Quarterly report pursuant to Section 13 or 15(d)

Summary of Significant Accounting Policies

v3.10.0.1
Summary of Significant Accounting Policies
9 Months Ended
Sep. 30, 2018
Summary of Significant Accounting Policies [Abstract]  
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Overview

 

InterCloud Systems, Inc. (the “Company”) was incorporated on November 22, 1999 under the laws of the state of Delaware and 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. The Company’s managed services solutions offer enterprise and service-provider customers the opportunity to adopt an operational expense model by outsourcing cloud deployment and management to the Company rather than the capital expense model that has dominated in recent decades in IT infrastructure management. The Company also offers enterprise and service provider customers specialty contracting services, including engineering, design, installation and maintenance services, that support the build-out and operation of some of the most advanced small cell, Wi-Fi and distributed antenna system (DAS) networks.

 

Principles of Consolidation and Accounting for Investments in Affiliate Companies

 

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which include Tropical Communications, Inc. (“Tropical”) (since August 2011 – sold in April 2017 in connection with the sale of the AWS Entities), Rives-Monteiro Leasing, LLC (“RM Leasing”) (since December 2011), TNS, Inc. (“TNS”) (since September 2012), and AW Solutions, Inc. and AW Solutions Puerto Rico, LLC (collectively, the “AWS Entities”) (since April 2013 – the AWS Entities were sold in April 2017. The results of operations of the Company’s former subsidiaries, Integration Partners – NY Corporation (“IPC”) (since January 2014 – the assets were sold in November 2017), RentVM Inc. (“RentVM”) (since February 2014 – discontinued in November 2017 in connection with the sale of the assets of the IPC subsidiary), ADEX Corporation, ADEX Puerto Rico, LLC and Highwire (collectively, “ADEX” or “ADEX Entities”) (since September 2012 – Highwire was sold in January 2017, and the ADEX Entities were sold in February 2018 – refer to Note 3, Disposals of Subsidiaries, for further detail), and SDN Essentials, LLC (“SDNE”) (since January 2016 – SDNE was sold in May 2017) have been included as discontinued operations on the accompanying financial statements (refer to Note 15, Discontinued Operations, for further information). All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The Company consolidates all entities in which it has a controlling voting interest and all variable interest entities (“VIE”) in which the Company is deemed to be the primary beneficiary.

 

The unaudited condensed consolidated financial statements include the accounts of Rives-Montiero Engineering, LLC (“RM Engineering”) (since December 2011), in which the Company owns an interest of 49%. The Company has the ability to exercise its call option to acquire the remaining 51% of RM Engineering for a nominal amount and thus makes all significant decisions related to RM Engineering even though it absorbs only 49% of the losses. Additionally, substantially all of the entity’s activities either involve or are conducted on behalf of the entity by the 51% holder of RM Engineering.

  

In June 2016, the Company made a loan to SDN Systems, LLC (“SDNS”). The loan is convertible into a 90% ownership stake in SDNS. The Company is the primary source of capital for SDNS. The Company evaluated the investment in SDNS at both September 30, 2018 and December 31, 2017. At September 30, 2018 and December 31, 2017, the criteria for a VIE were met. As such, the operations of SDNS have been included in the Company’s consolidated statement of accounts.

 

The unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of such statements. These unaudited condensed consolidated financial statements have been prepared in accordance with GAAP pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Additionally, the results of operations for the three months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2017 included in the Company’s 2017 Annual Report on Form 10-K, filed with the SEC on April 17, 2018.

 

Basis of Presentation

 

The unaudited condensed consolidated financial statements have been presented on a comparative basis. During the period from January 1, 2017 through September 30, 2018, the Company disposed of four subsidiaries, the results of which are included within discontinued operations for the nine months ended September 30, 2018 and the three and nine months ended September 30, 2017. The Company retrospectively updated the unaudited condensed consolidated financial statements as of December 31, 2017 and for the three and nine months ended September 30, 2017 to match the presentation on the unaudited condensed consolidated financial statements as of and for the three and nine months ended September 30, 2018.

 

Reverse Stock Splits

 

On July 7, 2017, the Company filed a Certificate of Amendment of its Certificate of Incorporation that effected a one-for-four reverse split of the Company’s issued and outstanding shares of common stock, par value $0.0001 per share, effective as of the open of trading on July 12, 2017. The Company’s stockholders, at the 2016 Annual Meeting of Stockholders, had previously authorized the Company’s Board of Directors to effect a reverse stock split within a range of ratios, including one-for-four, at any time within one year following such Annual Meeting, as determined by the board.

 

On February 22, 2018, the Company filed a Certificate of Amendment of its Certificate of Incorporation that effected a one-for-one hundred reverse split of the Company’s issued and outstanding shares of common stock, par value $0.0001 per share, effective as of the open of trading on February 23, 2018. The Company’s stockholders, by written consent dated December 5, 2017, had previously authorized the Company’s Board of Directors to effect a reverse stock split within a range of ratios, including one-for-one hundred, at any time within one year following the date of such written consent, as determined by the board.

 

All common share, warrant, stock option, and per share information in the consolidated financial statements gives retroactive effect to the one-for-four reverse stock split that was effected on July 12, 2017 and the one-for-one hundred reverse stock split that was effected on February 23, 2018. There was no change to the number of authorized shares of common stock of the Company as a result of the reverse stock splits. The par value of the Company’s common stock was unchanged at $0.0001 per share post-split.

 

Business Combinations

 

The Company accounts for its business combinations under the provisions of Accounting Standards Codification (“ASC”) Topic 805-10, Business Combinations (“ASC 805-10”), which requires that the purchase method of accounting be used for all business combinations. Assets acquired and liabilities assumed, including non-controlling interests, are recorded at the date of acquisition at their respective fair values. ASC 805-10 also specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combinations and are expensed as incurred. If the business combination provides for contingent consideration, the Company records the contingent consideration at fair value at the acquisition date and any changes in fair value after the acquisition date are accounted for as measurement-period adjustments if they pertain to additional information about facts and circumstances that existed at the acquisition date and that the Company obtained during the measurement period. Changes in fair value of contingent consideration resulting from events after the acquisition date, such as earn-outs, are recognized as follows: 1) if the contingent consideration is classified as equity, the contingent consideration is not re-measured and its subsequent settlement is accounted for within equity, or 2) if the contingent consideration is classified as a liability, the changes in fair value are recognized in earnings.

 

Revenue Recognition

 

The contracts of TNS and RM Engineering provide that payment for the Company’s 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 the Company sold in April 2017, 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.

  

On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“Topic 606”), to update the financial reporting requirements for revenue recognition. Topic 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. This guidance became effective for the Company beginning on January 1, 2018, and entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The Company adopted this standard using the modified retrospective approach on January 1, 2018.

 

In preparation for adoption of the standard, the Company evaluated each of the five steps in Topic 606, which are as follows: 1) Identify the contract with the customer; 2) Identify the performance obligations in the contract; 3) Determine the transaction price; 4) Allocate the transaction price to the performance obligations; and 5) Recognize revenue when (or as) performance obligations are satisfied.

 

The Company’s reported revenue was not affected in any period due to the adoption of ASC Topic 606 because: (1) the Company identified similar performance obligations under Topic 606 as compared with deliverables and separate units of account previously identified; (2) the Company has determined the transaction price to be consistent; and (3) the Company records revenue at the same point in time, upon delivery of services, under both ASC Topic 605 and Topic 606, as applicable under the terms of the contract with the customer. Additionally, the Company’s accounting for fulfillment costs or costs incurred to obtain a contract were not affected in any period due to the adoption of Topic 606.

 

There are also certain considerations related to accounting policies, business processes and internal control over financial reporting that are associated with implementing Topic 606. The Company has evaluated its policies, processes, and control framework for revenue recognition, and identified and implemented the changes needed in response to the new guidance.

 

Disclosure requirements under the new guidance in Topic 606 have been significantly expanded in comparison to the disclosure requirements under the current guidance, including disclosures related to disaggregation of revenue into appropriate categories, performance obligations, the judgments made in revenue recognition determinations, adjustments to revenue which relate to activities from previous quarters or years, any significant reversals of revenue, and costs to obtain or fulfill contracts. Additional considerations include the following:

 

Contract with customers (606-10-50-4)

 

All the Company’s recognized revenues are derived from contract with customers. The Company does not have other sources of revenue.

 

The Company does not have any contract assets. While the Company does incur credit losses on its receivables from customers that loss has not been significant historically.

 

Disaggregation of revenues (606-10-50-5 to 7)

 

The Company operated in one reportable segment, applications and infrastructure, during the period ended September 30, 2018. The Company is not aware of any disaggregated revenue disclosures presented outside of its financial statements or used by users of the Company’s financial statements.

 

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 Company’s contracts provide that payment for the Company’s 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 Company’s 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 upon completion of the project.

 

Contract balances (606-10-50-8 to 11)

 

The Company does not have contract assets. It has accounts receivables and contract liabilities (deferred revenues), which are separately presented on the face of its balance sheet.

 

The Company performs its obligations under a contract with a customer by transferring products and services in exchange for consideration from the customer. Accounts receivable are recorded when the right to consideration becomes unconditional. The timing of the Company’s performance often differs from the timing of the customer’s payment, which results in the recognition of a contract asset or a contract liability. The Company recognizes a contract asset when the Company transfers products or services to a customer and the right to consideration is conditional on something other than the passage of time. The Company recognizes a contract liability when it has received consideration, or an amount of consideration is due from the customer and the Company has a future obligation to transfer products or services.

 

A portion of the timing of payment for contracts with customers for application and infrastructure products and services is typically upfront (deposit). The Company recognizes revenues for such contracts upon completion. Therefore, deferred revenue is created when we receive deposits and is derecognized when it has no remaining performance obligations (upon completion of the project).

 

The only changes in the Company’s contract liabilities between measurement dates are the recognition of revenues included in the contract liability and deposits received from customers. No significant changes, such as those resulting from business combination, cumulative catch-up adjustments, impairment of a contract asset, or changes to time frames for a right to consideration to become unconditional or performance obligation to be satisfied occurred.

 

Performance Obligations (606-10-50-12 to 16)

 

The Company satisfies its obligations upon completion of service. There is a deposit due upfront, before commencement of work, and the remaining balance is generally due within 30 days of completion of service. The nature of the goods and services that the Company promised to transfer consists generally of infrastructure projects (e.g., cabling). The Company does not provide warranties except for warranties extended by the original manufacturer of the goods and does not offer any rights, refunds, or similar obligations.

 

The Company does not recognize revenues in a reporting period from performance obligations satisfied in previous months.

 

Transaction prices allocated to the remaining performance obligations (606-10-50-14)

 

As disclosed in its notes to the financial statements, the Company’s performance obligation has an original expected duration of less than a year.

 

The Company has fixed consideration in its contracts with customers.

 

Indefinite Lived Intangible Assets

 

The Company tests its indefinite-lived intangible assets for impairment at least annually (as of October 1) and whenever events or circumstances change that indicate impairment may have occurred. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in the Company’s expected future cash flows; a sustained, significant decline in the Company’s stock price and market capitalization; a significant adverse change in legal factors or in the business climate of the Company’s segments; unanticipated competition; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability indefinite-lived intangible assets and the Company’s consolidated financial results.

 

Commitments and Contingencies 

 

In the normal course of business, the Company is subject to various contingencies. The Company records a contingency in the consolidated financial statements when it is probable that a liability will be incurred and the amount of the loss is reasonably estimable, or otherwise disclosed, in accordance with ASC Topic 450, Contingencies (“ASC Topic 450”). Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. In the event the Company determines that a loss is not probable, but is reasonably possible, and it becomes possible to develop what the Company believes to be a reasonable range of possible loss, then the Company will include disclosures related to such matter as appropriate and in compliance with ASC Topic 450. To the extent there is a reasonable possibility that the losses could exceed the amounts already accrued, the Company will, when applicable, adjust the accrual in the period in which the determination is made, disclose an estimate of the additional loss or range of loss, indicate that the estimate is immaterial with respect to its financial statements as a whole or, if the amount of such adjustment cannot be reasonably estimated, disclose that an estimate cannot be made. 

 

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 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 was set on the court’s non-jury trial docket but was never set for trial. In June 2018, the parties agreed, with the court’s permission, that there are no factual issues in dispute and that this case may be decided on the filing of renewed summary judgment motions followed by a summary judgment hearing. In their renewed summary judgment motion, the plaintiffs alleged that their conversion rights are worth approximately $25 million. The final summary judgment hearing was held on August 29, 2018. The case is pending with the court on joint motions for summary judgement. 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 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.

 

Securities and Exchange Commission Subpoenas

  

On May 21, 2014, the Company received a subpoena from the SEC that stated that the staff of the SEC was conducting an investigation In the Matter of Galena Biopharma, Inc. File No. HO 12356 (now known as “In the Matter of Certain Stock Promotions”) and that the subpoena was issued to the Company as part of an investigation as to whether certain investor relations firms and their clients engaged in market manipulation. The subpoena and accompanying letter did not indicate whether the Company was, or was not, under investigation. Since May 2014, the Company provided testimony to the SEC and produced documents in response to that subpoena and several additional subpoenas received from the SEC in connection with that matter, including a subpoena issued on March 1, 2016 requesting information relating to a transaction involving the Company’s Series H preferred shares in December 2013.

 

In connection with the SEC investigation, in May 2015, the Company received information from the SEC that it was continuing an investigation of the Company and certain of its current and former officers, consultants of the Company and others, of “possible violation[s]” of Section 17(a) of the Securities Act and Sections 9(a) and 10(b) of the Exchange Act and the rules of the SEC thereunder in the offer or sale of securities and certain other matters with respect to which the SEC claims it has information, including the possible market manipulation of the Company’s securities dating back to January 2013. Based upon the Company’s internal investigations, the Company did not believe either it or any of its current or former officers or directors engaged in any activities that violated applicable securities laws.

 

On April 2, 2018, the Company received a notification from the SEC that it was closing the investigation and did not intend to recommend enforcement action against the Company.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation in accordance with ASC Topic 718, Compensation-Stock Compensation (“ASC Topic 718”). Under the fair value recognition provisions of this topic, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense on a straight-line basis over the requisite service period, based on the terms of the awards.

 

The Company applies ASC 505-50, Equity Based Payments to Non-Employees (“ASC Topic 505”), with respect to options and warrants issued to non-employees which require the use of option valuation models to measure the fair value of the options and warrants at the measurement date.

 

Net Income (Loss) Per Share

  

The Company follows ASC 260, Earnings Per Share, which requires presentation of basic and diluted earnings per share (“EPS”) on the face of the income statement for all entities with complex capital structures, and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation.

 

In the accompanying financial statements, basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period.

 

Partial common shares includable in the computation of fully-diluted per share results are not presented for the three and nine months ended September 30, 2017 in the unaudited condensed consolidated financial statements as their effect would be anti-dilutive.

 

The following sets forth the computation of diluted EPS for the three and nine months ended September 30, 2018.

 

    Three months ended September 30, 2018  
    Net loss (Numerator)     Shares (Denominator)     Per Share Amount  
Basic EPS   $ 1,515       115,333,855     $ 0.01  
Change in fair value of derivative instruments     (902 )     -       -  
Loss on extinguishment of debt     (2,930 )     -       -  
Interest expense and debt discounts related to convertible instruments     159       -       -  
Dilutive shares related to convertible preferred stock     -       3,752,448,031       -  
Dilutive shares related to convertible promissory notes     -       2,535,985,760       -  
Dilutive shares related to settlement agreements     -       265,937,144       -  
Dilutive shares related to warrants     -       4,738,111       -  
Dilutive EPS   $ (2,158 )     6,674,442,901     $ (0.00 )

 

    Nine months ended September 30, 2018  
    Net loss (Numerator)     Shares (Denominator)     Per Share Amount  
Basic EPS   $ 1,507       49,918,495     $ 0.14  
Change in fair value of derivative instruments     (4,182 )     -       -  
Loss on extinguishment of debt     (2,930 )     -       -  
Interest expense and debt discounts related to convertible instruments     818       -       -  
Dilutive shares related to convertible preferred stock     -       4,586,999,918       -  
Dilutive shares related to convertible promissory notes     -       2,981,053,409       -  
Dilutive shares related to settlement agreements     -       310,309,212       -  
Dilutive shares related to warrants     -       4,972,501       -  
Dilutive EPS   $ (4,787 )     7,933,253,535     $ (0.00 )

 

Diluted Earnings per Share (“Diluted EPS”) gives effect to all dilutive potential common shares outstanding during the period. The computation of Diluted EPS does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on losses. As a result, if there is a loss from continuing operations, Diluted EPS is computed in the same manner as Basic EPS. As of September 30, 2018, the Company’s common stock equivalents included 3,033,270,203 shares that could be converted based on outstanding debt, 5,062,788,181 shares that could be converted based on certain convertible preferred stock, 5,033,339 shares related to outstanding warrants, 315,515,089 shares related to an outstanding settlement agreement, and 417 shares related to outstanding options that were not included in the calculation of earnings per share for the period then ended. As of September 30, 2017, the Company’s common stock equivalents included 480,899 shares that could be converted based on outstanding debt, 458,760 shares related to outstanding warrants, and 417 shares related to outstanding options that were not included in the calculation of earnings per share for the period then ended. Such financial instruments may become dilutive and would then need to be included in future calculations of Diluted EPS. Potential common shares includable in the computation of fully-diluted per share results are not presented for the three and nine months ended September 30, 2017 in the unaudited condensed consolidated financial statements as their effect would be anti-dilutive.

  

Fair Value of Financial Instruments

 

ASC Topic 820 Fair Value Measurements and Disclosures (“ASC Topic 820”) provides a framework for measuring fair value in accordance with generally accepted accounting principles. 

 

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).

 

The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under ASC Topic 820 are described as follows:

 

  Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.
     
  Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
     
  Level 3 — Inputs that are unobservable for the asset or liability.

 

The following section describes the valuation methodologies that the Company used to measure different financial instruments at fair value.

 

Debt

 

The fair value of the Company’s debt, which approximated the carrying value of the Company’s debt as of September 30, 2018 and December 31, 2017, was estimated at $10,456 and $12,034, respectively. Factors that the Company considered when estimating the fair value of its debt included market conditions, liquidity levels in the private placement market, variability in pricing from multiple lenders and term of the debt. The level of the debt would be considered as Level 2.

   

The Company relies on the guidance provided by ASC Topic 480, Distinguishing Liabilities from Equity, to classify certain redeemable and/or convertible instruments. The Company first determines whether a financial instrument should be classified as a liability. The Company will determine the liability classification if the financial instrument is mandatorily redeemable, or if the financial instrument, other than outstanding shares, embodies a conditional obligation that the Company must or may settle by issuing a variable number of its equity shares.

 

Once the Company determines that a financial instrument should not be classified as a liability, the Company determines whether the financial instrument should be presented between the liability section and the equity section of the balance sheet (“temporary equity”). The Company will determine temporary equity classification if the redemption of the financial instrument is outside the control of the Company (i.e. at the option of the holder). Otherwise, the Company accounts for the financial instrument as permanent equity.

 

Initial Measurement

 

The Company records its financial instruments classified as liability, temporary equity or permanent equity at issuance at the fair value, or cash received.

 

Subsequent Measurement - Financial instruments classified as liabilities

 

The Company records the fair value of its financial instruments classified as liabilities at each subsequent measurement date. The changes in fair value of its financial instruments classified as liabilities are recorded as other expense/income. The Monte Carlo simulation is used to determine the fair value of derivatives for instruments with embedded conversion features.

 

Derivative Liabilities

 

The Company accounts for derivative instruments in accordance with ASC Topic 815, Derivatives and Hedging (“ASC Topic 815”), and all derivative instruments are reflected as either assets or liabilities at fair value on the consolidated balance sheets. The Company uses estimates of fair value to value its derivative instruments. Fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between able and willing market participants. In general, the Company’s policy in estimating fair values is to first look at observable market prices for identical assets and liabilities in active markets, where available. When these are not available, other inputs are used to model fair value such as prices of similar instruments, yield curves, volatilities, prepayment speeds, default rates and credit spreads, relying first on observable data from active markets. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable. The Company categorizes its fair value estimates in accordance with ASC Topic 820, based on the hierarchical framework associated with the three levels or price transparency utilized in measuring financial instruments at fair value as discussed above.

  

Additional Disclosures Regarding Fair Value Measurements

 

The carrying value of cash, accounts receivable, inventory, other assets, and accounts payable and accrued expenses approximate their fair value due to the short-term maturity of those items. 

   

Fair Value of Derivatives

 

The Company utilized a binomial lattice pricing model to determine the fair value of the derivative liability related to the outstanding warrants and the put and effective price of future equity offerings of equity-linked financial instruments.

 

Derivative Warrant Liabilities and Convertible Features 

 

The fair value of the derivative liabilities is classified as Level 3 within the Company’s fair value hierarchy. Please refer to Note 9, Derivative Instruments, for further discussion of the measurement of fair value of the derivatives and their underlying assumptions.

 

The fair value of the Company’s financial instruments carried at fair value at September 30, 2018 and December 31, 2017 were as follows:

 

    Fair Value Measurements at Reporting Date Using  
    Quoted Prices in Active Markets for Identical Assets (Level 1)     Significant Other Observable Inputs 
(Level 2)
    Significant Unobservable Inputs
(Level 3)
 
    September 30, 2018  
Liabilities:                  
Current derivative features related to convertible debentures   $      -     $      -     $ 2,001  
Current derivative features related to warrant derivatives     -       -       143  
Long-term derivative features related to preferred stock     -       -       17,131  
                         
Total liabilities at fair value   $ -     $ -     $ 19,275  

 

    December 31, 2017  
Liabilities:                  
Current derivative features related to convertible debentures   $ -     $ -     $ 3,145  
Current derivative features related to warrant derivatives     -       -       234  
Long-term derivative features related to convertible debentures     -       -       661  
Long-term derivative features related to preferred stock     -       -       15,990  
Fair value of Series M preferred stock     -       -       3,021  
                         
Total liabilities at fair value   $ -     $ -     $ 23,051  

 

The changes in Level 3 financial instruments measured at fair value on a recurring basis for the nine months ended September 30, 2018 were as follows:

 

    Amount  
Balance as of December 31, 2017   $ 23,051  
Change in fair value of derivative features related to convertible debentures     (910 )
Change in fair value of warrant derivatives     (1,506 )
Change in fair value of preferred stock derivatives     (1,103 )
Change in fair value of Series M preferred stock     (49 )
Fair value of derivative feature related to SCS LLC term loan     70  
Fair value of derivative feature related to Pryor Cashman LLP warrant     1,798  
Adjustment of derivative liability upon conversion of debt     (123 )
         
Balance as of March 31, 2018   $ 21,228  
         
Change in fair value of derivative features related to convertible debentures     (199 )
Change in fair value of warrant derivatives     (168 )
Change in fair value of preferred stock derivatives     431  
Change in fair value of Series M preferred stock     (122 )
Adjustment of derivative liability upon conversion of debt     (191 )
Adjustment of Series M preferred stock liability upon conversion into common stock     (237 )
         
Balance as of June 30, 2018   $ 20,742  
         
Change in fair value of derivative features related to convertible debentures     (966 )
Change in fair value of warrant derivatives     (214 )
Change in fair value of preferred stock derivatives     (273 )
Change in fair value of receivables purchase agreement derivative     (46 )
Fair value of derivative feature related to BOU Trust term loan     48  
Fair value of derivative feature related to RDW term loan     228  
Fair value of derivative feature related to RAI receivables purchase agreement     283  
Adjustment of preferred stock derivatives based on Series L preffered stock amendment     (301 )
Adjustment of preferred stock derivatives based on Series M preffered stock amendment     12  
Adjustment of Series M preferred stock derivative upon conversion into common stock     (238 )
         
Balance as of September 30, 2018   $ 19,275  

 

Treasury Stock

 

The Company records treasury stock at the cost to acquire it and includes treasury stock as a component of stockholders’ deficit.