 2017, to $27.5 million, as compared to $45.0 million for the year ended December 31, 2016. Costs of revenue as a percentage of revenues were 80% and 76% for the years ended December 31, 2017 and 2016, respectively. The decrease in cost of revenue was primarily the result of the sales of the following, our AWS subsidiary, which decreased from $11.6 million in 2016 to $3.1 million in 2017, a decrease of $8.5 million, our Highwire division which decreased from $6.2 million in 2016 to $.2 million in 2017, a decrease of $6.0 million, and our SDNE subsidiary which declined from $3.2 million in 2016 to $1.3 million in 2017, a decrease of $1.9 million. The total decline attributable to the sales of subsidiaries and divisions was $16.4 million. The remaining decline was due to decreased revenues in our ADEX and TNS subsidiaries.

 

This increase in cost of revenues percentage was primarily due to the lower gross profit margins in our professional services segment offset by higher gross profit margins in our applications and infrastructure segment. Cost of revenues as a percentage of revenues in the professional services business was 84% and 72% of revenues in the years ended December 31, 2017 and 2016, respectively. Cost of revenues as a percentage of revenues in the applications and infrastructure business was 72% and 84% of revenues in the years ended December 31, 2017 and 2016, respectively. Our gross profit percentage declined in our professional services segment due to increased use of subcontractors in 2017 compared to 2016. The sale of our Highwire division in January 2017 and the sale of our SDNE subsidiary in May 2017, which both had historically higher gross margins, also accounted for the decline.

   

Our gross profit percentage was 20% and 24% for the years ended December 31, 2017 and 2016, respectively. This decrease in gross profit percentage was primarily due to the lower gross profit margins in our former professional services segment offset by higher gross profit margins in our applications and infrastructure segment. Gross profit as a percentage of revenues in the applications and infrastructure segment was 28% and 16% of revenues in the years ended December 31, 2017 and 2016, respectively, as discussed above. Gross profit from the AWS subsidiary, which was sold in April 2017, was historically lower than the gross profit percentage of our TNS subsidiary, which resulted in the overall increased gross profit percentage for the segment. Gross profit as a percentage of revenues in the former professional services business was 16% and 28% of revenues in the years ended December 31, 2017 and 2016, respectively. This was a result of the sales of our Highwire division in January 2017 and our SDNE subsidiary in May 2017, which had 43% and 33% gross margins in 2016, respectively, and increased our overall gross margin percentage during that period.

 

Going forward, as a result of the sale of our ADEX subsidiary in February 2018, our gross margin will primarily consist of the applications and infrastructure segment.

 

Selling, General and Administrative. 

 

   Year ended December 31,   Change 
   2017   2016   Dollars   Percentage 
Selling, general and administrative  $6,966   $11,443   $(4,477)   -39%
Percentage of revenue   20%   19%         

 

Selling, 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. Selling, general and administrative expenses decreased $4.5 million, or 39%, to $7.0 million in the year ended December 31, 2017, as compared to $11.5 million in the year ended December 31, 2016. As a percentage of revenue, selling, general and administrative expenses was 20% and 19% as of December 31, 2017 and 2016, respectively. The decrease was primarily a result of a decrease in professional fees in 2017 compared to 2016. 

 

Salaries and Wages.

 

   As of December 31,   Change 
   2017   2016   Dollar   Percentage 
Salaries and wages  $6,412   $13,856   $(7,444)   -54%
Percentage of revenue   19%   23%   -    - 

 

For the year ended December 31, 2017, salaries and wages decreased $7.5 million to $6.4 million as compared to approximately $13.9 million for the year ended December 31, 2016. The decrease primarily resulted from the disposals of certain subsidiaries during 2017, along with a reduction in our corporate personnel. Salaries and wages were 19% of revenue in the year ended December 31, 2017, as compared to 23% in the year ended December 31, 2016. 

 

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Interest Expense.

 

   As of December 31,   Change 
   2017   2016   Dollar   Percentage 
Interest expense  $7,050   $13,754   $(6,704)   -49%

 

Interest expense for the years ended December 31, 2017 and 2016 was $7.1 million and $13.8 million, respectively. The expense incurred in the 2017 period primarily related to interest expense of $0.1 million related to the related-party loans, $3.8 related to term loans, $2.9 million of amortization of debt discounts and loans and $0.3 million related to other loans. This compared to the 2016 period where interest expense consisted of $1.7 million related to the related-party loans, $5.0 million related to term loans, $7.0 million of amortization of debt discounts and $0.1 million related to other loans. The overall decrease was a result of the lower outstanding principal balances in 2017 compared to 2016.  

 

Net Loss Attributable to our Common Stockholders.

 

Net loss attributable to our common stockholders was $44.5 million for year ended December 31, 2017, as compared to net loss attributable to common stockholders of $26.5 million for the year ended December 31, 2016.

 

Liquidity, Capital Resources and Cash Flows

 

Working Capital.

 

We believe that our available cash balance as of the date of this filing will not be sufficient to fund our anticipated level of operations for at least the next 12 months. Management believes that our ability to continue our operations depends on our ability to sustain and grow revenue and results of operations as well as our ability to access capital markets when necessary to accomplish our strategic objectives. Management believes that we will continue to incur losses for the immediate future. For the year ended December 31, 2017, we generated gross profits from operations, but we incurred negative cash flow from operations. We expect to finance our cash needs from the results of operations and, depending on results of operations, we may need additional equity or debt financing until we can achieve profitability and positive cash flows from operating activities, if ever.

 

At December 31, 2017, we had a working capital deficit of approximately $20.5 million, as compared to a working capital deficit of approximately $39.4 million at December 31, 2016. The decrease of $18.9 million in our working capital deficit from December 31, 2016 to December 31, 2017 was primarily the result of a decrease in the outstanding balances of term loans and notes to related parties.

 

On or prior to March 31, 2019, we have obligations relating to the payment of indebtedness on term loans and notes to related parties of $11.9 million and $0.075 million, respectively.

 

We anticipate meeting our cash obligations on our indebtedness that is payable on or prior to March 31, 2019 from the results of operations and, depending on results of operations, we will likely need additional equity or debt financing. Additionally, during February 2018, we sold the ADEX Entities for $3.0 million in cash plus a one-year convertible promissory note in the aggregate principal amount of $2.0 million. $2.5 million in cash was received at closing, with $0.5 million to be retained by the buyer for 90 days, of which $0.25 million has been received. $1.0 million of the $2.5 million in cash received at closing was applied to the repayment of our indebtedness to JGB (Cayman) Concord Ltd, with an additional $0.9 million in cash placed in an escrow account controlled by JGB (Cayman) Concord Ltd, to be released to us if certain conditions are met.

 

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. Our management has taken several actions to ensure that we will have sufficient liquidity to meet our obligations through March 31, 2019, including the reduction of certain general and administrative expenses, consulting expenses and other professional services fees, and the sale of certain of our operating subsidiaries. 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 preferred or common shares. 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 March 31, 2019. There is no assurance that we will be successful in any capital-raising efforts that we may undertake to fund operations during 2018.

 

We plan to generate positive cash flow from our subsidiaries. However, to execute our business plan, service our existing indebtedness and implement our business strategy, 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.

 

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We had capital expenditures of $0.03 million and $0.1 million in the years ended December 31, 2017 and 2016, 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.

 

As of December 31, 2017, we had cash of $0.7 million, which was exclusively denominated in U.S. dollars and consisted of bank deposits. 

 

Summary of Cash Flows.

 

The following summary of our cash flows for the years ended December 31, 2017and 2016 has been derived from our historical consolidated financial statements, which are included elsewhere in this report:

 

   Year ended December 31, 
(dollars amounts in thousands)  2017   2016 
     
Net cash used in operations   (1,758)  $(11,029)
Net cash provided by investing activities   5,477    20,998 
Net cash used in financing activities   (4,819)   (16,123)

 

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 or decrease our headcount.

 

Net cash used in operating activities for the year ended December 31, 2017 was $1.8 million, which included $0.6 million in stock compensation for services, charges of $2.9 million related to amortization of debt discount and deferred issuance costs, gain of $3.5 million on the fair value of derivative liabilities, losses of $8.9 million on the extinguishment of debt, goodwill and intangible asset impairment charges of $9.5 million, and changes in accounts receivable, other assets, deferred revenue, accounts payable and accrued expenses of $4.9 million. Non-cash charges related to depreciation and amortization totaled $0.6 million. Net cash used in operating activities for the year ended December 31, 2016 was $11.0 million, which included $3.4 million in stock compensation for services, charges of $6.9 million related to amortization of debt discount and deferred issuance costs, gain of $17.5 million on the fair value of derivative liabilities, losses of $9.6 million on the extinguishment of debt, gains of $0.4 million on the conversion of debt, changes in accounts receivable, other assets, deferred revenue, accounts payable and accrued expenses of $2.2 million, and cash provided by operating activities of discontinued operations of $2.9 million. Non-cash charges related to depreciation and amortization totaled $2.1 million. 

 

Net cash provided by investing activities. Net cash provided by investing activities for the year ended December 31, 2017 was $5.5 million, which consisted primarily of proceeds from the sale of Highwire of $4.0 million and proceeds from the sale of SDNE of $1.1 million. Net cash provided by investing activities for the year ended December 31, 2016 was $21.0 million, which consisted of capital expenditures of $0.1 million, cash paid for acquisitions of $0.1 million, issuance of notes receivable of $0.9 million, and cash provided by investing activities of discontinued operations of $21.9 million.

  

Net used in financing activities. Net cash used in financing activities for the year ended December 31, 2017 was $4.8 million, which resulted from proceeds from third-party borrowings of $0.7 million, repayments of term loans of $1.5 million, term loan-related payments from proceeds of the sale of Highwire of $3.6 million, and repayments of receivables purchase agreements of $0.5 million. Net cash used in financing activities for the year ended December 31, 2016 was $16.1 million, which resulted from proceeds from third-party borrowings of $2 million, repayments of third-party borrowings of $16.1 million, and restricted cash applied to long term loans of $2 million.

 

 

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Indebtedness.

 

At December 31, 2017 and 2016, term loans consisted of the following:

 

   December 31, 
   2017   2016 
Former owners of RM Leasing, unsecured, non-interest bearing, due on demand  $2   $2 
           
Promissory note with company under common ownership by former owner of Tropical, 9.75% interest, monthly payments of interest only of $1, unsecured and personally guaranteed by officer, matured in November 2016   -    106 
           
London Bay - VL Holding Company, LLC convertible promissory note, unsecured, 0% and 8.8% interest, respectively, maturing in October 2018   1,403    7,408 
           
WV VL Holding Corp convertible promissory note, unsecured, 0% and 8.8% interest, respectively, maturing in October 2018   2,005    7,003 
           
8% convertible promissory note, Tim Hannibal, unsecured, matured in October 2017   -    1,215 
           
12% senior convertible note, unsecured, Dominion Capital, matured in January 2017, net of debt discount of $29   -    1,170 
           
12% convertible note, Richard Smithline, unsecured, matured in January 2017, net of debt discount of $0 and $2, respectively   -    360 
           
Senior secured convertible debenture, JGB (Cayman) Waltham Ltd., bearing interest of 4.67%, maturing in May 2019, net of debt discount of $0 and $3,136, respectively   3,091    1,900 
           
Senior secured convertible note, JGB (Cayman) Concord Ltd., bearing interest at 4.67%, maturing in May 2019, net of debt discount of $0 and $1,668, respectively   11    2,080 
           
Senior secured note, JGB (Cayman) Waltham Ltd., bearing interest at 4.67%, maturing in May 2019, net of debt discount of $0 and $234, respectively   294    358 
           
6% senior convertible term promissory note, unsecured, Dominion Capital, matured on January 31, 2018, net of debt discount of $1   69    - 
           
12% senior convertible note, unsecured, Dominion Capital, matured in November 2017, net of debt discount of $0 and $65, respectively   75    475 
           
Receivables Purchase Agreement with Dominion Capital, net of debt discount of $44   -    430 
           
Promissory note issued to Trinity Hall, 3% interest, unsecured, matured in January 2018   500    500 
           
9.9% convertible promissory note, RDW Capital LLC. July 14, 2017 Note, maturing on July 14, 2018, net of debt discount of $74   81    - 
           
9.9% convertible promissory note, RDW Capital LLC. September 27, 2017 Note, maturing on September 27, 2018, net of debt discount of $91   64    - 
           
9.9% convertible promissory note, RDW Capital LLC. October 12, 2017 Note, maturing on October 12, 2018   480    - 
           
9.9% convertible promissory note, RDW Capital LLC. December 8, 2017 Note, maturing on December 8, 2018   133    - 
           
Promissory notes issued to Forward Investments, LLC, between 2% and 10% interest, matured on July 1, 2016, unsecured   1,421    - 
           
Promissory notes issued to Forward Investments, LLC, 3% interest, matured on January 1, 2018, unsecured   1,752    - 
           
Promissory notes issued to Forward Investments, LLC, 6.5% interest, matured on July 1, 2016, unsecured   390    - 
           
Promissory note to Tim Hannibal, 8% interest, matured on January 9, 2018, unsecured   300    - 
    12,071    23,007 
Less: Current portion of term loans   (11,013)   (21,147)
           
Long-term portion term loans, net of debt discount  $1,058   $1,860 

  

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Additional information on our term loans is set forth in our consolidated financial statements included in this report in Item 8, Financial Statements and Supplementary Data.

 

At December 31, 2017 and 2016, we had outstanding the following notes payable to related parties:

 

   December 31, 
   2017   2016 
         
Promissory note issued to CamaPlan FBO Mark Munro IRA, 3% interest, matured on January 1, 2018, unsecured, net of debt discount of $38  $-   $658 
Promissory note issued to 1112 Third Avenue Corp, 3% interest, matured on January 1, 2018, unsecured, net of debt discount of $36   -    339 
Promissory note issued to Mark Munro, 3% interest, matured on January 1, 2018, unsecured, net of debt discount of $62   -    575 
Promissory note issued to Pascack Road, LLC, 3% interest, matured on January 1, 2018, unsecured, net of debt discount of $152   -    2,398 
Promissory notes issued to Forward Investments, LLC, between 2% and 10% interest, matured on July 1, 2016, unsecured   -    4,235 
Promissory notes issued to Forward Investments, LLC, 3% interest, matured on January 1, 2018, unsecured, net of debt discount of $860   -    3,513 
Promissory notes issued to Forward Investments, LLC, 6.5% interest, matured on July 1, 2016, unsecured   -    390 
Former owner of IPC, unsecured, 8% interest, matured on May 30, 2016   -    5,755 
Former owner of IPC, unsecured, 15% interest   -    75 
Former owner of Nottingham, unsecured, 8% interest, matured on May 30, 2016        225 
Promissory note issued to Pascack Road, LLC, unsecured, due on demand   75    - 
           
    75    18,163 
Less: current portion of debt   (75)   (9,531)
Long-term portion of notes payable, related parties  $-   $8,632 

  

Additional information on our notes payable to related parties is set forth in our consolidated financial statements included in this report in Item 8, Financial Statements and Supplementary Data.

 

As of December 31, 2017, the outstanding balances of term loans and notes payable to related parties were $12.0 million and $0.1 million, respectively, net of debt discounts of $0.2 million and $0, respectively.  

 

The total outstanding principal balance per the loan agreements due to our debt holders was $12.2 million at December 31, 2017. We are currently in discussions with certain of our creditors to restructure some of these loan agreements to reduce the principal balance and extend maturity dates. However, there can be no assurance that we will be successful in reducing the principal balance or extending the maturity dates of any of our outstanding notes.

 

Accounts Receivable 

 

We had accounts receivable at December 31, 2017 and 2016 of $6.2 million and $9.9 million, respectively. Our day’s sales outstanding calculated on an annual basis at December 31, 2017 and 2016 was 66 days and 61 days, respectively. With the sale of our ADEX subsidiary in February 2018, our accounts receivable balance will decrease. 

 

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Off-balance sheet arrangements 

 

During the years ended December 31, 2017 and 2016, 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 items 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 recorded 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Our consolidated balance sheets as of December 31, 2017 and 2016, 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, 2017 and 2016, together with the related notes and the report of our independent registered public accounting firm, are set forth on pages F-1 to F-82 of this report.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

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.

 

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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 Accounting 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 inability to complete our implementation of comprehensive entity level 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, after our liquidity position improves, 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 Accounting Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. 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 (2013). 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 Accounting Officer, concluded that as of December 31, 2017, 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 Accounting Officer concluded that as of December 31, 2017 we had material weaknesses due to (i) our inability to complete our implementation of comprehensive entity level controls, (ii) our lacking 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, and (iii) the lack of 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. The monitoring of our accounting and reporting functions were not operating effectively. These facts, coupled with the lack of personnel, limits our ability to prepare and timely issue our required filings with the SEC. 

 

Changes in Internal Controls over Financial Reporting 

 

Other than the items noted above, there have been no changes in internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

 

ITEM 9B. OTHER INFORMATION

 

None.

 

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PART III

 

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 February 28, 2018.

 

 Name    Position    Age
              
Mark Munro    Chairman of the Board, Chief Executive Officer    55
Mark F. Durfee    Director    61
Charles K. Miller    Director    57
Neal L. Oristano    Director   62
Daniel J. Sullivan    Chief Accounting Officer    60

  

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 eight years. 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 2004, 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. in finance from the University of Wyoming. Mr. Durfee brings over 25 years of experience as a private equity investor to our board of directors.

 

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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. From July 2004 to July 2011, he was the Senior Vice President - Service Provider Sales at Juniper Networks, Inc., a networking software and systems company. Mr. Oristano received his B.S. in marketing from St. Johns University. Mr. Oristano brings over 35 years of technology experience, including enterprise and service provider leadership, to our board of directors.

  

Daniel J. Sullivan. Mr. Sullivan was our Chief Financial Officer from December 2011 to October 2014, has served as our Chief Accounting Officer since October 2014, and was a member of our board of directors from 2011 to November 2012. Mr. Sullivan has been the Chief Financial Officer for Munro Capital Inc., a diversified finance company, since August 2010. Prior to that, he served as Chief Financial Officer for VaultLogix LLC, an Internet vaulting company, from January 2003 to July 2010. Mr. Sullivan received his B.S. in accounting from the University of Massachusetts and his M.B.A. from Southern New Hampshire University (formerly New Hampshire College). Mr. Sullivan brings extensive experience in finance for both publicly-traded and private companies to our executive management team.

  

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 the 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 2017 and 2016, with the exception of a Statement of Changes of Beneficial Ownership of Securities on Form 4 for our director, Neal L. Oristano, filed on March 1, 2017.

 

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. 

 

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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, 2020;
     
  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, 2018; 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, 2019.

 

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.

 

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.

 

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We have obtained 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.

 

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, 2017 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, 2017 and 2016 to the named executive officers:

 

                       Non-Equity         
                       Incentive   All     
       Base       Stock   Option   Plan   Other     
Name and Principal  Fiscal   Salary   Bonus   Awards   Awards   Compensation   Compensation   Total 
Position   Year   ($)   ($)   ($)(1)   ($)    ($)   ($)   ($) 
Mark Munro   2017    507,692    -    -    -    -    -    507,692 
Chief Executive Officer   2016    536,923    400,000    2,500    -    -    -    939,423 
                                         
Frank Jadevaia   2017    -    -    -    -    -    -    - 
Former President (2)   2016    344,615    400,000    -    -    -    -    744,615 
                                         
Timothy A. Larkin   2017    232,691    -    8,550    -    -    -    241,241 
Former Chief Financial Officer (3)   2016    275,000    -    -    -    -    -    275,000 
                                         
Daniel J. Sullivan   2017    190,385    -    8,550    -    -    -    198,935 
Chief Accounting Officer   2016    226,250    -    -    -    -    -    226,250 

 

(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 3 to our consolidated financial statements included in Item 8. Financial Statements and Supplementary Data of this report.
   
(2) Mr. Jadevaia was our President from February 2014 through November 2016.
   
(3) Mr. Larkin was our Chief Financial Officer from October 2014 through December 2017.

 

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Employment and Severance Agreements

 

In February 2014, we entered into a three-year employment agreement with our former Vice President of Sales and Marketing, Scott Davis, and in October 2014, we entered into a three-year employment agreement with our former Chief Financial Officer, Timothy A. Larkin. Both officers resigned during 2017, and we have no further obligations to these former officers.

  

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, 2017.

 

   Stock Awards
   Number of      Market 
   Shares or      Value of 
   Units of      Shares or 
   Stock (#)      Units of 
   That Have   Stock  Stock ($) 
   Not   Award  That Have 
Name  Vested(1)   Grant Date  Not Vested 
Mark Munro   1,250(2)  6/2/2014  $2,985,000(3)
Daniel J. Sullivan   125(4)  8/28/2014   259,500(5)
Daniel J. Sullivan   63(6)  12/4/2013   241,668(7)
Daniel J. Sullivan   107(8)  5/23/2014   1,649,508(9)
Daniel J. Sullivan   88(10)  7/5/2016   23,904(11)
Daniel J. Sullivan   313(12)  1/27/2017   2,141(13)

 

(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 full on June 2, 2018.

 

(3)  The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $2,388.00, which was the closing market price of one share of our common stock on June 2, 2014.

 

(4) This restricted stock award vests in full on August 28, 2018.
   
(5) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $2,076.00, which was the closing market price of one share of our common stock on August 28, 2014.
   
(6) This restricted stock award vests in full on July 5, 2019.

  

(7) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $3,836.00, which was the closing market price of one share of our common stock on December 4, 2013.
   
(8) This restricted stock award vests in full on May 23, 2018.
   
(9) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $2,044.00, which was the closing market price of one share of our common stock on May 23, 2014.
   
(10) This restricted stock award vests in full on July 5, 2019.
   
(11) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $271.64, which was the closing market price of one share of our common stock on July 5, 2016.
   
(12) This restricted stock award vests in full on January 27, 2020
   
(13) The market value of this stock award is computed by multiplying the number of shares of restricted stock granted by $6.84, which was the closing market price of one share of our common stock on January 27, 2017.

 

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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 were eligible to receive awards under the 2012 Plan.  Awards under the 2012 Plan were issuable 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.

 

As of December 31, 2017, stock grants of an aggregate of 7,273 shares had been made under the 2012 Plan, and 373 shares authorized under the 2012 Plan remained available for award purposes.  However, in connection with the adoption and stockholder approval in June 2015 of our 2015 Performance Incentive Plan, which is described below, our board of directors determined that no further grants will be made under the 2012 Plan.

 

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 100,395 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.

 

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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. 

 

2015 Performance Incentive Plan. On June 26, 2015, we adopted our 2015 Performance Incentive Plan, or the 2015 Plan, to provide an additional means to attract, motivate, retain and reward selected employees and other eligible persons.  Our stockholders approved the plan on September 21, 2015.  Employees, officers, directors and consultants that provide services to us or one of our subsidiaries may be selected to receive awards under the 2015 Plan.

 

Our board of directors, or one or more committees appointed by our board or another committee (within delegated authority), administers the 2015 Plan.  The administrator of the 2015 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 2015 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 2015 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.

 

As of December 31, 2017, a total of 31,831 shares of our common stock was authorized for issuance with respect to awards granted under the 2015 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) 7.5% of the total number of outstanding shares of our common stock on the last trading day in December in the prior year, (ii) such lesser number as determined by our board of directors. As a result, on January 1, 2018, the number of shares authorized for issuance under the 2015 Plan increased by 736,537 shares.  In addition, the number of available shares will include any shares that are currently subject to awards under our 2012 Plan but that are not issued due to their forfeiture, cancellation or other settlement. 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 2015 Plan. As of December 31, 2017, stock grants of an aggregate of 19,389 shares have been made under the 2015 Plan, and 14,906 shares authorized under the 2015 Plan remained available for award purposes.

 

Awards under the 2015 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.

 

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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 2015 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 2015 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 2015 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 2015 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 2015 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 2015 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 2015 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 2015 Plan will terminate on June 25, 2025.  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 2015 Plan is ten years after the initial date of the award.

 

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 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 prorating 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.

 

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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, 2017. Other than as set forth in the table and described more fully below, during the year ended December 31, 2017, 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.

 

Name   Fees earned or paid in cash     Stock
awards
    Options awards     Non-equity incentive plan compensation     Nonqualified deferred compensation earnings     All other compensation     Total  
Mark F. Durfee   $      -     $      -     $       -     $        -     $      -     12,000 (2 ) $ 12,000  
Charles K. Miller     -       -       -       -       -     1,110 (2 )   1,110  
Neal L. Oristano     -       -       -       -       -     14,050  (2 )   14,050  
Roger M. Ponder (1)     -       -       -       -       -     5,525 (2 )   5,525  

 

 

(1) Mr. Ponder resigned as a director on December 19, 2017.
   
(2) Represents health insurance premiums paid on behalf of Mr. Durfee, Mr. Miller, Mr. Oristano, and Mr. Ponder.

 

At December 31, 2017, accrued expenses in the consolidated balance sheet included director compensation fees earned during 2015, 2016 and 2017. 

 

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. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER. MATTERS

 

The following table sets forth certain information regarding the beneficial ownership of our common stock as of February 28, 2018 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 February 28, 2018. 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.

 

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In the table below, the percentage of beneficial ownership of our common stock is based on 10,631,017 shares of our common stock outstanding as of February 28, 2018. 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, New Jersey 07702.

 

   Number of Shares Beneficially Owned   Percentage of Shares Beneficially Owned   Percentage of  
Name of Beneficial Owner  Common   Series J Preferred   Common   Series J Preferred   Cumulative
Voting Power
 
Executive Officers and Directors                         
Mark Munro(1)   4,303    387    *    39%   20%
Mark F. Durfee(2)   3,476    613    *    61%   31%
Charles K. Miller   143    -    *    *    * 
Neal Oristano   478    -    *    *    * 
Daniel J. Sullivan   638    -    *    *    * 
All named executive officers and directors as a group (five persons)   9,038    1,000    *    100%   51%

 

* Less than 1.0%.
   
(1) Includes (i) 3,207 shares of common stock held by Mr. Munro, (ii) 693 shares of common stock held by Mark Munro IRA, and (iii) 403 shares held by 1112 Third Avenue Corp. Mr. Munro has sole voting and investment power over the shares held by 1112 Third Avenue Corp.

 

(2) Includes (i) 100 shares held by Mr. Durfee, and (ii) 3,376 shares held by Pascack Road LLC. Mr. Durfee has sole voting and investment power over the shares held by Pascack Road LLC.

    

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. 

 

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Related Party Transactions

 

On April 25, 2017, we sold 80.1% of the assets of our AWS Entities. The purchase price paid by the buyer for the assets included the assumption of certain liabilities and contracts associated with our AWS Entities, the issuance to our company of a one-year convertible promissory note in the principal amount of $2.0 million, and a potential earn-out after six months in an amount equal to the lesser of (i) three times EBITDA of the AWS Entities for the six-month period immediately following the closing and (ii) $1.5 million. In addition, the asset purchase agreement contains a working capital adjustment. We have not yet finalized the numbers for the working capital adjustment. The potential earn-out was settled on February 16, 2018, in the form of convertible promissory note in the amount of $0.8 million. Roger M. Ponder, one of our former directors, is the CEO and greater than 10% beneficial owner of the buyer.

 

On July 25, 2017, Mark Munro, CEO, and Mark Durfee, Board Member, exchanged their outstanding related party debt for 100% of our Series J preferred stock with special voting rights. Mark Munro converted principal and interest of $1.7 million and $0.2 million, respectively. Mark Durfee converted principal and interest of $2.6 million and $0.5 million, respectively. As a result of the exchange, Mark Munro and Mark Durfee received 387 and 613 shares, respectively, of our Series J preferred stock. The fair value of the Series J Preferred Stock on date of issuance was $1,753. The difference between the fair value of the preferred stock and the debt converted was included in additional paid in capital.

 

Independence of the Board of Directors

 

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 the Nasdaq Capital Market.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

 

Audit and Audit-Related Fees

 

The aggregate fees billed by Sadler, Gibb & Associates, LLC, our principal accountants for the year ended December 31, 2017, 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 the services in connection with statutory and regulatory filings or engagements was approximately $126,500. 

 

The aggregate fees billed by WithumSmith+Brown, PC, our principal accountants for the years ended December 31, 2017 and 2016, 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 the services in connection with statutory and regulatory filings or engagements were approximately $171,000 and $572,500, respectively. 

 

   For the years ended 
   December 31, 
   2017   2016 
         
Sadler, Gibb & Associates, LLC        
Audit Fees  $126,500   $- 
Audit-Related Fees  $6,500   $- 
           
WithumSmith+Brown, PC          
Audit Fees  $171,000   $572,500 

 

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. 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.

 

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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: April 17, 2018 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   April 17, 2018
Mark Munro   (Principal Executive Officer)    
         
/s/ Daniel Sullivan   Chief Accounting Officer   April 17, 2018
Daniel Sullivan   (Principal Financial Officer and Principal Accounting Officer)    
         
/s/ Mark Durfee   Director   April 17, 2018
Mark Durfee        
         
/s/ Charles K. Miller   Director   April 17, 2018
Charles K. Miller        
         
/s/ Neal L. Oristano   Director   April 17, 2018
Neal L. Oristano        

  

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EXHIBIT INDEX

 

Exhibit 
Number  Description of Document
    
3.1  Certificate of Incorporation of the Company, as amended by the Certificate of Amendment dated August 16, 2001, and the Certificate of Amendment dated September 4, 2008, filed in the office of the Secretary of State of the State of Delaware on September 3, 2008 (incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.2  Certificate of Amendment to the Certificate of Incorporation of the Company dated January 10, 2013 (incorporated by reference to Exhibit 3.12 to Amendment No. 1 to the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on March 26, 2013).
3.3  Certificate of Amendment to the Certificate of Incorporation of the Company dated July 30, 2013 (incorporated by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed with the SEC on August 2, 2013).
3.4  Series A Certificate of Designation filed with the Delaware Secretary of State on July 11, 2011 (incorporated by reference to Exhibit 3.2 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.5  Series B Certificate of Designation filed with the Delaware Secretary of State on June 28, 2011 (incorporated by reference to Exhibit 3.3 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.6  Amendment No. 1 to Series B Certificate of Designation filed with the Delaware Secretary of State on October 23, 2012 (incorporated by reference to Exhibit 3.9 to the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.7  Series C Certificate of Designation filed with the Delaware Secretary of State on January 10, 2012 (incorporated by reference to Exhibit 3.4 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.8  Series D Certificate of Designation filed with the Delaware Secretary of State on March 5, 2012 (incorporated by reference to Exhibit 3.5 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.9  Series E Certificate of Designation filed with the Delaware Secretary of State on September 18, 2012 (incorporated by reference to Exhibit 3.6 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.10  Series F Certificate of Designation filed with the Delaware Secretary of State on September 17, 2012 (incorporated by reference to Exhibit 3.7 of the Company’s Registration Statement on Form S-1 filed (Registration No. 333-185293) with the SEC on December 5, 2012).
3.11  Series G Certificate of Designation filed with the Delaware Secretary of State on September 17, 2012 (incorporated by reference to Exhibit 3.8 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
3.12  Series H Certificate of Designation filed with the Delaware Secretary of State on November 16, 2012 (incorporated by reference to Exhibit 3.10 of the Company’s Registration Statement on Form S-1 filed (Registration No. 333-185293) with the SEC on December 5, 2012).
3.13  Series I Certificate of Designation filed with the Delaware Secretary of State on December 6, 2012 (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 6, 2012).
3.14  Amended and Restated Bylaws of the Company, dated as of November 16, 2012 (incorporated by reference to Exhibit 3.12 of the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
4.1  Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 5 to the Company’s Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on August 5, 2013).
4.2  Form of Warrant, dated September 17, 2012, issued by the Company in connection with the Loan and Security Agreement dated as of September 17, 2012 (incorporated by reference to Exhibit 10.18 of the Company's Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
4.3  First Amendment, dated November 13, 2012, to Form of Warrant of the Company dated September 17, 2012 (incorporated by reference to Exhibit 10.25 of the Company's Registration Statement on Form S-1(Registration No. 333-185293)  filed with the SEC on December 5, 2012).
4.4  Form of Warrant issued by the Company to ICG USA, LLC on April 30, 2013 (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K filed with the SEC on May 3, 2013).
4.5  Form of Amended and Restated Warrant issued by the Company to ICG USA, LLC in respect of warrant originally issued on April 30, 2013 (incorporated by reference to Exhibit 10.41 of the Company's Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on August 5, 2013).
4.6  Form of Warrant issued by the Company to ICG USA, LLC on August 28, 2013 (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K filed with the SEC on May 3, 2013).
4.7  Warrant Agreement by and between the Company and Corporate Stock Transfer and form of Warrant Certificate (incorporated by reference to Exhibit 4.4 to the Company's Registration Statement on Form S-1 (Registration No. 333-185293) filed on September 10, 2013).

 

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4.9  Form of Warrant, dated July 1, 2014 issued by the Company to 31 Group, LLC (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on July 8, 2014).
4.10  Form of Warrant dated October 8, 2014 issued by the Company to each of the investors listed on the Schedule of Buyers attached to the Securities Purchase Agreement, dated as of October 8, 2014 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on October 10, 2014).
4.11  Form of Warrant, dated as of December 3, 2014, issued by the Company to GPB Life Science Holdings, LLC (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on December 8, 2014).
10.1  2012 Performance Incentive Plan (incorporated by reference to Exhibit A to the Company’s Information Statement filed with the SEC on December 17, 2012).
10.2  Form of Indemnification Agreement with Executive Officers and Directors (incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-1 (Registration No. 333-185293) filed with the SEC on December 5, 2012).
10.3  Director Compensation Policy (incorporated by reference to Exhibit 10.4 of the Company's Registration Statement on Form S-1 filed with the SEC on December 5, 2012).
10.4  Employee Stock Purchase Plan (incorporated by reference to Exhibit B to the Company’s Information Statement filed with the SEC on December 17, 2012).
10.5  2015 Performance Incentive Plan (incorporated by reference to Annex A to the Company's Proxy Statement filed with the SEC on August 4, 2015).
10.6  Convertible Promissory Note, dated January 1, 2014, issued by the Company to Frank Jadevaia (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on January 7, 2014).
10.7  Amendment No. 1 to Promissory Note, dated as of December 31, 2014, between the Company and Frank Jadevaia (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 7, 2015).
10.8  Employment Agreement, dated as of February 15, 2014, between the Company and Frank Jadevaia, as amended by a Letter Agreement dated March  25, 2014 (incorporated by reference to Exhibit 10.48 to the Company’s Annual Report on Form 10-K filed with the SEC on April 8, 2014).
10.9  Employment Agreement, dated as of February 21, 2014, between the Company and Scott Davis, as amended by a Letter Agreement dated March 25, 2014 (incorporated by reference to Exhibit 10.49 to the Company’s Annual Report on Form 10-K filed with the SEC on April 8, 2014).
10.10  Exchange Agreement, dated as of March 12, 2014, among the Company, Rives-Monteiro Leasing, LLC, Tropical Communications, Inc., ADEX Corporation, T N S, Inc., ADEXCOMM Corporation, AW Solutions, Inc., and Integration Partners-NY Corporation and Dominion Capital LLC and 31 Group LLC (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 14, 2014).
10.11  Letter Agreement, dated April 4, 2014, amending the Exchange Agreement, dated as of March 12, 2014, by and among the Company, Rives-Monteiro Leasing, LLC, Tropical Communications, Inc., ADEX Corporation, T N S, Inc., ADEXCOMM Corporation, AW Solutions, Inc., and Integration Partners-NY Corporation and Dominion Capital LLC and 31 Group LLC (incorporated by reference to Exhibit 10.51 to the Company’s Annual Report on Form 10-K filed with the SEC on April 8, 2014).
10.12  Purchase Agreement, dated March 25, 2014, among the Company, VaultLogix, LLC, Data Protection Services, LLC, U.S. Data Security Acquisition, LLC, and Tier 1 Solutions, Inc., as amended by a Letter Agreement dated July 28, 2014,  by a Letter Agreement dated August 14, 2014, by a Letter Agreement dated September 17, 2014, and by a Letter Agreement dated October 7, 2014  (incorporated by reference to the Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on October 7, 2014).
10.13  Securities Purchase Agreement, dated as of July 1, 2014, between 31 Group, LLC and the Company (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on July 8, 2014).
10.14  Senior Convertible Note, dated July 1, 2014, issued by the Company to 31 Group, LLC (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on July 8, 2014).
10.15  Loan and Security Agreement, dated as of October 1, 2014, among the Company, the entities party thereto as Guarantors, the entities party thereto as Lenders, and White Oak Global Advisors, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on October 15, 2014).

 

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10.16  Pledge Agreement, dated as of October 1, 2014, among the parties identified as Pledgors thereto and White Oak Global Advisors, LLC (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on October 15, 2014).
10.17  Security Agreement, dated as of October 1, 2014, executed by the Company in favor of White Oak Global Advisors, LLC (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the SEC on October 15, 2014).
10.18  Securities Purchase Agreement, dated as of October 8, 2014, among the Company and each of the purchasers of Common Stock and Warrants (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on October 10, 2014).
10.19  Registration Rights Agreement, dated as of October 8, 2014, by and among the Company and each of purchasers of Common Stock and Warrants (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on October 10, 2014).
10.20  Employment Agreement, by and between the Company and Timothy A. Larkin (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on October 17, 2014).
10.21  Securities Purchase Agreement, dated as of November 14, 2014, by and between the Company and Dominion Capital LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on November 21, 2014).
10.22  Demand Promissory Note, dated as of November 17, 2014, issued by the Company to Dominion Capital LLC (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on November 21, 2014).
10.23  Bridge Financing Agreement, dated as of December 2, 2014, by and between GPB Life Science Holdings, LLC and the Company (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on December 8, 2014).
10.24  12% Senior Secured Note, dated as of December 3, 2014, issued by the Company to GPB Life Science Holdings, LLC (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on December 8, 2014).
10.25  Form of Note, dated as of February 25, 2015, issued by the Company to each of Mark Munro 1996 Charitable Remainder UniTrust, CamaPlan FBO Mark Munro IRA, 1112 Third Avenue Corp., Mark Munro and Pascack Road, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March  3, 2015).
10.26  Put Option Agreement, dated as of March 3, 2015, by and between the Company and Forward Investments, LLC.
10.27  Form of Note, dated as of March 4, 2015, issued by the Company to Forward Investments, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 10, 2015).
10.28  Sale of Accounts and Security Agreement, dated as of March 20, 2015, by and among InterCloud Systems, Inc., T N S, Inc., Integration Partners-NY Corporation, ADEX Corporation, AW Solutions, Inc. and Faunus Group International, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 26, 2015).
10.29  Guaranty Agreement, dated as of March 20, 2015, made by RentVM, Inc., ADEX Puerto Rico, LLC, ADEXCOMM Corporation, Tropical Communications, Inc., AW Solutions Puerto Rico, LLC, Rives-Monteiro Leasing, LLC and Rives-Monteiro Engineering, LLC in favor of Faunus Group International, Inc. (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on March 26, 2015).
10.30  Exchange Agreement, dated April 7, 2015, between InterCloud Systems, Inc. and 31 Group LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 13, 2015).
10.31  Exchange Agreement, dated April 7, 2015, between InterCloud Systems, Inc. and Capital Ventures International (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on April 13, 2015).
10.32  Securities Purchase Agreement, effective as of May 14, 2015, between InterCloud Systems, Inc. and the Investor party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).

 

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10.33  Term Promissory Note, dated May 14, 2015, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.34  Amendment Agreement, dated May 14, 2015, by and among InterCloud Systems, Inc. and the Investor party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.35  Amendment No. 1 to the Bridge Financing Agreement, dated May 15, 2015, between InterCloud Systems, Inc. and the Lender party thereto (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.36  Securities Purchase Agreement, dated May 15, 2015, between InterCloud Systems, Inc. and the Lender party thereto (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.37  Amended and Restated 12% Senior Secured Convertible Note No. 1, dated December 3, 2014, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.38  Amended and Restated 12% Senior Secured Convertible Note No. 2, dated December 24, 2014, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.39  12% Senior Secured Convertible Note, dated May 15, 2015, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.40  Amended and Restated Warrant No. 1, dated December 3, 2014, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.41  Amended and Restated Warrant No. 2, dated December 24, 2014, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.10 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.42  Additional Warrant, dated May 15, 2015, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.11 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.43  Restructuring Warrant, dated May 15, 2015, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.12 to the Company’s Current Report on Form 8-K filed with the SEC on May 18, 2015).
10.44  Securities Purchase Agreement, effective as of August 6, 2015, between InterCloud Systems, Inc. and the Investor party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 12, 2015).
10.45  12% Senior Convertible Note, dated August 6, 2015, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on August 12, 2015).
10.46  Securities Purchase Agreement, effective as of August 11, 2015, between InterCloud Systems, Inc. and the Investor party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on August 12, 2015).
10.47  12% Senior Convertible Note, dated August 11, 2015, issued by InterCloud Systems, Inc. to the Lender party thereto (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on August 12, 2015).
10.48  Amendment No. 2 to Bridge Financing Agreement, dated as of August 12, 2015, between InterCloud Systems, Inc. and the Lender party thereto (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the SEC on August 12, 2015).
10.49  Revised Amendment No. 2 to Bridge Financing Agreement, dated as of August 12, 2015, between InterCloud Systems, Inc. and the Lender party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Amendment No. 1 to Current Report on Form 8-K filed with the SEC on September 14, 2015).
10.50  Securities Purchase Agreement, effective as of November 12, 2015, between InterCloud Systems, Inc. and the Buyer party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on November 18, 2015).

  

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10.51  Senior Convertible Note, dated November 12, 2015, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on November 18, 2015).
10.52  Exchange Agreement, dated November 12, 2015, between InterCloud Systems, Inc. and the Holder party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on November 18, 2015).
10.53  Form of Senior Convertible Note, between InterCloud Systems, Inc. and the Holder party thereto (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on November 18, 2015).
10.54  Securities Purchase Agreement, effective as of December 29, 2015, between InterCloud Systems, Inc. and the Investor party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on December 30, 2015).
10.55  10% Original Issue Discount Senior Convertible Debenture, dated December 29, 2015, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on December 30, 2015).
10.56  Conversion Agreement, dated December 29, 2015, between InterCloud Systems, Inc. and the Holder party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on December 30, 2015).
10.57  Asset Purchase Agreement, dated February 17, 2016 by and among InterCloud Systems, Inc., KeepItSafe, Inc., VaultLogix, LLC, Data Protection Services, L.L.C. and U.S. Data Security Acquisition, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on February 19, 2015).
10.58  Securities Exchange Agreement, effective as of February 17, 2016, by and among InterCloud Systems, Inc., VaultLogix, LLC and the Lender party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on February 19, 2015).
10.59  8.25% Senior Secured Convertible Note, dated February 18, 2016, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on February 19, 2015).
10.60  Forbearance and Amendment Agreement, dated as of May 17, 2016, by and between InterCloud Systems, Inc. and the Holder party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.61  Forbearance and Amendment Agreement, dated as of May 17, 2016, by and between InterCloud Systems, Inc., VaultLogix, LLC, and the Holder party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.62  Second Amended and Restated Senior Secured Convertible Debenture, dated May 17, 2016, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.63  Amended and Restated Senior Secured Convertible Note, dated May 17, 2016, issued by InterCloud Systems, Inc. and VaultLogix, LLC, to the Holder party thereto (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.64  0.67% Senior Secured Note, dated May 17, 2016, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.65  0.67% Senior Secured Note, dated May 17, 2016, issued by InterCloud Systems, Inc. and VaultLogix, LLC, to the Holder party thereto (incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.66  Amendment Agreement, dated as of May 23, 2016, by and between InterCloud Systems, Inc. VaultLogix, LLC, JGB (Cayman) Waltham Ltd., and JGB (Cayman) Concord Ltd. (incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.67  Additional Debtor Joinder, dated May 23, 2016, executed by InterCloud Systems, Inc. and the additional parties thereto (incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).
10.68  Security Agreement, dated as of February 18, 2016, among VaultLogix, LLC and the Secured Party thereto (incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2016).

 

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10.69  Third Amended and Restated Senior Secured Convertible Debenture, dated as of September 1, 2016, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on September 9, 2016).
10.70  Amended and Restated Senior Secured Note, dated as of September 1, 2016, issued by InterCloud Systems, Inc. to the Holder party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on September 9, 2016).
10.71  Second Amended and Restated Senior Secured Convertible Note, dated as of September 1, 2016, issued by InterCloud Systems, Inc. and VaultLogix, LLC, to the Holder party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on September 9, 2016).
10.72  Amendment Agreement, dated as of September 1, 2016, by and between the Holder, the Holder Affiliate, InterCloud Systems, Inc., VaultLogix, LLC, and each of the Guarantors party thereto (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on September 9, 2016).
10.73  Asset Purchase Agreement, dated as of February 28, 2017, by and among the Company, ADEX Corporation, and HWN, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 1, 2017).
10.74  Consent, dated as of February 28, 2017, by and among the Company and the Holders party thereto (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on March 1, 2017).
10.75  Securities Exchange Agreement, dated as of February 28, 2017, by and between the Company and the Holder party thereto (incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the SEC on March 1, 2017).
10.76  Common Stock Purchase Warrant, dated February 28, 2017, executed by the Company in favor of the Holder party thereto (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the SEC on March 1, 2017).
21.1  List of Subsidiaries
31.1  Certification of the Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as Amended.
31.2  Certification of the Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as Amended.
32.1  Certification of our Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2  Certification of our Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS  XBRL Instance Document
101.SCH  XBRL Taxonomy Extension Schema Document
101.CAL  XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF  XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB  XBRL Taxonomy Extension Label Linkbase Document.
101.PRE  XBRL Taxonomy Extension Presentation Linkbase Document.

 

† 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.

 

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INTERCLOUD SYSTEMS, INC.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

InterCloud Systems, Inc. PAGE
   
Reports of Independent Registered Public Accounting Firms F-2 - F-3
   
Consolidated Balance Sheets as of December 31, 2017 and December 31, 2016 F-4
   
Consolidated Statements of Operations for the years ended December 31, 2017 and December 31, 2016 F-5
   
Consolidated Statements of Stockholders' Deficit for the years ended December 31, 2017 and December 31, 2016 F-6
 
Consolidated Statements of Cash Flows for the years ended December 31, 2017 and December 31, 2016 F-7
   
Notes to Consolidated Financial Statements F-8

 

 F-1 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of Intercloud Systems, Inc.:

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Intercloud Systems, Inc. (“the Company”) as of December 31, 2017, the related consolidated statements of operations, stockholders’ deficit, and cash flows for the year ended December 31, 2017 and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

Explanatory Paragraph Regarding Going Concern

 

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, a stockholders’ deficit, and a working capital deficit that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

/s/ Sadler, Gibb & Associates, LLC

 

We have served as the Company’s auditor since 2017.

 

Salt Lake City, UT

April 17, 2018

 

 

 F-2 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of
InterCloud Systems, Inc.

 

We have audited the consolidated balance sheet of InterCloud Systems, Inc. (the “Company”) as of December 31, 2016 and the related consolidated statements of operations, stockholders' deficit, and cash flows for the year then ended (the “2016 consolidated financial statements”). These 2016 consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 2016 consolidated financial statements based on our audit.

 

We conducted our audit 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 consolidated 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 audit 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 financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the 2016 consolidated financial statements present fairly, in all material respects, the consolidated financial position of InterCloud Systems, Inc. at December 31, 2016, and the results of its operations and its cash flows for the year ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

 

The 2016 consolidated financial statements were prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations, has violated loan covenants, had events of default, has a working capital deficiency and an accumulated deficit, and has significant outstanding debt obligations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The 2016 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

 

WithumSmith+Brown, PC

East Brunswick, New Jersey

 

March 13, 2017, except for the retrospective reclassifications related to the sales of Nottingham and IPC described in Note 21 and the reverse stock split described in Note 3, as to which the date is April 17, 2018

 

 F-3 

 

 

INTERCLOUD SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

 

<
   December 31, 
ASSETS  2017   2016 
         
Current Assets:        
Cash  $681   $1,781 
Accounts receivable, net of allowances of $696 and $412 respectively   6,234    9,856 
Loans receivable, net of reserves of $924 and $891, respectively   3,617    382 
Other current assets   2,724    1,633 
Current assets of discontinued operations   41    4,737 
Total current assets   13,297    18,389 
           
Property and equipment, net   44    346 
Goodwill   -    16,987 
Customer lists, net   1,751    4,521 
Tradenames, net   908    3,178 
Other intangible assets, net   -    256 
Cost method investment   340    - 
Other assets   116    240 
Non-current assets of discontinued operations   -    10,652 
Total assets  $16,456   $54,569 
           
LIABILITIES AND STOCKHOLDERS' DEFICIT          
           
Current Liabilities:          
Accounts payable  $4,652   $6,459 
Accrued expenses   8,008    9,660 
Deferred revenue   3,209    1,947 
Income taxes payable   15    53 
Bank debt, current portion   114    121 
Notes payable, related parties   75    9,531 
Contingent consideration   -    515 
Derivative financial instruments   3,379    1,749 
Term loans, current portion, net of debt discount   11,013    21,147 
Current liabilities of discontinued operations   3,338    6,620 
Total current liabilities   33,803    57,802 
           
Long-term Liabilities:          
Notes payable, related parties, net of current portion   -    8,632 
Deferred income taxes   239    1,002 
Series M Preferred Stock; $0.0001 par value; 500 shares authorized; 386 and 0 issued and outstanding as of December 31, 2017 and 2016, respectively   3,021    - 
Term loans, net of current portion, net of debt discount   1,058    1,860 
Derivative financial instruments   16,651    1,316 
Total long-term liabilities