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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: September 30, 2015

 

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

FOR THE TRANSITION PERIOD FROM                      TO                     

COMMISSION FILE NUMBER: 0-20190

 

 

Authentidate Holding Corp.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		14-1673067
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
Connell Corporate Center 300 Connell Drive, 1st Floor, Berkeley Heights, New Jersey		07922
(Address of principal executive offices)		(Zip Code)

(908) 787-1700

(Registrant’s telephone number, including area code)

Connell Corporate Center, 300 Connell Drive, 5^th Floor, Berkeley Heights, New Jersey

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

 

 

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

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

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨		Smaller reporting company		x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding November 5, 2015
Common Stock, $0.001 par value per share		42,755,942 shares

 

 

 

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Table of Contents

Authentidate Holding Corp.

Form 10-Q

Table of Contents

 

				Page
Part I		Financial Information
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets (Unaudited)			3
		Condensed Consolidated Statements of Operations and Comprehensive Operations (Unaudited)			4
		Condensed Consolidated Statements of Cash Flows (Unaudited)			5
		Notes to Condensed Consolidated Financial Statements (Unaudited)			6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			24
Item 4.		Controls and Procedures			25
Part II		Other Information
Item 1.		Legal Proceedings			25
Item 1A.		Risk Factors			25
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			43
Item 3.		Defaults upon Senior Securities			44
Item 4.		Mine Safety Disclosures			44
Item 5.		Other Information			44
Item 6.		Exhibits			44
Signatures					46

 

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Authentidate Holding Corp. and Subsidiaries

Condensed Consolidated Balance Sheets

 

 

		September 30,
		2015				June 30,
(in thousands, except per share data)		(Unaudited)				2015
Assets
Current assets
Cash and cash equivalents		$	282			$	247
Restricted cash			256				256
Accounts receivable, net			217				274
Inventory, net			598				603
Prepaid expenses and other current assets			437				222
Total current assets			1,790				1,602
Property and equipment, net			253				301
Other assets
Licenses, net			1,811				1,904
Other assets, net			334				356
Total assets		$	4,188			$	4,163
Liabilities and Shareholders’ Deficit
Current liabilities
Accounts payable, accrued expenses and other liabilities		$	2,478			$	2,109
Notes payable, net of unamortized discount			3,169				2,150
Warrant liability			373				214
Deferred revenue			68				67
Total current liabilities			6,088				4,540
Long-term deferred revenue			80				88
Total liabilities			6,168				4,628
Commitments and contingencies (Note 10)
Shareholders’ deficit
Preferred stock, $.10 par value; 5,000 shares authorized, Series B, 28 shares and Series D, 665 shares issued and outstanding on September 30, 2015 and June 30, 2015, respectively			69				69
Common stock, $.001 par value; 190,000 shares authorized, 42,195 and 42,116 shares issued and outstanding on September 30, 2015 and June 30, 2015, respectively			42				42
Additional paid-in capital			206,559				205,909
Accumulated deficit			(208,650	)			(206,485	)
Total shareholders’ deficit			(1,980	)			(465	)
Total liabilities and shareholders’ deficit		$	4,188			$	4,163

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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Authentidate Holding Corp. and Subsidiaries

Condensed Consolidated Statements of Operations and Comprehensive Operations (Unaudited)

 

 

		Three Months Ended
		September 30,
(in thousands, except per share data)		2015				2014
Revenues
Hosted software services		$	382			$	508
Telehealth products and services			16				544
Total revenues			398				1,052
Operating expenses
Cost of revenues			207				593
Selling, general and administrative			1,501				2,011
Product development			162				370
Depreciation and amortization			182				189
Total operating expenses			2,052				3,163
Operating loss			(1,654	)			(2,111	)
Other expense			(409	)			—
Net loss		$	(2,063	)		$	(2,111	)
Basic and diluted loss per common share		$	(0.05	)		$	(0.06	)
Comprehensive operations
Net loss		$	(2,063	)		$	(2,111	)
Comprehensive loss		$	(2,063	)		$	(2,111	)

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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Authentidate Holding Corp. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

 

		Three Months Ended
		September 30,
(in thousands)		2015				2014
Cash flows from operating activities
Net Loss		$	(2,063	)		$	(2,111	)
Adjustments to reconcile net loss to net cash used in operating activities
Amortization of debt discount and deferred financing costs			170				—
Change in warrant liability			159				—
Depreciation and amortization			182				189
Share-based compensation			123				139
Warrants issued for services			12				2
Restricted shares and stock options issued for services			161				99
Changes in assets and liabilities
Accounts receivable			57				(40	)
Inventory			5				39
Prepaid expenses and other current assets			(215	)			(157	)
Accounts payable, accrued expenses and other liabilities			225				102
Deferred revenue			(7	)			1
Net cash used in operating activities			(1,191	)			(1,737	)
Cash flows from investing activities
Purchases of property and equipment and other assets			—				(29	)
Other intangible assets acquired			(19	)			(55	)
Net cash used by investing activities			(19	)			(84	)
Cash flows from financing activities
Net proceeds from issuance of preferred and common stock and exercise of warrants			—				2,124
Proceeds from issuance of short-term promissory notes			1,245				—
Dividends paid			—				(18	)
Net cash provided by financing activities			1,245				2,106
Net (decrease) increase in cash and cash equivalents			35				285
Cash and cash equivalents, beginning of period			247				1,084
Cash and cash equivalents, end of period		$	282			$	1,369

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

1. Basis of Presentation and Liquidity

The accompanying unaudited condensed consolidated financial statements have been prepared by the company pursuant to the rules and regulations of the Securities and Exchange Commission and, in the opinion of management, reflect all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The condensed consolidated financial statements include the accounts of Authentidate Holding Corp. (AHC) and its subsidiaries (collectively, the “company”). All significant intercompany transactions and balances have been eliminated in consolidation. The results of operations for the period ended September 30, 2015 are not necessarily indicative of the results to be expected for the full year. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the annual consolidated financial statements and notes thereto included in the company’s Form 10-K for the fiscal year ended June 30, 2015 and the corresponding Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The company has incurred significant recurring losses and negative cash flows from operations and our product development activities have required substantial capital investment to date. These factors, among others, raise substantial doubt about our ability to continue as a going concern. Our condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Additionally, on March 6, 2015 we announced that the Department of Veterans Affairs (VA) informed the company that it did not intend to exercise the fourth and final option year under our contract for telehealth products and services. The company’s contract with the VA was originally awarded in April 2011 and consisted of a base year and four one-year option years which were exercisable at the VA’s sole discretion. The current option year under the contract expired on May 15, 2015 and the transition process with the VA was completed by that date. Our VA revenue included both recurring service revenues as well as hardware sales. As a result of the non-renewal of the VA contract we expect to report significantly reduced revenues over the next several quarters and we have taken steps to reduce our operating costs and better align our resources with the growth opportunities we intend to pursue. As a result, we have implemented a number of changes to our business plan with the ultimate goal to increase revenues and generate positive cash flow from operations, including a recalibration of marketing and sales efforts that have already resulted in growth from existing customers and sales to new customers. These changes include cost reductions from reducing our workforce and use of consultants that we made in the third quarter of fiscal 2015 and additional workforce reductions through August 31, 2015. These reductions are expected to reduce operating expenses on an annualized basis. The company has also taken actions to realign our data center operations and has executed an agreement with its landlord to relocate its offices, which are expected to result in additional annualized savings.

Since June 2015, the company has completed debt financing transactions resulting in total proceeds of approximately $1.2 million, however, the company has an immediate need for additional capital and is exploring additional potential transactions to improve our capital position, ensure we are able to meet our working capital requirements and provide funds to pay these debt obligations which are due in the next twelve months. Based on its business plan, the company expects its existing resources, revenues generated from operations, net proceeds from our debt financing transactions, other transactions we are considering and proceeds received from the exercise of outstanding warrants (of which there can be no assurance) or a restructuring of outstanding debt obligations (of which there can be no assurance) to satisfy its working capital requirements for at least the next twelve months. If necessary, management of the company believes that it can raise additional equity or debt financing to satisfy its working capital requirements. However, no assurances can be given that we will be able to support our costs or pay debt obligations through revenues derived from operations or generate sufficient cash flow to satisfy our other obligations. Unless we are able to increase revenues substantially or generate additional capital from other transactions, our current cash resources will only satisfy our working capital needs for a limited period of time and we will need to raise additional funds to meet our obligations in the future. In addition to our recently announced letter of intent for a business combination transaction, we are continuing to explore additional potential transactions to improve our capital position to ensure we are able to meet our financing and working capital requirements. Currently, the company does not have any definitive agreements with any third parties for such transactions and there can be no assurances that the company will be successful in completing the transaction contemplated by the letter of intent or in raising additional capital or securing financing when needed or on terms satisfactory to the company. Any inability to obtain required financing on sufficiently favorable terms could have a material adverse effect on our business, results of operations and financial condition.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

2. Loss Per Share

The following table sets forth the calculation of basic and diluted loss per share for the periods presented (in thousands, except per share data):

 

		Three Months Ended September 30,
		2015				2014
Net loss		$	(2,063	)		$	(2,111	)
Preferred stock dividends			(102	)			(101	)
Net loss applicable to common shareholders		$	(2,165	)		$	(2,212	)
Weighted average shares			42,192				39,405
Basic and diluted loss per common share		$	(0.05	)		$	(0.06	)

All common stock equivalents were excluded from the loss per share calculation for all periods presented because the impact is antidilutive. At September 30, 2015, options (5,577,000), restricted stock units (883,000), warrants (34,769,000), convertible debt (3,600,000), Series D preferred stock (6,125,000) and Series B preferred stock (250,000) were outstanding. At September 30, 2014, options (3,813,000), restricted stock units (910,000), warrants (27,676,000), Series D preferred stock (6,125,000) and Series B preferred stock (250,000) were outstanding.

3. Share-Based Compensation

Share-based compensation by category is as follows (in thousands):

 

		Three Months Ended September 30,
		2015				2014
SG&A		$	108			$	124
Product development			10				10
Cost of revenues			5				5
Share-based compensation expense		$	123			$	139

We computed the estimated fair values of all option-based compensation using the Black-Scholes option pricing model and the assumptions set forth in the following table. We based our estimate of the life of these options on historical averages over the past five years and estimates of expected future behavior. The expected volatility was based on the company’s historical stock volatility. The assumptions used in the company’s Black-Scholes calculations for fiscal 2016 and 2015 are as follows:

 

		Risk Free Interest Rate				Dividend Yield				Volatility Factor				Weighted Average Expected Option Life (Months)
Fiscal year 2016			1.6	%			0	%			85	%			48
Fiscal year 2015			0.6	%			0	%			84	%			48

The Black-Scholes option-pricing model requires the input of highly subjective assumptions. Because the company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models may not provide a reliable single measure of the fair value of share-based compensation for employee stock options. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of share-based compensation as circumstances change and additional data becomes available over time, which may result in changes to these assumptions and methodologies. Such changes could materially impact the company’s fair value determination.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

On August 23, 2011, the stockholders approved the 2011 Omnibus Equity Incentive Plan (the 2011 Plan). The 2011 Plan replaces the 2010 Employee Stock Option Plan and the 2001 Non-Executive Director Stock Option Plan. On May 1, 2014, the stockholders approved an amendment to the 2011 Plan to increase the number of shares of common stock available for issuance under the plan by 3,400,000 shares. As amended, the 2011 Plan provides for the issuance of up to 6,750,000 shares of the company’s common stock in connection with stock options, restricted share awards and other stock compensation vehicles.

Stock option activity under the company’s stock option plans for employees and non-executive directors for the period ended September 30, 2015 is as follows (in thousands, except per share and average life data):

 

Employees Information		Number of Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Life (Years)				Aggregate Intrinsic Value
Outstanding June 30, 2015			2,131			$	2.27
Granted			300				0.30
Expired/Forfeited			(322	)			1.58
Outstanding September 30, 2015			2,109			$	2.09				6.16			$	1
Exercisable at September 30, 2015			1,160			$	2.80				3.58			$	—
Expected to vest at September 30, 2015			743			$	1.26				7.68			$	—
Non-Executive Director Information		Number of Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Life (Years)				Aggregate Intrinsic Value
Outstanding June 30, 2015			2,185			$	0.62
Granted			1,293				0.27
Expired			(10	)			6.00
Outstanding September 30, 2015			3,468			$	0.48				8.31			$	97

Non-executive director options are granted at market price and vest on the grant date.

As of September 30, 2015, there were approximately 426,000 restricted stock units outstanding that were granted to employees as of January 15, 2013 and January 28, 2014 in connection with the company’s compensation modification program. These restricted stock units vest when the company achieves cash flow breakeven, as defined.

As of September 30, 2015, there was approximately $406,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements that is expected to be recognized over a weighted-average period of 17 months.

No options were exercised during the three month periods ended September 30, 2015 and 2014, respectively. The weighted average grant date fair value of options granted during the three month periods ended September 30, 2015 and 2014 was approximately $0.14 and $0.42, respectively. These values were calculated using the Black-Scholes option-pricing model.

The total fair value of options vested was $199,000 and $295,000 for the three month periods ended September 30, 2015 and 2014, respectively.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

In December 2012, the board of directors agreed that all non-employee directors would receive all of their cash director compensation, including amounts payable for committee service, service as a committee chair and per meeting fees, in restricted shares of our common stock or stock options issued at fair value in accordance with the terms of the 2011 Plan for periods ending after December 2012. During the three months ended September 30, 2015, the company issued 78,854 shares of restricted common stock and 496,768 stock options (with a total fair value of approximately $104,000) to certain non-executive directors in connection with this program. In October 2015 the company issued 43,980 shares of restricted common stock (with a fair value of approximately $13,000) to a director under this program for the quarter ended September 30, 2015. During the three months ended September 30, 2015, the board of directors also issued 600,000 stock options (with a total fair value of approximately $57,000) to the interim chief strategy officer for services.

4. Pending Acquisition

On August 25, 2015 the company announced that it had entered into a non-binding letter of intent with Peachstate Health Management, LLC d/b/a AEON Clinical Laboratories, an expanding clinical laboratory based in Gainesville, GA (“AEON”) for the acquisition of all of the outstanding membership interests of AEON in exchange for shares of a newly created class of Series E preferred stock of Authentidate (the “Series E Shares”). The letter of intent contemplates the AEON members will be issued Series E Shares convertible into 19.9% of the outstanding shares of the company’s common stock on the date of the closing of the merger transaction, and an additional number of Series E Shares convertible into 5% of the outstanding shares of the company’s common stock upon approval of the merger transaction by the shareholders of the company. If AEON achieves certain financial results during the next four years, the AEON members will be issued additional tranches of Series E Shares which, including the previously issued Series E Shares, will be convertible into 85% of the outstanding shares of the company’s common stock (on a partially diluted basis as defined). The letter of intent also provides for the issuance of Series E Shares as bonus shares for the achievement of certain incremental financial results for the four fiscal years ending December 31, 2019, convertible into 5% of the outstanding shares of the company’s common stock (on a partially diluted basis as defined ). The holders of the Series E Shares will have certain preferential rights, including the right to vote separately as a class to nominate and elect one director for each 10% of the outstanding shares of the company’s common stock into which the outstanding Series E Shares shall be convertible. The letter of intent is non-binding and any agreement is subject to the negotiation and execution of a definitive transaction agreement which may vary from the terms set forth in the letter of intent. Accordingly, there can be no assurance that a definitive agreement will be reached by the parties, or that any agreement will result in the completion of the merger transaction.

5. Inventory

In connection with our manufacturing and sales plans for our telehealth service, the company has purchased certain components and contract manufacturing services for the production of the monitoring appliances. These inventory amounts are stated at the lower of cost or market and consist of the following (in thousands):

 

		September 30, 2015				June 30, 2015
Purchased components, net		$	261			$	261
Finished goods			337				342
Total inventory		$	598			$	603

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

6. Other Intangible Assets

The following table sets forth licenses, net and other intangible assets that are included in other assets as follows (in thousands):

 

		September 30, 2015												June 30, 2015
		Gross Carrying Amount				Accumulated Amortization				Net Book Value				Gross Carrying Amount				Accumulated Amortization				Net Book Value				Useful Life In Years
Patents		$	357			$	282			$	75			$	357			$	276			$	81				17
Trademarks			226				110				116				214				108				106				20
Acquired technologies			95				75				20				95				72				23				2
Licenses			4,221				2,410				1,811				4,212				2,308				1,904				3 - 10
Total		$	4,899			$	2,877			$	2,022			$	4,878			$	2,764			$	2,114

As of September 30, 2015 and June 30, 2015 goodwill amounted to approximately $50,000 and is included in other assets.

The company amortizes licenses and other intangible assets under the straight line method. Amortization expense was approximately $113,000 and $88,000 for the three months ended September 30, 2015 and 2014, respectively. Amortization expense for the next five fiscal years and thereafter is expected to be as follows (in thousands):

 

June 30,
2016		$	416
2017			424
2018			332
2019			304
2020			277
Thereafter			269
		$	2,022

7. Notes Payable

On January 29, 2015, the company received a short-term loan of $200,000 from a strategic lender pursuant to which we issued a secured promissory note to the lender in the aggregate principal amount of $200,000. The note was secured by a first priority lien on certain equipment owned by the company with a net present value equivalent to the face value of the note, was due and payable on March 30, 2015 and accrued interest at the rate of 6% per annum. The note and accrued interest was repaid on the maturity date.

On February 17, 2015, the company entered into a securities purchase agreement with an accredited investor pursuant to which we issued a promissory note in the aggregate principal amount of $100,000 and common stock purchase warrants to purchase up to 80,000 shares of common stock for gross proceeds of $100,000. The note was an unsecured obligation of the company, was not convertible into equity securities of the company and accrued interest at a rate of 8% per annum. The note was due and payable on the six month anniversary of the issue date, subject to the right of the investor to extend the maturity date for up to an additional six months. The net proceeds from this transaction were approximately $92,000. The warrants vested in equal monthly installments over twelve months if the notes were outstanding and, subject to vesting requirements, were exercisable for a period of 54 months commencing on the six month anniversary of the issuance date at an initial exercise price of $1.01 per share. Although the securities purchase agreement that the company entered into with this investor contemplated a second closing for $900,000 of additional proceeds, the second closing did not occur and the company did not receive the additional funds. This note and the vested portion of the warrants were exchanged for notes and warrants issued in the June 8, 2015 transaction discussed below and the warrants issued for this transaction were cancelled.

On February 17, 2015, in a separate transaction, the company issued a short-term promissory note in the aggregate principal amount of $950,000 and warrants to purchase 99,500 shares of common stock to an accredited investor for gross proceeds of $950,000. The holder of the short-term note is an entity controlled by Douglas B. Luce, the brother of J. David Luce, a member of the board of directors of the company. The short-term note is an unsecured obligation of the company, is not convertible into equity

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

securities of the company and accrued interest at a rate of 5.76% per annum. The short-term note was due and payable on the first to occur of the one month anniversary of the issue date or the date on which the company received at least $950,000 in proceeds from equity or debt financing. The short-term note contains covenants and events of default customary for similar transactions. The net proceeds from this transaction were approximately $940,000. The warrants are exercisable for a period of 54 months commencing on the six month anniversary of the issuance date and have an initial exercise price of $1.01 per share. On April 3, 2015, the company entered into an amendment agreement with the holder of the $950,000 short-term promissory note in order to amend such note to extend its maturity date from March 19, 2015 to July 2, 2015. In addition, pursuant to the amendment agreement, the company also agreed to grant the holder the right to exchange the principal amount of the short-term note (and unpaid interest thereon) into the securities of the company sold in the next financing, as defined in the amendment agreement. This investor subsequently agreed not to participate in the convertible debt financing for which a closing was held June 8, 2015 and in consideration of such election, the participation right was modified to allow him to exchange such note for comparable securities in an alternative transaction. In consideration of waivers previously granted by the holder of potential events of default under the short-term note and the amendment to extend the maturity date, the company agreed to issue the holder warrants to purchase 3,166,667 shares of common stock of the company. The warrants are exercisable for a period of 54 months commencing six months following the date of issuance and have an exercise price equal to $0.31 per share. Through a series of amendment agreements, the maturity date of this note has been further extended and the interest rate has been increased to 12% per annum in connection with such extensions. The company is engaged in ongoing discussions and negotiations with the holder of this note in order to seek modifications to the terms of the obligation, including extensions of the repayment date. The company anticipates that in order to complete these negotiations, it will be required to grant conversion rights and/or issue additional warrants.

On April 24, 2015, the company issued a promissory note in the aggregate principal amount of $500,000 to Lazarus Investment Partners LLLP, the beneficial owner of approximately 29.3% of the company’s common stock, in a private transaction. The note is an unsecured obligation of the company and is not convertible into equity securities of the company. The note was originally due and payable on the first to occur of July 2, 2015 or the date on which the company received at least $900,000 in proceeds from equity or debt financing transactions. Interest on the note was originally 5.76% per annum payable at maturity. The note contains terms and events of default customary for similar transactions. In consideration of the loan, the company and Lazarus entered into a warrant amendment agreement pursuant to which the company agreed to amend certain of the terms of the existing 6,233,636 common stock purchase warrants held by Lazarus to reduce the exercise price of such warrants to $0.25, which was $0.01 above the most recently reported closing consolidated bid price of the company’s common stock prior to the execution of the transaction documents, and to extend the expiration date of the warrants to October 25, 2019. The warrants amended were issued in various transactions from 2010 through 2014 at exercise prices ranging between $0.88 and $2.00. The fair value related to the warrant modifications was recorded as a debt discount and amortized over the term of the new agreement. Through a series of amendment agreements, the maturity date of this note has been further extended and the interest rate has been increased to 12% per annum in connection with such extensions. The company is engaged in ongoing discussions and negotiations with the holder of this note in order to seek modifications to the terms of the obligation, including extensions of the repayment date. The company anticipates that in order to complete these negotiations, it will be required to grant conversion rights and/or issue additional warrants.

On June 8, 2015, the company entered into definitive agreements relating to a private placement of up to $3.0 million in principal amount of senior secured convertible notes and common stock purchase warrants. An initial closing for an aggregate principal amount of $900,000 of notes and warrants to purchase 3,626,667 shares of common stock was held on June 8, 2015. Subject to certain limitations, the warrants are exercisable on or after the six month anniversary of the date of issuance at an initial exercise price of $0.30 per share and will expire 54 months from the initial exercise date. In addition, subject to certain limitations, the warrants provide that, beginning six months from issuance, the company shall have the right to cause the holder to exercise the warrants provided that the following conditions are satisfied: (i) the closing bid price of the company’s common stock is at least $0.45 for the 20 consecutive trading days prior to the date of the mandatory exercise notice and (ii) all of the warrants issued in the transaction are called by the company for a mandatory exercise. A final closing for up to $2.1 million of debentures and warrants to purchase 8,400,000 shares of common stock has not occurred. As a condition of the initial closing, the holder of an aggregate principal amount of $100,000 of previously issued promissory notes was required to exchange such notes and certain warrants held by it for senior secured notes and warrants issued in this transaction. These notes, subject to certain exceptions, rank senior to existing and future indebtedness of the company and are secured to the extent and as provided in the security agreement entered into between the company and the purchasers. Each note matures on the one-year anniversary of the issuance date thereof and, subject to certain limitations, is convertible at any time at the option of the holder into shares of the company’s common stock at an initial conversion price of $0.25 per share. Subject to certain exemptions, if the company issues or sells shares of its common stock, rights to purchase shares of its common stock, or securities convertible into shares of its common stock for a price per share that is less than the conversion price then in effect, the conversion price then in effect will be decreased to equal 85% of such lower price and the exercise price of the warrants will be decreased to a lower price based on the amount by which the conversion price of the notes was reduced due to such

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

transaction. The foregoing adjustments to the conversion price will not apply to certain exempt issuances, including issuances pursuant to certain employee benefit plans. In addition, the conversion price is subject to adjustment upon stock splits, reverse stock splits, and similar capital changes. The senior secured notes bear interest at 9% per annum with interest payable upon maturity or on any earlier redemption date. At any time after the issuance date, the company will have the right to redeem all or any portion of the outstanding principal balance of the notes, plus all accrued but unpaid interest at a price equal to 110% of such amount and the holders shall have the right to convert any or all of the amount to be redeemed into common stock prior to redemption. The notes are secured by a first priority lien on the company’s assets related to its “Inscrybe Referral and Order Management” and “Inscrybe Hospital Discharge” solutions. Subject to certain exceptions, the notes contain customary covenants against incurring additional indebtedness and granting additional liens and contain customary events of default. Upon the occurrence of an event of default under the notes, a holder may require the company to repay all or a portion of its notes in cash, at a price equal to 110% of the principal and accrued and unpaid interest.

The company also agreed to file a registration statement covering the resale of the shares of the company’s common stock issuable upon conversion of the notes and exercise of the warrants and to use commercially reasonable efforts to have the registration declared effective in a timely manner. The Company will be subject to certain monetary penalties, as defined in the agreement if the registration statement is not filed, does not become effective on a timely basis, or does not remain available for the resale, as such term is defined in the registration rights agreement.

On August 7, 2015, the company issued a senior secured promissory note in the aggregate principal amount of $320,000 to an accredited investor in a private transaction dated August 7, 2015. The note is due and payable on December 31, 2015 and interest shall accrue on the note at the rate of 10.0% per annum. The note is not convertible into equity securities of the company and it contains terms and events of default customary for similar transactions. The note is secured by a first priority lien on certain of our assets, as described in a security agreement entered into between the company and the purchaser dated as of August 7, 2015. In consideration of the loan, the company and the purchaser entered into a warrant amendment agreement pursuant to which the company agreed to amend certain of the terms of the existing 5,474,829 common stock purchase warrants currently held by the purchaser and an affiliate to reduce the exercise price of such warrants to $0.17 and to extend the expiration date of the warrants to December 13, 2019. The warrants amended were issued in various transactions from 2012 through 2013 at exercise prices ranging between $0.95 and $1.34. The fair value related to the warrant modifications was recorded as a debt discount and is being amortized over the term of the new agreement. The purchaser is an entity affiliated with J. David Luce, a member of our board of directors. The company is using the net proceeds from the transaction for general business and working capital purposes.

On August 26, 2015, the company issued promissory notes in the aggregate principal amount of $400,000 to Lazarus Investment Partners LLLP, the beneficial owner of approximately 29.0% of the company’s common stock, and an entity affiliated with J. David Luce, a member of our board of directors, in a private transaction. The notes are unsecured obligations of the company and are not convertible into equity securities of the company. The notes bear interest at 20% per annum, payable in arrears, and are due upon the earlier of (i) August 26, 2016, or (ii) within 30 days of the closing of the contemplated acquisition, merger or similar transaction with Peachstate Health Management, LLC (d/b/a AEON Clinical Laboratories) as described above, or a similar alternative acquisition, merger or similar transaction with an unaffiliated third party, or (iii) the closing of a sale of equity or debt securities of the company, or series of closings, as part of the same transaction, of equity or debt securities within a period of 90 days, in the gross amount of at least $5,000,000 in cash proceeds. The holders have the right, at their option, to convert interest and principal due on the note into any alternative financing that may be undertaken by the company while the notes are outstanding.

In September 2015, the company issued promissory notes in the aggregate principal amount of $525,000 to accredited investors in a private transaction. The notes are unsecured and are not convertible into equity securities of the company. The notes bear interest at 20% per annum, payable in arrears, and are due upon the earlier of (i) September 18, 2016, or (ii) within 30 days of the closing of a sale of equity or debt securities of the company, or series of closings, as part of the same transaction, of equity or debt securities within a period of 90 days, in the gross amount of at least $5,000,000 in cash proceeds. The company also issued the investors warrants to purchase an aggregate of 1,050,000 shares of common stock. The warrants are exercisable commencing twelve months following their issuance for a period of 54 months at an exercise price of $0.30 per share. These closings are part of an offering of up to $1 million of notes and 2 million warrants.

Except for the June 8, 2015 transaction, the company allocated the proceeds from the note transactions to the notes and the related warrants based on the relative fair values of such instruments using the fair value of the notes at a market rate of interest and the fair value of the warrants based on the Black-Scholes option pricing model and the applicable assumptions set forth in Note 3 of Notes to Condensed Consolidated Financial Statements. These allocations resulted in effective interest rates for the $100,000 note of approximately 39% per annum, for the $950,000 note of approximately 65% per annum, for the $500,000 note of approximately 71% per annum, for the $800,000 senior secured note of approximately 36% per annum, for the $320,000 secured note of approximately

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

63%, for the $400,000 note of approximately 20% and for the $525,000 notes of approximately 54%, respectively. However, since the subjective nature of the inputs for the option pricing and other models used to calculate fair values can materially affect fair value estimates, in management’s opinion, such models may not provide a reliable single measure of the fair value of the warrants and the resulting effective interest rates. In connection with the note transactions the company recorded promissory notes of $3,595,000, debt discount of $913,000, an initial warrant liability of $214,000, non-cash loss on extinguishments discussed below of $557,000 and additional paid-in-capital of $1,256,000 related to the fair value of the warrants.

As a result of the ratchet provision included in the June 8, 2015 transaction, the company recorded a warrant liability and a debt discount based on the fair value of the warrants issued in connection with the new senior secured note. As discussed more fully in Note 13 of Notes to Condensed Consolidated Financial Statements, the company is required to revalue these warrants at the end of each reporting period. In connection with the modifications of the $950,000 and $100,000 short-term notes discussed above, the company issued additional warrants and agreed to modifications that, for accounting purposes, resulted in the extinguishment of the old notes and the creation of new notes. Accordingly, the company recorded non-cash losses on extinguishment of approximately $557,000 as other expense in the fourth quarter ended June 30, 2015. The non-cash amortization of the debt discount of $127,000 and deferred financing costs of $43,000 is included in other expense for the three months ended September 30, 2015. There was no amortization for the three months ended September 30, 2014.

The following table sets forth the notes and unamortized debt discount (in thousands):

 

		September 30,				June 30,
		2015				2015
Notes payable
Secured notes payable		$	1,220			$	900
Unsecured notes payable			2,375				1,450
Unamortized debt discount			(426	)			(200	)
Notes payable		$	3,169			$	2,150

8. Preferred Stock

As of September 30, 2015, there are 28,000 shares of Series B preferred stock outstanding. The Series B preferred stock was originally issued in a private financing in October 1999 and the conversion and redemption features were amended in October 2002 to provide for the rights and obligations described in this note. The company has the right to repurchase the outstanding Series B preferred stock at a redemption price equal to $25.00 per share, plus accrued and unpaid dividends. The holder of such shares has the right to convert shares of preferred stock into an aggregate of 250,000 shares of our common stock at a conversion rate of $2.80 per share. In the event the company elects to redeem these securities, the holder will be able to exercise its conversion right subsequent to the date that we issue a notice of redemption but prior to the deemed redemption date as would be set forth in such notice. At September 30, 2015, the company has accrued dividends in the amount of $17,500 which remain unpaid and are due December 31, 2015.

As of September 30, 2015, there are 665,000 shares of Series D convertible preferred stock outstanding. The Series D preferred stock was issued in June 2013 in connection with the cancelation of an aggregate principal amount of $6,500,000 of senior secured notes and can be converted by the holders into an aggregate of 6,125,024 shares of common stock at an initial conversion rate of $1.08571 per share. The holders of such shares have the right to convert the preferred shares at anytime commencing on the six month anniversary of the issue date; however, the shares received upon conversion may not be offered or sold except pursuant to an effective registration statement or an applicable exemption from the registration requirements of the Securities Act and applicable state securities laws. The company has the right to repurchase the outstanding Series D preferred stock at a redemption price equal to $10.00 per share, plus accrued and unpaid dividends, beginning two years after issuance and to require holders to convert their Series D preferred stock beginning three years after issuance. Dividends on the Series D preferred stock accrue at a rate of 5% per annum and are payable semi-annually in cash or stock at the company’s option. At September 30, 2015, the company has accrued dividends in the amount of approximately $83,100 which remain unpaid and are due December 31, 2015.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

9. Shareholder’s Equity

The changes in shareholders’ equity for the three months ended September 30, 2015 are summarized as follows (in thousands):

 

		Preferred Stock				Common Stock				Additional Paid-in Capital				Accumulated Deficit				Total Shareholders’ Deficit
Balance, June 30, 2015		$	69			$	42			$	205,909			$	(206,485	)		$	(465	)
Preferred stock dividends															(102	)			(102	)
Share-based compensation expense											123								123
Restricted shares and stock options issued for services											161								161
Warrants issued for services											12								12
Warrants issued with debt											354								354
Net loss															(2,063	)			(2,063	)
Balance, September 30, 2015		$	69			$	42			$	206,559			$	(208,650	)		$	(1,980	)

During the three months ended September 30, 2015 there were no stock options or warrants exercised.

10. Commitments and Contingencies

During fiscal 2009, the company purchased certain inventory components under arrangements that required payment only after such components where actually used in production. Based on the company’s current production plans we have determined that these components will not be used and we offset the inventory balance for undelivered items against the related accounts payable balance during the quarter ended March 31, 2015. Additionally, we intend to return approximately $0.2 million of such items that are included in the inventory and accounts payable balances as of September 30, 2015. The vendor that provided these components is currently disputing this arrangement and is requesting payment for these items. The company believes the amount at issue is approximately $1.2 million and intends to vigorously contest this assertion. Management does not believe that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

We are also subject to claims and litigation arising in the ordinary course of business. Our management considers that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

We are not currently engaged in any other litigation which would be anticipated to have a material adverse effect on our financial condition or results of operations.

We have entered into employment agreements with our chief executive officer, chief financial officer and interim chief strategy officer that specify the executive’s current compensation, benefits and perquisites, the executive’s entitlements upon termination of employment, and other employment rights and responsibilities. In connection with the termination of the company’s employment relationship with its former chief executive officer and president in February 2015, the company is presently reviewing its severance obligations to him and the vesting and other post-termination provisions of certain of the unexercised stock options and other unvested stock options and unvested restricted stock units held by him as of the effective date of his separation from the company.

We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, we have not made any payments under these agreements that have been material individually or in the aggregate. As of September 30, 2015, we are not aware of any obligations under such indemnification agreements that would require material payments.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

11. Income Taxes

The company continues to recognize its tax benefits which are fully offset by a valuation allowance due to the uncertainty that the deferred tax assets will be realized. We will continue to evaluate the realizability of our net deferred tax assets and may record additional benefits in future earnings if we determine the realization of these assets is more likely than not.

12. Other Expense

Other expense consists of the following (in thousands):

 

		Three Months Ended
		September 30,
		2015				2014
Amortization of debt discount		$	(127	)		$	—
Amortization of deferred financing costs			(43	)			—
Interest expense			(80	)			—
Change in fair value of warrant liability			(159	)			—
Total other expense		$	(409	)		$	—

The amortization of debt discount and deferred financing costs for fiscal 2016 relates to the notes discussed in Note 7 of Notes to Condensed Consolidated Financial Statements.

13. Fair Value Measurements

The company measures fair value for financial assets and liabilities in accordance with the provisions of the accounting guidance regarding fair value measurements. The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those three levels is as follows:

 

•

Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.

 

•

Level 2: Inputs other than quoted prices for identical assets or liabilities that are observable for the asset or liability, either directly or indirectly.

 

•

Level 3: Significant unobservable inputs.

The company’s assets and liabilities subject to fair value measurements as of September 30, 2015 and June 30, 2015 are as follows (in thousands):

 

		Fair Value Measurements Using Fair Value Hierarchy
		Fair value				Level 1				Level 2				Level 3
September 30, 2015
Warrant liability		$	373			$	—			$	—			$	373
Total		$	373			$	—			$	—			$	373
June 30, 2015
Warrant liability		$	214			$	—			$	—			$	214
Total		$	214			$	—			$	—			$	214

The warrant liability represents the fair value of the warrants issued by the company that have reset features. The company is required to revalue the warrant liability at the end of each reporting period and record a non-cash gain or loss in the statement of operations for the change in the fair value of the warrant liability in the period in which the change occurs. The fair value of the warrant liability is estimated using an adjusted Black-Scholes model and the applicable level 1 and level 2 inputs disclosed in Note 3 of Notes to Condensed Consolidated Financial Statements and an unobservable level 3 input regarding the likelihood of a reset occurring. Since the company uses a level 3 input, the warrant liability in included in the level 3 category in the table above. Estimating fair value requires the input of highly subjective assumptions and because changes in such assumptions can materially affect the fair value estimate, in management’s opinion, the existing models may not provide a reliable single measure of the fair value of the related assets or liabilities.

 

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

For the three months ended September 30, 2015, the company recorded a non-cash loss of approximately $159,000 in other expense for the change in fair value of the warrant liability. For the three months ended September 30, 2014, there were no gains or losses resulting from the fair value measurement of assets or liabilities.

14. Accounting Standards Adopted in Fiscal 2016

The company has not adopted any FASB Accounting Standards Updates (ASU) during fiscal 2016.

15. Common Stock Warrants

During the three months ended September 30, 2015, the company issued warrants to purchase shares of its common stock as follows. The company issued 100,000 warrants to a consultant for services with an exercise price of $0.19 per share. These warrants have a five year life and, are exercisable beginning six months after the grant date. Under this consulting arrangement, the company may grant up to an additional 800,000 warrants to this consultant based on the achievement of performance targets. Unless such performance targets are achieved, no additional warrants would be issued under this arrangement. The fair value of these warrants, as determined by the Black Scholes Model, was charged to operations on the grant date. Further, as discussed more fully in Notes 7 of Notes to Condensed Consolidated Financial Statements, the company issued warrants to purchase 1,050,000 shares of the company’s common stock in connection with the issuance of promissory notes in September 2015.

A schedule of common stock warrant activity is as follows (in thousands, except per share and average life data):

 

		Number of Shares				Weighted Average Exercise Price Per Share				Weighted Average Remaining Contractual Life (Years)				Aggregate Intrinsic Value
Outstanding, June 30, 2015			33,669			$	0.84
Issued			1,150				0.29
Expired			(50	)			1.40
Outstanding, September 30, 2015			34,769				0.67				3.49			$	916
Exercisable, September 30, 2015			26,425			$	0.97				3.12			$	916

16. Other Subsequent Events

In October 2015, the company issued promissory note in the aggregate principal amount of $450,000 to Peachstate Medical Holdings LLC, d/b/a AEON Clinical Laboratories in a private transaction. The note is unsecured and is not convertible into equity securities of the company. The note bears interest at 20% per annum, payable in arrears, and is due upon the earlier of (i) October 28, 2016, or (ii) within 30 days of the closing of a sale of equity or debt securities of the company, or series of closings, as part of the same transaction, of equity or debt securities within a period of 90 days, in the gross amount of at least $5,000,000 in cash proceeds. The company also issued the investor warrants to purchase an aggregate of 1,000,000 shares of common stock. The warrants are exercisable commencing twelve months following their issuance for a period of 54 months at an exercise price of $0.30 per share.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements and Factors That May Affect Future Results

Certain statements in this Form 10-Q, including information set forth under Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). We desire to avail ourselves of certain “safe harbor” provisions of the Act and are therefore including this special note to enable us to do so. Forward-looking statements in this Form 10-Q or hereafter included in other publicly available documents filed with the Securities and Exchange Commission, reports to our stockholders and other publicly available statements issued or released by us involving known and unknown risks, uncertainties and other factors which could cause our actual results, performance (financial or operating) or achievements to differ from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. Such future results are based upon our management’s best estimates based upon current conditions and the most recent results of operations. These risks include, but are not limited to risks associated with the market acceptance of our software, products and services, competition, pricing, technological changes, implementation of our business plan, and other risks as discussed in our filings with the Securities and Exchange Commission, in particular our Annual Report on Form 10-K for the year ended June 30, 2015 and our subsequently filed reports filed with the Securities and Exchange Commission , all of which risk factors could adversely affect our business and the accuracy of the forward-looking statements contained herein.

Overview

Authentidate Holding Corp. (Authentidate or the company) and its subsidiaries provide secure web-based revenue cycle management applications and telehealth products and services that enable healthcare organizations to increase revenues, improve productivity, reduce costs, coordinate care for patients and enhance related administrative and clinical workflows and compliance with regulatory requirements. Our web-based services are delivered as Software as a Service (SaaS) to our customers interfacing seamlessly with billing and document management systems. These solutions incorporate multiple features and security technologies such as business- rules based electronic forms, intelligent routing, transaction management, electronic signatures, identity credentialing, content authentication, automated audit trails and remote patient management capabilities. Both web and fax-based communications are integrated into automated, secure and trusted workflow solutions.

Our telehealth solutions provide in-home patient vital signs monitoring systems and services to improve care for patients and reduce the cost of care by delivering results to their healthcare providers via the Internet. Our telehealth solutions combine our tablet or Electronic House Call™ patient vital signs monitoring appliances or our Interactive Voice Response patient vital signs monitoring solution with a web-based management and monitoring software module. Both solutions enable unattended measurements of patients’ vital signs and related health information and are designed to aid wellness and preventative care, and deliver better care to specific patient segments that require regular monitoring of medical and behavioral health conditions. Healthcare providers can easily view each specific patient’s vital statistics and make adjustments to the patient’s care plans securely via the Internet. This service provides a combination of care plan schedule reminders and comprehensive disease management education as well as intelligent routing to alert on-duty caregivers whenever a patient’s vital signs are outside of the practitioner’s pre-set ranges. Healthcare providers and health insurers are also expected to benefit by having additional tools to improve patient care and reduce in-person and emergency room patient visits and hospital readmissions.

We operate our business in the US with technology and service offerings that address emerging growth opportunities based on the regulatory and legal requirements specific to each market. Our business is engaged in the development and sale of web-based services largely based on our Inscrybe^® platform and related capabilities and our telehealth products and services. In recent years we have focused our efforts on developing and introducing solutions for use in the healthcare information technology industry.

We believe there are a number of on-going factors that will be favorable for the healthcare information technology industry in the near future. These factors include regulatory reforms in the U.S. focused on controlling costs, automating medical records and processes and expanding the availability of healthcare coverage, and healthcare industry trends to significantly reduce costs, shorten the length of hospital stays, reduce hospital readmissions, shift patient care towards wellness and preventative care programs and automate healthcare records and processes. Furthermore, we believe our business will benefit as the recent U.S. Supreme Court decisions upholding the healthcare law are better recognized in the marketplace. Because healthcare information technology solutions play an important role in healthcare by improving safety, efficiency and reducing cost, they are often viewed as more strategic than other capital purchases. In addition, government agencies, as well as politicians and policymakers appear to agree that the growing cost of our healthcare system is unsustainable and the intelligent use of information systems will improve health outcomes and, correspondingly, drive down costs. The broad recognition that healthcare information technology is essential to help control healthcare costs and improve quality contributed to the inclusion of healthcare information technology incentives in the American Recovery and Reinvestment Act (ARRA) and accompanying Health Information Technology for Economic and Clinical Health (HITECH)

 

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provisions which include more than $35 billion in incentives for healthcare organizations to modernize operations through “meaningful use” of healthcare information technology. Further, as more consumers are provided with insurance coverage, healthcare providers may face increased volumes that could create capacity constraints, and they may find it challenging to profitably provide care at the planned reimbursement rates under the expanded coverage models. Another aspect of the market for healthcare information technology is the shift away from fee-for-service or volume-based reimbursement towards value-based or outcomes-based reimbursement. Payers, including health insurance companies and federal and state governments, are implementing programs to link reimbursement to quality measurements and outcomes, and this alignment creates significant financial motivation for adoption of healthcare information technology products and services. We believe that there are substantial sums of reimbursement funds that are tied to incentive programs such as value based purchasing, 30-day readmission rules and quality reporting requirements. There are also a growing number of third-party studies that document how telehealth can positively impact the way healthcare is delivered. From chronic care to behavioral health and wellness programs, a wide range of patient populations can benefit from telehealth. We believe that telehealth products are helping physicians and patients to accomplish a number of goals, including, shifting visits away from high-cost settings; reducing the cost of managing patients; reducing unnecessary hospital readmissions; reducing the duration of hospital stays; improving access to care for patients located in remote areas; and improving outcomes. We believe the factors discussed above will create strong incentives for providers to maximize efficiency and create the need for additional investments in healthcare information technology solutions and services. We also believe that the healthcare information technology industry will likely benefit as healthcare providers and governments continue to recognize that these solutions and services contribute to safer, more efficient healthcare.

We have experienced net losses and negative cash flow from operating activities while we have been focused on developing our products and services, refining our business strategies and repositioning our businesses for growth. Although we believe we are well positioned for such growth, we expect to continue to generate net losses and negative cash flow for the foreseeable future as we seek to expand our potential markets and generate increased revenues. As discussed in more detail below, we have completed several financing transactions, and sold non-core assets to fund our working capital needs. See “Liquidity and Capital Resources”.

During fiscal 2016 we have continued to focus primarily on marketing our telehealth products and services and our referral and order management solution while implementing various measures to decrease our operating costs. We have also focused our efforts on evaluating strategic transactions, including the proposed transaction with Peachstate Health Management, LLC, as described in Note 4 of Notes to Condensed Consolidated Financial Statements. We intend to continue to take steps to refine our core product and service offerings, expand our addressable markets, manage operating costs and position the company for long-term growth. We believe the company is well positioned for growth as the healthcare markets it serves are growing rapidly and expected to continue to grow over the next several years according to third party analyst market assessments. Additionally, our products and services target the “12 month episode of care” market, which is the largest and fastest growing market segment for remote patient management services. As discussed above, we also believe our business will benefit as federal government healthcare reforms are implemented and healthcare industry trends take hold. Although we have taken steps to focus our business in these areas, our progress will continue to be impacted by the timing of customer contracts and implementations, our ability to fund our operating costs and the market acceptance of our products and services.

As previously reported, on March 6, 2015 we announced that the Department of Veterans Affairs (VA) informed the company that it did not intend to exercise the fourth and final option year under our contract for telehealth products and services. The company’s contract with the VA was originally awarded in April 2011 and consisted of a base year and four one-year option years which were exercisable at the VA’s sole discretion. We completed our project with the VA upon the expiration of the option year on May 15, 2015. Our VA revenue included both recurring service revenues as well as hardware sales. As a result of the non-renewal of the VA contract we expect to report significantly reduced revenues over the next several quarters and we have taken steps to reduce our operating costs and better align our resources with the growth opportunities we intend to pursue. As a result, we have implemented a number of changes to our business plan with the ultimate goal to increase revenues and positive cash flow from operations, including a recalibration of marketing and sales efforts that have already resulted in growth from existing customers and sales to new customers. These changes include cost reductions from reducing our workforce and use of consultants that we made in the third quarter of fiscal 2015 and additional workforce reductions through August 31, 2015. These reductions are expected to reduce operating expenses by approximately $4,151,000 on an annualized basis. We have also taken actions to realign our data center operations for an expected annualized cost reduction of $203,000 and have executed an agreement with our landlord to relocate our corporate offices, which is expected to result in annualized savings of $372,000.

We believe that our experience with the VA telehealth project has enabled us to refine our telehealth products and services and position the company for success in the commercial market which we believe provides a significantly larger opportunity for the company as this market develops. We have continued to develop lower cost solutions for the commercial market that we were not able to deploy at the VA and we have already reduced our operating costs in excess of the monthly recurring revenues and equipment margins that we were generating from the VA project. Moving forward, we plan to repurpose our volume-tested, web-based management and monitoring solutions and investments to focus on offering a broader array of cost effective solutions to the healthcare market and increase our sales efforts on commercial market opportunities which we believe offer greater potential for growth.

 

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In addition, on August 25, 2015, we announced that we had entered into a non-binding letter of intent with Peachstate Health Management, LLC d/b/a AEON Clinical Laboratories, a clinical laboratory based in Gainesville, GA for the acquisition of all of the outstanding membership interests of AEON in exchange for shares of a newly created class of Series E preferred stock of Authentidate. As described in greater detail above, the letter of intent provides that if certain financial results are achieved during the next four years, the AEON members would be issued Series E Shares convertible into 85% of the outstanding shares of our common stock on a partially diluted basis. The letter of intent is non-binding and any agreement is subject to the negotiation and execution of a definitive transaction agreement which may vary from the terms set forth in the letter of intent. Accordingly, there can be no assurance that a definitive agreement will be reached by the parties, or that any agreement will result in the completion of the merger transaction.

Our current revenues consist principally of transaction fees for web-based hosted software services and revenues from hardware sales and rentals, monthly monitoring services and maintenance fees from our telehealth business. Growth in our business is affected by a number of factors, including general economic and business conditions, and is characterized by long sales cycles. The timing of customer contracts, implementations and ramp-up to full utilization can have a significant impact on results and we believe our results over a longer period of time provide better visibility into our performance.

We intend to continue our efforts to market our web-based services and related products in our target markets. We also intend to focus on identifying additional applications and markets where our technology can address customer needs.

Critical Accounting Policies

There have been no changes to our critical accounting policies during the three months ended September 30, 2015. Critical accounting policies and the significant estimates made in accordance with such policies are regularly discussed with our Audit Committee. Those policies are discussed under Critical Accounting Policies in our Management’s Discussion and Analysis of Financial Condition and Results of Operations section included in item 7, as well as in our consolidated financial statements and the footnotes thereto contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2015.

Results of Operations

Three and months ended September 30, 2015 compared to three months ended September 30, 2014

Revenues were $398,000 for the quarter ended September 30, 2015 compared to $1,052,000 for the prior year period. These results reflect a decrease in revenues from both our telehealth products and services and hosted software services due to lower equipment sales and service revenues and transaction volumes, respectively.

Cost of revenues decreased to $207,000 for the quarter ended September 30, 2015 compared to $593,000 for the same period in the prior year, due primarily to lower costs related to telehealth revenues and lower personnel costs for our hosted software services.

Selling general and administrative (SG&A) expenses decreased to $1,501,000 for the quarter ended September 30, 2015 compared to $2,011,000 for the prior year period. The change is due primarily to lower personnel and consulting expenses offset in part by incremental legal and merger related expenses and does not give effect to the impact of our recent cost-cutting measures for data center and facility expenses.

Product development expenses were $162,000 for the quarter ended September 30, 2015 compared to $370,000 for the prior year period reflecting lower personnel and contractor expenses.

Depreciation and amortization expense was $182,000 for the quarter ended September 30, 2015 compared to $189,000 for the prior year period. This change reflects lower expenditures for property and equipment during the current period.

Other expense was $409,000 for the quarter ended September 30, 2015 compared to zero for the prior year period. Other expense for current period reflects the non-cash amortization of debt discount and deferred financing costs on notes payable, the non-cash loss on the change in the fair value of the warrant liability and interest expense on notes payable.

Net loss for the quarter ended September 30, 2015 was $2,063,000, or $0.05 per share, compared to $2,111,000, or $0.06 per share, for the prior year period. The decrease in net loss for the period is due primarily to the decrease in SG&A and product development expenses discussed above.

 

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Liquidity and Capital Resources

Overview

Our operations and product development activities have required substantial capital investment to date and we have been largely dependent on our ability to sell additional shares of our common stock or other equity and debt securities to obtain financing to fund our operating deficits, product development activities, business acquisitions, capital expenditures and telehealth activities. Since June 2015, we have completed debt financing transactions resulting in total proceeds of approximately $1.7 million. The material terms of these debt transactions are summarized in Notes 7 and 16 of Notes to Condensed Consolidated Financial Statements. We are using the proceeds from these transactions for working capital and general corporate purposes, including supporting the rollout of our telehealth products and services. However, we have an immediate need for additional capital and are exploring additional potential transactions to improve our capital position, ensure we are able to meet our working capital requirements and provide funds to pay these debt obligations which are due in the next twelve months. We have developed and intend to continue to develop new applications to grow our business and address new markets. As discussed in more detail below, our recurring operating losses and capital needs, among other factors, raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

In August 2012 we filed with the SEC a registration statement on Form S-3 and a pre-effective amendment to such registration statement under the Securities Act in December 2012. The shelf registration statement was declared effective by the SEC in December 2012 and replaces our prior shelf registration statement. This shelf registration statement allows us to sell, from time to time in one or more public offerings, shares of our common stock, shares of our preferred stock, debt securities or warrants to purchase common stock, preferred stock or debt securities, or any combination of such securities, for proceeds in the aggregate amount of up to $40 million, subject to SEC limitations. There is approximately $29 million available under this registration statement for future transactions, subject to SEC limitations. The terms of such future offerings, if any, and the type of equity or debt securities would be established at the time of the offering. This disclosure shall not constitute an offer to sell or a solicitation of an offer to buy the securities, nor shall there be any sale of these securities in any jurisdiction in which an offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction. Any offer of the securities will be solely by means of the prospectus included in the registration statement and one or more prospectus supplements that will be issued at the time of the offering.

Cash Flows

The company has incurred significant losses and our operations and product development activities have required substantial capital investment to date. Under our current operating plan to grow our business, our ability to improve operating cash flow has been highly dependent on the market acceptance of our offerings. As discussed more fully in the Overview section above, the VA, our largest customer, did not renew our contract beyond May 15, 2015 and we expect to report significantly reduced revenues over the next several quarters. We have taken steps to reduce our operating costs and better align our resources with our growth opportunities; however, and based on our business plan, we expect our existing resources, revenues generated from operations, net proceeds from our debt financing transactions, other transactions we are considering and proceeds received from the exercise of outstanding warrants (of which there can be no assurance) or a restructuring of outstanding debt obligations (of which there can be no assurance) to satisfy our working capital requirements for at least the next twelve months. If necessary, management of the company believes that it can raise additional equity or debt financing to satisfy its working capital requirements. However, no assurances can be given that we will be able to support our costs or pay debt obligations through revenues derived from operations or generate sufficient cash flow to satisfy our other obligations. These factors, among others, raise substantial doubt about our ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments to the recoverability and classification of asset carrying amounts or the amounts and classifications of liabilities that might result from the outcome of these uncertainties. Unless we are able to increase revenues substantially or generate additional capital from other transactions, our current cash resources will only satisfy our working capital needs for a limited period of time. As discussed above, we have an immediate need for additional capital and in addition to our recently announced letter of intent for a business combination transaction we are continuing to explore additional potential transactions to improve our capital position to ensure we are able to meet our financing and working capital requirements. We would expect to raise additional funds through public or private equity offerings, debt financings or strategic alliances or a restructuring of outstanding debt obligations. Raising additional funds by issuing equity or convertible debt securities may cause our stockholders to experience substantial dilution in their ownership interests and new investors may have rights superior to the rights of our other stockholders. Raising additional funds through debt financing or preferred stock, if available, may involve covenants that restrict our business activities and options and such additional securities may have powers, designations, preferences or rights senior to our currently outstanding securities or may require the granting of liens on our assets or preferences on revenue sources. We may also enter into financing transactions which involve the granting of liens on our assets or which grant preferences of

 

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payment from our revenue streams, all of which could adversely impact our ability to rely on our revenue from operations to support our ongoing operating costs. Alternatively, we may seek to obtain new financing from existing security holders, which may include reducing the exercise or conversion prices of outstanding securities, or the issuance of additional equity securities. Currently, the company does not have any definitive agreements with any third parties for such transactions and there can be no assurances that the company will be successful in completing the transaction contemplated by the letter of intent, raising additional capital or securing financing when needed or on terms satisfactory to the company. If we are unsuccessful in raising additional capital we will need to reduce costs and operations substantially or potentially suspend operations. Accordingly, any inability to obtain required financing on sufficiently favorable terms could have a material adverse effect on our business, results of operations and financial condition.

At September 30, 2015, cash and cash equivalents amounted to approximately $282,000 and total assets at that date were $4,188,000. Since June 30, 2015 cash and cash equivalents increased approximately $35,000 reflecting the issuance of company securities offset in part by cash used principally to fund operating losses, product development activities, changes in working capital, and capital expenditures during the three months ended September 30, 2015. Our current estimated monthly operational requirements after giving effect to our cost cutting measures, but not to any special or one-time events, is approximately $350,000. Cash used for the period includes investments in licenses and other assets, and the prepayment of certain insurance premiums and maintenance contracts. We expect to continue to use cash to fund operating losses, changes in working capital, product development activities, and capital expenditures for the foreseeable future.

Net cash used in operating activities for the three months ended September 30, 2015 was approximately $1,191,000 compared to $1,737,000 for the prior year period reflecting a decrease in cash used for operations during the current period. Net cash used by investing activities was $19,000 for the three months ended September 30, 2015 compared to $84,000 for the prior year period. This change reflects a decrease in asset and related purchases for the current period. Net cash provided by financing activities for the three months ended September 30, 2015 was approximately $1,245,000 compared to $2,106,000 for the prior year period. The amount for the current period reflects the proceeds from short-term note transactions discussed above. The amount for the prior year reflects the proceeds from the August 2014 registered direct offering less the payment of certain preferred stock dividends.

Our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including:

 

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our relationships with suppliers and customers;

 

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the market acceptance of our products and services;

 

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the levels of promotion and advertising that will be required to launch our new offerings and achieve and maintain a competitive position in the marketplace;

 

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price discounts on our products and services to our customers;

 

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our pursuit of strategic transactions; including our ability to complete the transaction contemplated by our recently announced letter of intent for a business combination;

 

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our need to repay existing indebtedness;

 

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our business, product, capital expenditure and research and development plans and product and technology roadmaps;

 

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the level of accounts receivable and inventories that we maintain;

 

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technological advances;

 

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our decision to redeem our outstanding shares of preferred stock; and

 

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our competitors’ response to our offerings.

Financing Activities

Except as discussed above, we have not engaged in any external financing activities in fiscal 2016 and 2015.

Other Matters

The events and contingencies described below have impacted or may impact our liquidity and capital resources.

In August 2015, we announced that our board was focused on exploring strategic alternatives in order to enhance shareholder value. Subsequently, on August 25, 2015, we announced that we had entered into a non-binding letter of intent with Peachstate Health Management, LLC d/b/a AEON Clinical Laboratories, an expanding clinical laboratory based in Gainesville, GA (“AEON”) for the acquisition of all of the outstanding membership interests of AEON in exchange for shares of a newly created class of Series E preferred stock of Authentidate. As described in greater detail in Note 4 of Notes to Condensed Consolidated Financial Statements, the letter of intent provides that if certain financial results are achieved during the next four years, the AEON members would be issued Series E Shares convertible into 85% of the outstanding shares of the company’s common stock on a partially diluted basis as of the closing date.

 

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Presently, 28,000 shares of our Series B preferred stock, originally issued in a private financing in October 1999, remain outstanding. As of October 1, 2004, our right to redeem these shares of Series B preferred stock is vested. Accordingly, we have the right to repurchase such shares at a redemption price equal to $25.00 per share, plus accrued and unpaid dividends. The holder, however, has the right to convert these shares of preferred stock into an aggregate of 250,000 shares of our common stock at a conversion rate of $2.80. In the event we elect to redeem these securities, the holder will be able to exercise its conversion right subsequent to the date that we issue a notice of redemption but prior to the deemed redemption date as would be set forth in such notice. As of September 30, 2015, no shares of the Series B preferred stock have been redeemed.

In connection with our private placement of Series D preferred stock in June 2013, we issued 665,000 shares of Series D 5% convertible preferred stock. The Series D preferred stock is convertible into 6,125,024 shares of our common stock at an initial conversion rate of $1.08571 per share. Each share of Series D preferred stock has a stated value of $10.00 per share. The company has the right to repurchase these shares at the stated value per share, plus accrued and unpaid dividends, starting in June 2015 and to require the holders to convert such securities into common stock starting in June 2016. Each holder of our Series D preferred stock has the right to convert such shares into common stock at anytime commencing on the six month anniversary date of the issue date. The Series D preferred stock will pay dividends at the rate of 5% per annum, payable in cash or shares of common stock, at the company’s option subject, however, to limitations required by the Nasdaq stock market.

Commitments

Office Lease Commitments

We entered into the lease agreement for our executive offices on July 11, 2005. The lease was for a term of ten years and four months, with a commencement date of October 1, 2005 and covers approximately 19,700 total rentable square feet. The annual rent in the first year was $324,000 increasing to $512,000 in year 2 and increasing at regular intervals until year 10 when the annual rent would be approximately $561,000. Effective February 1, 2010, we amended our lease to reduce the annual rent to approximately $512,000 for the remaining lease term and extended the lease term for one year through January 2017. As part of the lease agreement, we posted a letter of credit securing our lease payments which was reduced to approximately $256,000. On September 23, 2015, we amended our lease to relocate our executive offices to approximately 5,200 total rentable square feet in the same building. The lease amendment is dated as of September 15, 2015 and will be effective upon the completion of renovations to the premises or, if earlier, the date that the company occupies the space. The amended lease has a term of six years following the occupancy date and annual rentals ranging from approximately $135,000 in the first year to $148,000 in the final year. The lease also provides us with a one-time option to renew the lease for a term of five years at the then-current market rate and, provided we pay an early termination fee, allows us an early termination option on each of the 18-month, 27-month and 36-month anniversary dates of the effective date of the amendment. As part of the lease agreement, we will reduce our letter of credit securing our lease payments to approximately $135,000.

Contractual Commitments

A summary of the contractual commitments associated with our lease obligations as of September 30, 2015 is as follows (in thousands):

 

		Total				Less than 1 year				1-3 years				4-5 years				More than 5 years
Leases
Operating		$	891			$	166			$	420			$	293			$	12
Capital			40				16				24				—				—
Total lease obligations		$	931			$	182			$	444			$	293			$	12

In connection with the termination of the company’s employment relationship with its former chief executive officer and president in February 2015, the company is presently reviewing its severance obligations to him and the vesting and other post-termination provisions of certain of the unexercised stock options and other unvested stock options and unvested restricted stock units held by him as of the effective date of his separation from the company.

 

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Off-Balance Sheet Arrangements

We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources. We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, we have not made any payments under these agreements that have been material individually or in the aggregate. As of September 30, 2015, we were not aware of any obligations under such indemnification agreements that would require material payments.

Effects of Inflation and Changing Prices

The impact of general inflation on our operations has not been significant to date and we believe inflation will continue to have an insignificant impact on us.

Present Accounting Standards Not Yet Adopted

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (Topic 606). This ASU is intended to clarify the principles for recognizing revenue by removing inconsistencies and weaknesses in revenue requirements; providing a more robust framework for addressing revenue issues; improving comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; and providing more useful information to users of financial statements through improved revenue disclosure requirements. The new standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. The provisions of this ASU were effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2016. Early application is not permitted. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date”, which defers the effective date to fiscal periods beginning after December 15, 2017. Early adoption is permitted for fiscal periods beginning after December 15, 2016. The standard permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the impact of this standard on our consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” This ASU requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition, and apply existing guidance under the Stock Compensation Topic of the ASC as it relates to awards with performance conditions that affect vesting to account for such awards. The provisions of this ASU are effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2015. We are currently evaluating the impact of this standard on our consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “ Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This ASU is intended to define management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Specifically, ASU 2014-15 provides a definition of the term substantial doubt and requires an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). It also requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans and requires an express statement and other disclosures when substantial doubt is not alleviated. The new standard will be effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of this standard on our consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU is intended to simplify the presentation of debt issuance costs and conform to the guidance in International Financial Reporting Standards, which requires that transaction costs be deducted from the carrying value of the financial liability and not recorded as separate assets. Additionally, the requirement to recognize debt issuance costs as deferred charges

 

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conflicts with the guidance in FASB Concepts Statement No. 6, “Elements of Financial Statements,” which states that debt issuance costs are similar to debt discounts and in effect reduce the proceeds of borrowing, thereby increasing the effective interest rate. FASB Concepts Statement No. 6 further states that debt issuance costs cannot be an asset because they provide no future economic benefit. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. For public business entities, the amendments in this ASU are effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2015. In August 2015, the FASB issued ASU No. 2015-15, “Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements—Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting.” This ASU adds SEC paragraphs pursuant to the SEC Staff Announcement at the June 18, 2015, Emerging Issues Task Force meeting about the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements to this topic. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. We are currently evaluating the impact of this standard on our consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement”, which provides explicit guidance to help companies evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The new guidance clarifies that if a cloud computing arrangement includes a software license, the customer should account for the license consistent with its accounting for other software licenses. If the arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 is effective for public business entities for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2015. An entity can elect to adopt the amendments either prospectively for all arrangements entered into or materially modified after the effective date, or retrospectively. Early adoption is permitted for all entities. We are currently evaluating the impact of this standard on our consolidated financial statements.

In May 2015, the FASB issued ASU 2015-08, “Business Combinations—Pushdown Accounting—Amendment to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115.” This ASU was issued to amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115. This update is not expected to have a significant impact on our consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory.” The amendments in this ASU require an entity to measure in scope inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. A reporting entity should apply the amendments prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. We are currently evaluating the impact of this standard on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are not exposed to significant financial market risks from changes in foreign currency exchange rates and are only minimally impacted by changes in interest rates. However, in the future, we may enter into transactions denominated in non-U.S. currencies or increase the level of our borrowings, which could increase our exposure to these market risks. We have not used, and currently do not contemplate using, any derivative financial instruments.

Interest Rate Risk

At any time, fluctuations in interest rates could affect interest earnings on our cash and marketable securities. We believe that the effect, if any, of reasonably possible near term changes in interest rates on our financial position, results of operations, and cash flows would not be material. Currently, we do not hedge these interest rate exposures. The primary objective of our investment activities is to preserve capital. We have not used derivative financial instruments in our investment portfolio.

At September 30, 2015, our unrestricted cash totaled approximately $282,000 and was in non-interest bearing checking accounts used to pay operating expenses.

 

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, have concluded that, based on the evaluation of these controls and procedures, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure.

Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Our management, however, believes our disclosure controls and procedures are in fact effective to provide reasonable assurance that the objectives of the control system are met.

Changes in Internal Control over Financial Reporting

There was no change in our system of internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the quarter ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II Other Information

Item 1. Legal Proceedings

We are subject to claims and litigation arising in the ordinary course of business. Our management considers that any liability from any reasonably foreseeable disposition of such claims and litigation, individually or in the aggregate, would not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Item 1A. Risk Factors

As provided for under the Private Securities Litigation Reform Act of 1995, we wish to caution shareholders and investors that the following important factors, among others discussed throughout this Quarterly Report on Form 10-Q and a restated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2015 and in our reports subsequently filed with the SEC. You should carefully consider the risks described below, together with all of the following risk factors and the other information included in this report, in considering our business herein as well as the information included in our other reports filed with the SEC. These risks have affected, and in some cases could affect, our actual results of operations and cause our results to differ materially from those anticipated in forward looking statements made herein. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations, financial condition and/or operating results. If any of the matters or events described in the following risks actually occurs, our business, financial condition or results of operations could be harmed. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment due to any of these risks.

Risks Related to Our Financial Condition

Failure to increase our revenue and keep our expenses consistent with revenues could prevent us from achieving and maintaining profitability in the near term as we seek to generate new business revenues to offset the loss of our largest customer.

We incurred net losses of approximately $9,700,000, $7,143,000 and $11,349,000 for the fiscal years ended June 30, 2015, 2014 and 2013, respectively and had an accumulated deficit of approximately $206,485,000 at June 30, 2015. We also had a net loss of $2,063,000 for the three months ended September 30, 2015 and had an accumulated deficit of approximately $208,650,000 at September 30, 2015. We have expended, and will continue to be required to expend, substantial funds to pursue product development

 

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projects, enhance our marketing and sales efforts and to otherwise operate our business. Therefore, we will need to generate higher revenues to achieve and maintain profitability and cannot assure you that we will be profitable in any future period. Further, our ability to generate the level of revenues we require to achieve profitability was adversely impacted by the decision of the Department of Veterans Affairs not to exercise the remaining renewal period of our contract. The loss of this customer has increased and accelerated our need to diversify our business by adding new customers. Our prospects should be considered in light of the difficulties frequently encountered in connection with the establishment of a new business line, which characterizes our business, such as the difficulty in creating a viable market, the significant related development and marketing costs and the overall competitive environment in which we operate. Accordingly, there can be no assurance that we will be able to achieve profitable operations in future operating periods. Our business results are likely to remain uncertain as we are unable to reliably predict revenues from our current customers. Revenue levels achieved from our customers, the mix of products and solutions that we offer, our ability to introduce new products as planned and our ability to reduce and manage our operating expenses will affect our financial results. Consequently, we may not be profitable in any future period. Unless we can generate additional revenues from sales or rentals of products and services to existing customers or obtain new customers, we will continue to generate substantial operating losses and may need to curtail our business and incur additional restructuring or exit costs, which may be material. These factors, among others, raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Our capital requirements have been significant and until our revenues can sufficiently support our operating costs, we expect to raise additional capital to finance our operations and repay outstanding debt obligations.

Our capital requirements have been and will continue to be significant. We have been substantially dependent upon private placements and registered offerings of our securities and on short-term and long-term debt transactions to fund such requirements. We are expending significant amounts of capital to develop, promote and market our software, services and products. Due to these expenditures, we have incurred significant losses to date. We used approximately $4,951,000, $4,726,000 and $5,214,000 in cash for operating activities for the fiscal years ended June 30, 2015, 2014 and 2013, respectively and $1,191,000 for the three months ended September 30, 2015. Our available cash and cash equivalents as of September 30, 2015 totaled approximately $282,000. Our current estimated monthly operational requirements after giving effect to our cost cutting measures, but not to any special or one-time events is approximately $350,000. Since June 2015, we have completed a number of debt financing transactions resulting in total proceeds of approximately $1.7 million, and have approximately $1.45 million in notes that are due in November 2015. The company is engaged in ongoing discussions and negotiations with the holders of these notes in order to seek modifications to the terms of these obligations, including extensions of the repayment date. We have an immediate need for additional capital and are continuing to explore additional potential transactions to improve our capital position. We expect our existing resources, revenues generated from operations, net proceeds from our debt financing transactions, other transactions we are considering and proceeds received from the exercise of outstanding warrants or restructuring of debt (of which there can be no assurance) to satisfy our working capital requirements for at least the next twelve months; however, no assurances can be given, that we will be able to attain sales levels and support our costs through revenues derived from operations or generate sufficient cash flow to satisfy our other obligations. These factors, among others, raise substantial doubt about our ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments to the recoverability and classification of assets carrying amounts or the amounts and classifications of liabilities that might result from the outcome of these uncertainties. Unless we are able to increase revenues substantially or generate additional capital from other transactions, our current cash resources will only satisfy our working capital needs for a limited period of time. In addition to our recently announced letter of intent for a business combination transaction, we are continuing to explore additional potential transactions to improve our capital position to ensure we are able to meet our financing and working capital requirements. We would expect to raise additional funds through public or private equity offerings, debt financings or strategic alliances. Raising additional funds by issuing equity or convertible debt securities may cause our stockholders to experience substantial dilution in their ownership interests and new investors may have rights superior to the rights of our other stockholders. Raising additional funds through debt financing or preferred stock, if available, may involve covenants that restrict our business activities and options and such additional securities may have powers, designations, preferences or rights senior to our currently outstanding securities. We may also enter into financing transactions which involve the granting of liens on our assets or which grant preferences of payment from our revenue streams, all of which could adversely impact our ability to rely on our revenue from operations to support our ongoing operating costs. Alternatively, we may seek to obtain new financing from existing security holders, which may include reducing the exercise or conversion prices of outstanding securities, or the issuance of additional equity securities. Currently, the company does not have any definitive agreements with any third-parties for such transactions and there can be no assurance, however, that we will be successful in completing the transaction contemplated by the letter of intent, raising additional capital or securing financing when needed or on terms satisfactory to the company. If we are unable to raise additional capital when required, or on acceptable terms, we will need to reduce costs and operations substantially or potentially suspend operations, any of which would have a material adverse effect on our business, financial condition and results of operations. Our future capital requirements will depend on, and could increase substantially as a result of many factors, including:

 

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our need to utilize cash to support research and development activities and to make incremental investments in our organization;

 

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•

our ability to achieve targeted revenue, gross profit margins and cost management objectives;

 

•

our ability to reach break-even or profitability;

 

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the success of our sales and marketing efforts;

 

•

our need to repay indebtedness;

 

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the extent and terms of any development, marketing or other arrangements; and

 

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changes in economic, regulatory or competitive conditions, including the continuing economic weakness and federal budgetary uncertainty.

We depend on a limited number of customers for a substantial portion of our revenues, and the loss of the VA as a customer and the loss, or a significant reduction in purchases by, one or more of our other important customers will adversely affect our operating results.

We receive a significant amount of our revenues from a limited number of customers. Over recent years, the Department of Veterans Affairs (VA) had been our largest customer, generating approximately 45% of our total consolidated revenues for the fiscal year ended June 30, 2015. On March 6, 2015, the company announced that the VA informed the company that it was not exercising the fourth and final option year under the contract for telehealth services. Our VA revenue included both recurring services revenue as well as hardware sales. Due to this, the company expects to report significantly reduced revenues over the next several quarters and the loss of this business will materially adversely affect our business, results of operations and financial condition until we are able to replace the revenues that had been generated through our VA contract. We will need to attract new clients and attempt to diversify our customer base from a limited number of potential customers. In general, most of our customer orders for our telehealth business have been and are expected to continue to be made on a purchase order basis, which does not generally require any long-term commitments nor any minimum purchase requirements. Therefore, these customers may alter their past purchasing behavior with little or no notice to us for various reasons. If our customers alter their past (or expected) purchasing behavior, or if we encounter any problems collecting amounts due from them, our financial condition and results of operations could be negatively impacted.

Our revenues may be affected by changes in technology spending levels.

In the past, unfavorable or uncertain macroeconomic conditions and reduced global technology spending rates have adversely affected the markets in which we operate. Current economic conditions and ongoing uncertainty about the economic recovery could reduce the demand for our products and services and negatively impact revenues and operating profit. We are unable to predict changes in general macroeconomic conditions and when global spending rates will be affected. Furthermore, even if spending rates increase, we cannot be certain that the market for our products and services will be positively impacted. If there are future reductions in spending rates, or if spending rates do not increase, our revenues, operating results and financial condition may be adversely affected.

Healthcare policy changes, including recent laws to reform the U.S. healthcare system, may have a material adverse effect on us.

Healthcare costs have risen significantly over the past decade. There have been, and continue to be, proposals by legislators, regulators, and third-party payors to keep these costs down. Certain proposals, if passed, could impose limitations on the prices we will be able to charge for our products, or the amounts of reimbursement available for our products from governmental agencies or third-party payors. These limitations could have a material adverse effect on our financial position and results of operations.

On March 23, 2010, the Patient Protection and Affordable Care Act was signed into law and on March 30, 2010, the Health Care and Education Reconciliation Act of 2010 was signed into law. Together, the two measures make the most sweeping and fundamental changes to the U.S. healthcare system since the creation of Medicare and Medicaid. The Health Care Reform laws include a large number of health-related provisions to take effect over the next four years, including expanding Medicaid eligibility, requiring most individuals to have health insurance, establishing new regulations on health plans, establishing health insurance exchanges, requiring manufacturers to report payments or other transfers of value made to physicians and teaching hospitals, and modifying certain payment systems to encourage more cost-effective care and a reduction of inefficiencies and waste, including through new tools to address fraud and abuse. In 2013, a 2.3% excise tax on the sale by manufacturers, producers and importers of certain medical devices that are not exempted from such tax was imposed under these health care reform laws. Further, as administrative rules implementing healthcare reform under the legislation are not yet finalized or have been modified, the impact of the healthcare reform legislation on our business is unknown, and there can be no assurances that healthcare reform legislation will not adversely impact either our operational results or the manner in which we operate our business. Healthcare industry participants may respond by reducing their investments or postponing investment decisions, including investments in our solutions and services.

 

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In addition, various healthcare reform proposals have also emerged at the state level. We cannot predict the exact effect newly enacted laws or any future legislation or regulation will have on us. However, the implementation of new legislation and regulation may lower reimbursements for our products, reduce medical procedure volumes and adversely affect our business, possibly materially. In addition, the enacted excise tax may materially and adversely affect our operating expenses and results of operations.

We depend on growth in the software as a service market, and lack of growth or contraction in this market could materially adversely affect our sales and financial condition.

Our hosted software and web-based solutions compete with other “software as a service” solutions. Demand for our solutions and software offerings is driven by several factors, including an increased focus on protecting business-critical applications, government and industry regulations requiring data protection and integrity, and the growth in the market for software as a service. Segments of the computer and software industry have in the past experienced significant economic downturns and decreases in demand as a result of changing market factors. A change in the market factors that are driving demand for offerings of software as a service could adversely affect our sales, profitability and financial condition.

We depend on third parties for the supply and manufacture of our telehealth products, which may result in delays and quality-control issues could adversely impact our business.

We do not own or lease any manufacturing facilities. Accordingly, in order to market our telehealth solution we purchase finished products and components from unaffiliated suppliers and use a contract manufacturer to produce our Electronic House Call device. In addition, we may use unaffiliated third parties to provide products and distribution services for this solution. If the agreements with these third parties are terminated or if they are unable to perform their obligations under such agreements, it could take several months to establish and qualify alternative suppliers and manufacturing and distribution partners for our products and we may not be able to fulfill our customers’ orders in a timely manner. At the present time we believe that if existing third party relationships terminate, alternative providers are available on commercially reasonable terms. However, there can be no assurance that the future production capacity of our current manufacturer will be sufficient to satisfy our requirements or that alternative providers of components or manufacturing or distribution services will be available on commercially reasonable terms, or at all. The failure to identify suitable alternative suppliers, manufacturers or distributors could adversely impact our customer relationships and our financial condition. In addition, due to our use of third-party manufacturers and distributors, we do not have control over the timing of product shipments. Delays in shipment could result in the deferral or cancellation of purchases of our products, which would harm our results of operations in any particular quarter. Revenue for a period may be lower than predicted if large orders forecasted for that period are delayed or are not realized, which could impact cash flow or result in a decline in our stock price.

Our business may be adversely affected by legal proceedings.

We have been in the past, and may become in the future, involved in legal proceedings. You should carefully review and consider the various disclosures we make in our reports filed with the SEC regarding legal matters that may affect our business.

The expense of defending such litigation may be substantial and the time required to defend the actions could divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows. We cannot predict with certainty the outcome of any legal proceedings in which we become involved and it is difficult to estimate the possible costs to us stemming from any such matters. In addition, an unfavorable outcome in such litigation could have a material adverse effect on our business, results of operations, financial position and cash flows.

Our success is dependent on the performance of our management and the cooperation, performance and retention of our executive officers and key employees.

Our business and operations are substantially dependent on the performance of our senior management team and executive officers. If our management team is unable to perform it may adversely impact our results of operations and financial condition. We do not maintain “key person” life insurance on any of our executive officers. The loss of one or several key employees could seriously harm our business. Any reorganization or reduction in the size of our employee base could harm our ability to attract and retain other valuable employees critical to the success of our business.

 

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If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired.

Our future success depends upon the continued service of our key management, technical, sales, finance, and other critical personnel. Other than with respect to employment agreements that we entered into with our executive officers, our key personnel do not have employment agreements and we cannot assure you that we will be able to retain them. Key personnel have left our company in the past and there likely will be additional departures of key personnel from time to time in the future. Further, following the non-renewal of our telehealth contract with the VA, in order to reduce our operating costs, we have implemented several reductions in staff and the use of external resources and to date have eliminated a number of positions throughout the company, or more than 50% of our workforce. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives, the effectiveness of our disclosure controls and procedures and our internal control over financial reporting, and the results of our operations. In addition, hiring, training, and successfully integrating replacement sales and other personnel could be time consuming, may cause additional disruptions to our operations, and may be unsuccessful, which could negatively impact future revenues.

Developing and implementing new or updated software and services and other product offerings may take longer and cost more than expected.

We rely on a combination of internal development, strategic relationships, licensing and acquisitions to develop our products and services. The cost of developing new software, services and other product offerings, such as Inscrybe Healthcare and related modules, and our telehealth offerings is inherently difficult to estimate. Our development and implementation of proposed software, services or other product offerings may take longer than originally expected, require greater investment of cash resources than initially expected, require more testing than originally anticipated and require the acquisition of additional personnel and other resources. Accordingly, we expect to face substantial uncertainties with respect to the performance and market acceptance of new software and services and other product offerings. If we are unable to develop new or updated software, services or other product offerings on a timely basis and implement them without significant disruptions to the existing systems and processes of our customers, we may lose potential revenues and harm our relationships with current or potential customers.

The success of any of our product acquisition and licensing activities is subject to uncertainty and any completed acquisitions or licenses may reduce our earnings, be difficult to integrate, not perform as expected or require us to obtain additional financing.

We regularly evaluate selective acquisitions and look to continue to enhance our product line by acquiring rights to additional products and services. Such acquisitions may be carried out through the purchase of assets, joint ventures and licenses or by acquiring other companies. However, we cannot assure you that we will be able to complete acquisitions or in-licensing arrangements that meet our target criteria on satisfactory terms, if at all. Successfully integrating a product or service acquisition or in-licensing arrangement can be a lengthy and complex process. The diversion of our management’s attention and any delays or difficulties encountered in connection with any of our acquisitions or arrangements could result in the disruption of our ongoing business or inconsistencies in standards, controls, procedures and policies that could negatively affect our ability to maintain relationships with customers, suppliers, employees and others with whom we have business dealings. In addition, other companies, including those with substantially greater resources than ours, may compete with us for the acquisition of product or in-licensing candidates and approved products, resulting in the possibility that we devote resources to potential acquisitions or arrangements that are never completed. If we do engage in any such acquisition or arrangement, we will incur a variety of costs, and we may never realize the anticipated benefits of the acquisition or arrangement in light of those costs. If we fail to realize the expected benefits from acquisitions or arrangements we may consummate in the future, whether as a result of unidentified risks, integration difficulties, regulatory setbacks or other events, our business, results of operations and financial condition could be adversely affected.

In addition, our product acquisition and licensing activities may require us to obtain additional debt or equity financing, resulting in increased debt obligations or dilution of ownership to our existing stockholders, as applicable. Therefore, we may not be able to finance acquisitions on terms satisfactory to us, if at all.

New or updated software, services and product offerings will not become profitable unless they achieve sufficient levels of market acceptance, which may require significant efforts and costs.

There can be no assurance that customers and potential customers will accept from us new or updated software, services and other products. The future results of our business will depend, in significant part, on the success of our software, services or other product offerings. Current and potential customers may choose to use similar products and services offered by our competitors or may not purchase new or updated software, services or products, especially when they are initially offered and if they require changes in equipment or workflow. For software, services and products we are developing or may develop in the future, there can be no assurance that we will attract sufficient customers or that such offerings will generate sufficient revenues to cover their associated development, marketing and maintenance costs. Furthermore, there can be no assurance that any pricing strategy that we implement for any new software and services or other product offerings will be economically viable or acceptable to the target markets. Failure to

 

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achieve broad penetration in target markets with respect to new or updated software, services and product offerings could have a material adverse effect on our business prospects. Further, achieving market acceptance for new or updated software, services and product offerings is likely to require substantial marketing efforts and expenditure of significant funds to create awareness and demand by potential customers.

We do not have patents on all the technology we use, which could harm our competitive position.

Presently, we have one issued U.S. patent and one pending patent application. We also have been granted a license to one issued U.S. patent by Authentidate International AG, two issued U.S. patents by our former joint venture partner and their affiliate and one issued U.S. patent by a third party. We also entered into a license and settlement agreement with Robert Bosch Healthcare Systems, Inc. providing for the resolution and dismissal, with prejudice, of the purported patent infringement lawsuit filed by Bosch against Express MD in January 2012 and a license to the various asserted patents. Some of the technology embodied in some of our current products cannot be patented. We have registered the trademarks “Authentidate”, “Inscrybe”, “InscrybeMD”, “AuthentiProof” and “Inscrybe Office” in the U.S., the trademark “Authentidate” in the European Community and Canada, “AuthentiProof” in Canada, Mexico and the European Community, “Inscrybe” in the European Community and Canada, “Inscrybe Office,” and a number of other trademarks as Madrid Protocol international registrations. We continue to take steps to protect our intellectual property rights including filing additional trademark and patent applications where appropriate. We rely on confidentiality agreements with our key employees to the extent we deem it to be necessary. We further intend to file patent applications for any new products we may develop, to the extent that we believe that any technology included in such products is patentable. There can be no assurance that any patents in fact, will be issued or that any such patents that do issue will be effective to protect our products and services from duplication by other manufacturers or developers or to prevent our competitors from offering similar products and services. Other companies operating within our business segments may independently develop substantially equivalent proprietary information or otherwise obtain access to our know-how, much of which is maintained as trade secrets and there can be no assurance that we will be able to afford the expense of any litigation which may be necessary to enforce our rights under any patent.

In addition, with respect to our telehealth offerings, in connection with the termination of the joint venture, our former joint venture partner and an affiliate licensed to us certain intellectual property assets to enable us to continue to commercialize and develop the ExpressMD Solutions remote patient monitoring products and services. Accordingly, our right to utilize any such intellectual property is subject to the terms of this agreement. Further, and similar to the intellectual property owned by us, there can be no assurance that the intellectual property licensed to us will be effective to protect our products and services from duplication by other manufacturers or developers or to prevent our competitors from offering similar products and services.

We have investigated patents held by third parties of which we are aware and we believe that our products and services, including our telehealth offerings, do not infringe on the claims of these patents. However, we cannot provide any assurances that our products and services do not infringe upon any third party patents or violate the proprietary rights of others, including the patents we have investigated, and it is possible that such infringement or violation has occurred or may occur. As previously reported, we recently settled a claim with Robert Bosch Healthcare Systems, Inc. regarding a purported patent infringement lawsuit filed by Bosch against Express MD in January 2012. While the company does not believe that it was or is infringing any of the asserted patents, in order to mitigate its risk and avoid further costs and distractions of litigation, it entered into the license and settlement agreement.

In the event that products we sell or services we provide are deemed to infringe upon the patents or proprietary rights of others, we could be required to modify our products and/or services or obtain a license for the manufacture, use and/or sale of such products and services. There can be no assurance that, in such an event, we would be able to do so in a timely manner, upon acceptable terms and conditions, or at all, and the failure to do any of the foregoing could have a material adverse effect upon our business. Moreover, there can be no assurance that we will have the financial or other resources necessary to defend against a patent infringement or proprietary rights violation action. In addition, if our products, services or proposed products or services are deemed to infringe upon the patents or proprietary rights of others, we could, under certain circumstances, become liable for damages or subject to an injunction, which could also have a material adverse effect on our business.

Because we currently derive our revenues from a few telehealth products and services, hosted software and web-based service offerings, any decline in demand for these offerings could severely harm our ability to generate revenues.

We currently derive our revenues from a limited number of telehealth products and services, hosted software and web-based service offerings. In addition, our focus on building our business is concentrated on markets for telehealth solutions, hosted software and web-based services where content integrity, workflow automation, electronic signatures, time and date stamping and web-based services are important to customers. As a result, we are particularly vulnerable to fluctuations in demand for these offerings, whether as a result of competition, product obsolescence, technological change, customer spending, or other factors. If our revenues derived from our offerings were to decline significantly, our business and operating results would be adversely affected. As occurred following the end of our business relationship with the VA, if our relationships with significant customers were disrupted we could lose a significant percentage of our anticipated revenues which could have material adverse effect on our business.

 

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Some of our hosted software and web-based service offerings have long and unpredictable sales cycles, which may impact our quarterly operating results.

Transactions for some of our hosted software and web-based service offerings may require customers to undertake customized installations to integrate the solutions into their legacy systems and require them to modify existing business practices. The period from our initial contact with a potential customer until the execution of an agreement is difficult to predict and can be in excess of six to twelve months. The sales cycles for these transactions can be long and unpredictable due to a number of uncertainties such as:

 

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customers’ budgetary constraints;

 

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the need to educate potential customers about our software and service offerings;

 

•

the timing of customers’ budget cycles;

 

•

delays caused by customers’ internal review processes;

 

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customers’ willingness to invest resources and modify their network infrastructures to make use of our offerings; and

 

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for sales to government customers, governmental regulatory approval and purchasing requirements.

We are unable to control or influence many of these factors. Further, we have experienced delays in the pace of adoption and use by our customers of our transaction-based offerings, such as Inscrybe Healthcare, which has adversely affected our earnings. We may experience similar delays with our other products and services and products and services currently under development. During the sales cycle and the implementation period, we may expend substantial time, effort and money preparing contract proposals, negotiating contracts and implementing solutions without receiving any related revenue. In addition, many of our expenses are relatively fixed in the short term, including personnel costs and technology and infrastructure costs. Accordingly, our inability to generate sufficient revenues from these offerings has a direct impact on our results of operations.

The failure to properly manage our growth could cause our business to lose money.

We are using our sales and marketing efforts in order to develop and pursue existing and potential market opportunities. This growth is expected to place a significant demand on management and operational resources. In order to manage growth effectively, we must implement and improve our operational systems and controls on a timely basis. If we fail to implement these systems and controls, our business, financial condition, results of operations and cash flows may be materially and adversely affected.

Healthcare industry consolidation could impose pressure on our price, reduce our potential client base and reduce demand for our offerings.

Many hospitals and health care centers have consolidated to create larger healthcare enterprises with greater market power. If this consolidation trend continues, it could reduce the size of our potential customer base and give the resulting enterprises greater bargaining power, which may lead to erosion of the prices for our products and services. In addition, this consolidation could also erode our revenue base.

Our hosted software and web-based services and web site may be subject to intentional disruption.

Although we believe we have sufficient controls in place to prevent intentional disruptions, such as software viruses specifically designed to impede the performance of our software and web-based services, we may be affected by such efforts in the future. Further, despite the implementation of security measures, this infrastructure or other systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, programming errors, attacks by third parties or similar disruptive problems, resulting in the potential misappropriation of our proprietary information or interruptions of our services. Any compromise of our security, whether as a result of our own systems or systems that they interface with, could substantially disrupt our operations, harm our reputation and reduce demand for our services.

Performance problems with our systems, security breaches and other disruptions could cause us to lose business or incur liabilities.

Our customer satisfaction and our business could be harmed if we experience transmission delays or failures or loss of data in the systems we use to provide services to our customers, including transaction-related services. Further, in the ordinary course of our business, we collect and store sensitive data, including our proprietary information and that of our customers in our data center and on our networks. These systems are complex and, despite testing and quality control and security measures, we cannot be certain that problems will not occur or that they will be detected and corrected promptly if they do occur, and our information technology systems

 

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may be vulnerable to attacks by hackers or breached due to error or malfeasance. In providing these services, we rely on internal systems as well as communications and hosting services provided by third parties, such as the Internet. To operate without interruption, both we and the service providers we use must guard against:

 

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damage from fire, power loss and other natural disasters;

 

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communications failures;

 

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software and hardware errors, failures or crashes;

 

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security breaches, computer viruses and similar disruptive problems; and

 

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other potential interruptions.

We have experienced periodic system interruptions in the past, and we cannot guarantee that they will not occur again. In the event of a catastrophic event at our data center or any third party facility we use, we may experience an extended period of system unavailability, which could negatively impact our business. Further, any compromise of our electronic systems, including the unauthorized access, use or disclosure of sensitive information, the disruption or breach of our networks or security measures, the loss of stored data, could have a material adverse impact on our business, expose us to reputational damage, result in legal claims and cause us to incur material liabilities. Such events would also be likely to require us to incur significant costs to improve cyber security, including through organizational changes, deploying additional personnel and protection technologies, further training of employees, and engaging third party experts and consultants. In addition, any real or perceived compromise of our security or disclosure of sensitive information may result in lost revenues by, deterring clients from using or purchasing our products and services in the future or by clients electing to use competing suppliers. Although we maintain insurance for our business, we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur or that this coverage will continue to be available on acceptable terms or in sufficient amounts.

In addition, some of our web-based services may, at times, be required to accommodate higher than expected volumes of traffic. At those times, we may experience slower response times or system failures. Any sustained or repeated interruptions or disruptions in these systems or slowdown in their response times could damage our relationships with customers. Further, the Internet has experienced, and is likely to continue to experience, significant growth in the number of users and the amount of traffic. If the Internet continues to experience increased usage, the Internet infrastructure may be unable to support the demands placed on it which could harm its reliability and performance. Any significant interruptions in our services or increases in response time could result in a loss of potential or existing users of services and, if sustained or repeated, could reduce the attractiveness of our services.

We are subject to product liability risks associated with the production, marketing and sale of products used in the healthcare industry.

The production, marketing and sale of devices used in the healthcare industry have inherent risks of liability in the event of product failure or claim of harm caused by product operation. Furthermore, even meritless claims of product liability may be costly to defend against. The commercialization of the telehealth device exposes us to such claims. These types of product liability claims may result in decreased demand for this product, injury to our reputation, related litigation costs, and substantial monetary awards to plaintiffs. We attempt to limit by contract our liability, however, the limitations of liability set forth in the contracts may not be enforceable in certain jurisdictions or may not otherwise protect us from liability for damages. We may also be subject to claims that are not covered by contract, such as a claim directly by a patient. Although we currently maintain product liability insurance, we may not have sufficient insurance coverage, and we may not be able to obtain sufficient coverage at a reasonable cost. Our inability to obtain product liability insurance at an acceptable cost or to otherwise protect against potential product liability claims could inhibit the commercialization of any products that we develop. If we are sued for any injury caused by our products or processes, then our liability could exceed our product liability insurance coverage and our total assets.

We need to comply with ongoing regulatory requirements applicable to our telehealth product and our results of operations may be adversely impacted by any failure to comply with these requirements. Further, modifications to our current telehealth products may require new marketing clearances or approvals or require us to cease marketing or recall the modified products until such clearances or approvals are obtained.

Our telehealth product is a medical device that is subject to extensive regulation in the United States. Unless an exemption applies, each medical device that we wish to market in the United States must receive either 510(k) clearance or premarket approval from the U.S. Food and Drug Administration, or the FDA, before the product can be sold. Either process can be lengthy and expensive. The FDA’s 510(k) clearance procedure, also known as “premarket notification,” is the process we have used for our current telehealth product. The regulatory clearance for our telehealth product provides for its use for its intended purposes. In addition, we are subject to inspection and marketing surveillance by the FDA to determine our compliance with all regulatory requirements and the manufacturing, labeling, packaging, adverse event reporting, storage, advertising, promotion, distribution and

 

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record-keeping for approved products are subject to extensive regulation. If the FDA determines that our promotional materials or activities constitute promotion of an unapproved use or we otherwise fail to comply with other FDA regulations, we may be subject to regulatory enforcement actions, including a public warning letter, injunction, civil fines, suspensions, loss of regulatory clearance, product recalls or product seizures. In the more egregious cases, criminal prosecution, civil penalties, or disgorgement of profits are possible. The subsequent discovery of previously unknown problems may also result in restrictions on the marketing of our products, and could include voluntary or mandatory recall or withdrawal of products from the market. Further, we cannot predict the likelihood, nature or extent of adverse government regulation that may arise from future legislation or administrative action. In addition, the FDA has increased its focus on regulating computer software intended for use in a healthcare setting, including applications meant to run on a mobile platform or on a browser tailored for use on a mobile platform. If our software solutions or applications are deemed to be actively regulated medical devices by the FDA, we could be subject to more extensive requirements governing pre- and post-marketing activities. As described above, complying with these regulations could be time consuming and expensive, and may require FDA clearance or pre-market approval. If we are not able to maintain regulatory compliance with any of our products, we may be subject to regulatory enforcement actions as described above and may not be permitted to market our products, which would have a material adverse impact on our results of operations, cash flows and financial condition.

Further, any modification to an FDA-cleared medical device that could significantly affect its safety or effectiveness, or that would constitute a major change or modification in its intended use, requires a new FDA 510(k) clearance or, possibly, a premarket approval. The FDA requires every manufacturer to make its own determination as to whether a modification requires a new 510(k) clearance or premarket approval, but the FDA may review and disagree with any decision reached by the manufacturer. In the future, we may make modifications to our telehealth products and, in appropriate circumstances, determine that new clearance or approval is unnecessary. Regulatory authorities may disagree with our decisions not to seek new clearance or approval and may require us to obtain clearance or approval for modifications to our products. If that were to occur for a previously cleared or approved product, we may be required to cease marketing or recall the modified device until we obtain the necessary clearance or approval. Under these circumstances, we may also be subject to significant regulatory fines or other penalties.

In February 2014, the FDA conducted a routine inspection of our business premises related to our telehealth products and upon the completion of their inspection issued us inspectional observations on FDA Form 483. We have provided the FDA with written responses to the Form 483 that describes the actions we have taken to address their observations and we believe that we have responded to the observations noted by the FDA. In February 2015, the FDA issued an Establishment Inspection Report (EIR) and considered the inspection “closed”. We would expect another inspection in 2016 based on the typical biennial inspections cycle from the FDA. Beyond incurring compliance-related expenses, we are presently unable to predict what impact, if any, these matters or ensuing proceedings, if any, will have on our financial condition, results of operations or cash flows.

Our ability to generate revenues from our telehealth products is subject to our ability to obtain acceptable prices or an adequate level of reimbursement from payors of healthcare costs.

Our ability to commercialize our telehealth product successfully will depend in part on the extent to which appropriate coverage and reimbursement levels for the cost of this product are obtained by us or by our direct customers from governmental authorities, private health insurers and other organizations. The ability of customers to obtain appropriate reimbursement for their products and services from private and governmental payors is critical to the success of medical technology device companies as the availability of reimbursement affects which products customers purchase and the prices they are willing to pay. The cost containment measures that healthcare payors and providers are instituting and the effect of any healthcare reform could materially and adversely affect our ability to generate revenues from this product and our profitability. In addition, given ongoing federal and state government initiatives directed at lowering the total cost of healthcare, the United States Congress and state legislatures will likely continue to focus on healthcare reform and the reform of the Medicare and Medicaid payment systems. While we cannot predict whether any proposed cost-containment measures will be adopted, the announcement or adoption of these proposals could reduce the price that we receive for our telehealth product in the future. We cannot predict the outcomes of any of legislative or regulatory efforts at reducing costs of providing healthcare and regulatory changes in this regard may have a material adverse effect on our business.

The healthcare industry is highly regulated at the local, state and federal level.

In addition to regulatory requirements concerning the commercialization of medical devices, we are subject to a significant and wide-ranging number of regulations both within the United States and elsewhere, such as regulations in the areas of healthcare fraud and the security and privacy of patient data. Existing and new laws and regulations affecting the health care industry could create unexpected liabilities for us, cause us to incur additional costs, and restrict our operations. Many health care laws are complex, and their application to specific services and relationships may not be clear and these laws and regulations may be applied to us in ways that we do not anticipate, particularly as we develop and release new and more sophisticated products and services. Our failure to accurately anticipate the application of these laws and regulations, or our other failure to comply with them, could create liability for us, result in adverse publicity, and negatively affect our business. Some of the risks we face from health care regulation are described below:

 

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Healthcare Fraud. Federal and state governments continue to enhance regulation of and increase their scrutiny over practices involving healthcare fraud affecting healthcare providers whose services are reimbursed by Medicare, Medicaid and other government healthcare programs. Our healthcare provider clients are subject to laws and regulations on fraud and abuse which, among other things, prohibit the direct or indirect payment or receipt of any remuneration for patient referrals, or arranging for or recommending referrals or other business paid for in whole or in part by these federal or state healthcare programs. Federal enforcement personnel have substantial funding, powers and remedies to pursue suspected or perceived fraud and abuse. The effect of this government regulation on our clients is difficult to predict. Many of the regulations applicable to our clients and that may be applicable to us, including those relating to marketing incentives offered in connection with medical device sales, are vague or indefinite and have not been interpreted by the courts. They may be interpreted or applied by a prosecutorial, regulatory or judicial authority in a manner that could broaden their applicability to us or require our clients to make changes in their operations or the way in which they deal with us. If such laws and regulations are determined to be applicable to us and if we fail to comply with any applicable laws and regulations, we could be subject to civil and criminal penalties, sanctions or other liability, including exclusion from government health programs, which could have a material adverse effect on our business, results of operations and financial condition.

Security and Privacy of Patient Information. Federal, state and local laws regulate the confidentiality of patient records and the circumstances under which those records may be released. These regulations govern both the disclosure and use of confidential patient medical record information and require the users of such information to implement specified security measures. United States regulations currently in place governing electronic health data transmissions continue to evolve and are often unclear and difficult to apply. Similarly, laws in non-U.S. jurisdictions may have similar or even stricter requirements related to the treatment of patient information. In the United States, HIPAA regulations require national standards for some types of electronic health information transactions and the data elements used in those transactions, security standards to ensure the integrity and confidentiality of health information and standards to protect the privacy of individually identifiable health information. Covered entities under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), which include healthcare organizations such as our clients, and our claims transmission services, are required to comply with the privacy standards, the transaction regulations and the security regulations. Moreover, the Health Information Technology for Economic and Clinical Health Act (HITECH) provisions of the American Recovery and Reinvestment Act of 2009 (ARRA) and associated regulatory requirements, extend many of the HIPAA obligations, formerly imposed only upon covered entities, to business associates as well. As a business associate of our clients who are covered entities, we were in most instances already contractually required to ensure compliance with the HIPAA regulations as they pertain to handling of covered client data. However, the extension of these HIPAA obligations to business associates by law has created additional liability risks related to the privacy and security of individually identifiable health information. Evolving HIPAA and HITECH related laws or regulations and regulations in non-U.S. jurisdictions could restrict the ability of our clients to obtain, use or disseminate patient information. This could adversely affect demand for our solutions if they are not re-designed in a timely manner in order to meet the requirements of any new interpretations or regulations that seek to protect the privacy and security of patient data or enable our clients to execute new or modified healthcare transactions. We may need to expend additional capital, software development and other resources to modify our solutions and devices to address these evolving data security and privacy issues. Furthermore, our failure to maintain confidentiality of sensitive personal information in accordance with the applicable regulatory requirements could damage our reputation and expose us to breach of contract claims (although we contractually limit liability, when possible and where permitted), fines and penalties.

Electronic Health Records Laws and Associated Interoperability Standards. A number of federal and state laws govern the use and content of electronic health record systems. For example, ARRA requires “meaningful use of certified electronic health record technology” by health care providers in order to receive incentive payments. Regulations have been issued that identify standards and implementation specifications and establish the certification standards for qualifying electronic health record technology. Nevertheless, these standards and specifications are subject to interpretation by the entities designated to certify such technology. While we have not sought to obtain certification of our software solutions for “meaningful use” under the criteria adopted by the U.S. Department of Health and Human Services regarding electronic health records, our software solutions operate in the framework of facilitating the electronic exchange of health care information by our customers and our solutions must be designed in a manner that facilitates our customers’ compliance with these laws. Further, there is increasing demand among customers, industry groups and government authorities that healthcare software and systems provided by various vendors be compatible with each other. Market forces or governmental/regulatory authorities could create software interoperability standards that would apply to our solutions, health care devices or solutions, and if our software solutions, health care devices or services are not consistent with those standards, we could be forced to incur substantial additional development costs to conform. We may incur increased development costs and delays in delivering solutions if we need to upgrade our software solutions to either obtain compliance with these varying and evolving standards or to facilitate such compliance by our customers. In addition, any standards applicable to our products and solutions may lengthen our sales and implementation cycle. To the extent that any such standards are narrowly construed or delayed in publication, or that we are delayed in achieving any certification that is necessary or desirable, our sales could be impaired and we may have to invest significantly in changes to our software solutions or devices. Because this is a topic of increasing state and federal regulation, we expect additional and continuing modification of the current legal and regulatory environment. We cannot predict the content or effect of possible future regulation on our business activities.

 

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In addition, in accordance with requirements under HIPAA, the U.S. Department of Health and Human Services (“HHS”) is implementing a new version of the standards for HIPAA-covered electronic transactions, including claims, remittance advices, and requests and responses for eligibility. These standards are called ANSI-5010. Additionally, HIPAA required all entities that are covered by HIPAA to upgrade to the tenth revision of the International Statistical Classification of Diseases and Related Health Problems promulgated by the World Health Organization, also known as ICD-10, for use in reporting medical diagnoses and inpatient procedures.

If we are unable to generate sufficient demand for our current telehealth products and services, we may not be able to recover our inventory and other investments.

In connection with our manufacturing and sales plans for our current telehealth products, we purchased certain components and contract manufacturing services for the production of our Electronic House Call monitoring appliance. Our ability to recover our investment in building inventories of our current telehealth products is subject to risks. If we are unable to generate sufficient demand for our products, or incur regulatory penalties relating to our telehealth products, we may not be able to recover the cost of our investments in our telehealth business and our financial condition and results of operations could be negatively impacted. As described in greater detail in Note 10 of Notes to Condensed Consolidated Financial Statements, we have determined that certain components that were held in inventory will not be used in production and we offset the inventory balance for undelivered items against the related accounts payable balance during the quarter ended March 31, 2015. Although to the company’s knowledge, no formal legal proceedings have been commenced regarding this matter, we are currently disputing the payment arrangements regarding these items with the relevant vendor. The company believes the amount at issue is approximately $1.2 million and intends to vigorously contest demands by the vendor for payment. Management does not believe that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

If our manufacturer and suppliers for our telehealth products fail to comply with the FDA’s Quality System Regulation, or QSR, and other applicable post market requirements, our operations could be disrupted, our product sales and profitability could suffer, and we may be subject to a wide variety of FDA enforcement actions.

After a device is placed on the market, numerous regulatory requirements also apply to our manufacturer and suppliers. The manufacturing processes of some of our vendors must comply with the FDA’s Quality System Regulation, or QSR, which governs the methods used in, and the facilities and controls used for, the design, testing, manufacture, control, quality assurance, installation, servicing, labeling, packaging, storage and shipping of medical devices. The FDA enforces the QSR through unannounced inspections. If one of our suppliers fails a QSR inspection, or if a corrective action plan adopted by a supplier is not sufficient, the FDA may bring an enforcement action, and our operations could be disrupted and the manufacturing of our products delayed. We are also subject to the FDA’s general prohibition against promoting our products for unapproved or “off-label” uses, the FDA’s adverse event reporting requirements and the FDA’s reporting requirements for field correction or product removals. The FDA has recently placed increased emphasis on its scrutiny of compliance with the QSR and these other post market requirements. If we or our manufacturer or suppliers violate the FDA’s requirements or fail to take adequate corrective action in response to any significant compliance issue raised by the FDA, the FDA can take various enforcement actions which could cause our product sales and profitability to suffer.

Our hosted software and web-based services and other product offerings may not be accepted by the market, which would seriously harm our business.

Demand and market acceptance for our currently available hosted software and web-based services and other product offerings remain subject to a high level of uncertainty. Achieving widespread acceptance of these or future offerings will continue to require substantial marketing efforts and the expenditure of significant funds to create and maintain brand recognition and customer demand for such offerings. Demand for our software, services and other product offerings depends on, among other things:

 

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the perceived ability of our offerings to address real customer problems;

 

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the perceived quality, price, ease-of-use and interoperability of our offerings as compared to our competitors’ offerings;

 

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the market’s perception of the ease or difficulty in deploying our software or services, especially in complex network environments;

 

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the continued evolution of electronic commerce as a viable means of conducting business;

 

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market acceptance and use of new technologies and standards;

 

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the ability of network infrastructures to support an increasing number of users and services;

 

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the pace of technological change and our ability to keep up with these changes; and

 

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general economic conditions, which influence how much money our customers and potential customers are willing to allocate to their information technology budgets.

There can be no assurance that adequate marketing arrangements will be made and continued for our products and services and there can be no assurance that any of these offerings will ever achieve or maintain widespread market acceptance or that such offerings will be profitable.

If we cannot continuously enhance our hosted software and web-based service offerings in response to rapid changes in the market, our business will be harmed.

The software-based services industry and computer industry are characterized by extensive research and development efforts which result in the frequent introduction of new products and services which render existing products and services obsolete. Our ability to compete successfully in the future will depend in large part on our ability to maintain a technically competent research and development staff and our ability to adapt to technological changes in the industry and enhance and improve our hosted software and web-based service offerings and successfully develop and market new offerings that meet the changing needs of our customers. Although we are dedicated to continued improvement of our offerings with a view towards satisfying market needs with the most advanced capabilities, there can be no assurance that we will be able to continue to do so on a regular basis and remain competitive with products offered by other manufacturers. At the present time, we do not have a targeted level of expenditures for research and development. We will evaluate all opportunities but believe the majority of our research and development will be devoted to enhancements of our existing offerings.

If our hosted software and web-based service offerings and telehealth solutions are not competitive, our business will suffer.

We are engaged in the highly competitive businesses of developing hosted software and web-based workflow management services and telehealth solutions. These markets are continually evolving and, in some cases, subject to rapid technological change. Many of our competitors have greater financial, technical, product development, marketing and other resources than we do. These organizations may be better known than we are and have more customers than we do. We cannot provide assurance that we will be able to compete successfully against these organizations. We believe that the principal competitive factors affecting our markets include performance, ease of use, quality/reliability of our offerings, scalability, features and functionality, price and customer service and support. There can be no assurance that we will be able to successfully incorporate these factors into our software and web-based services or telehealth solutions and compete against current or future competitors or that competitive pressure we face will not harm our business. If we are unable to develop and market products to compete with the products of competitors, our business will be materially and adversely affected.

Our business, including Inscrybe Healthcare and our telehealth products and services are relatively new business lines and although the level of competition for these offerings is uncertain at this point in time, the field of software-based solutions in which we compete, particularly with respect to healthcare information technology solutions, is highly competitive. There can be no assurances, however, that any of our offerings will achieve market acceptance.

We also expect that competition will increase as a result of industry consolidations and the formation of new companies with new, innovative offerings. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their software and service offerings to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share, any of which could harm our business.

Our hosted software and web-based services are complex and are operated in a wide variety of computer configurations, which could result in errors or product failures.

Our hosted software and web-based services are complex and may contain undetected errors, failures or bugs that may arise when they are first introduced or when new versions are released. These offerings may be used in large-scale computing environments with different operating systems, system management software and equipment and networking configurations, which may cause errors or failures in our offerings or may expose undetected errors, failures or bugs in such offerings. Our customers’ computer environments are often characterized by a wide variety of configurations that make pre-release testing for programming or compatibility errors difficult and time-consuming. Despite testing by us and by others, errors, failures or bugs may not be found in new products or releases after commencement of commercial use. Errors, failures or bugs in our offerings could result in negative publicity, returns,

 

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loss of or delay in market acceptance of our hosted software or web-based services or claims by customers or others. Alleviating these problems could require significant expenditures of our capital and resources and could cause interruptions, delays or cessation of our licenses which could cause us to lose existing or potential customers and would adversely affect our financial conditions, results of operations and cash flows. Most of our license agreements with customers contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that these provisions may not prove effective in limiting our liability.

We have a significant amount of net operating loss carry forwards which we may not be able to utilize in certain circumstances.

At June 30, 2015, we had net operating loss, or NOL, carry forwards for federal income tax purposes of approximately $162,000,000 available to offset future taxable income. Under Section 382 of the Internal Revenue Code, following an “ownership change,” special limitations apply to the use by a “loss corporation” of its (i) NOL carry forwards arising before the ownership change and (ii) net unrealized built-in losses (if such losses existed immediately before the ownership change and exceed a statutory threshold amount) recognized during the five years following the ownership change ((i) and (ii) are referred to collectively as the “Applicable Tax Attributes”). After an ownership change, the amount of the loss corporation’s taxable income for each post-change taxable year that may be offset by the Applicable Tax Attributes is limited to the product of the “long-term tax-exempt rate” (published by the IRS for the month of the ownership change) multiplied by the value of the loss corporation’s stock (the “Section 382 Limitation”). To the extent that the loss corporation’s Section 382 Limitation in a given taxable year exceeds its taxable income for the year, that excess increases the Section 382 Limitation in future taxable years.

Risks Related to Our Common Stock and Other Securities

Our stock price is volatile and could decline.

The price of our common stock has been, and is likely to continue to be, volatile. Our stock price during the fiscal year ended June 30, 2015 traded as low as $0.16 per share and as high as $1.20 per share and during the three months ended September 30, 2015, our common stock traded within a range of $0.09 to $0.55. We cannot assure you that your initial investment in our common stock will not fluctuate significantly. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including:

 

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quarterly variations in our operating results;

 

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announcements we make regarding significant contracts, acquisitions, dispositions, strategic partnerships, or joint ventures;

 

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additions or departures of key personnel;

 

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the introduction of competitive offerings by existing or new competitors;

 

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uncertainty about and customer confidence in the current economic conditions and outlook;

 

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reduced demand for any given product on web-based service offering; and

 

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sales of our common stock.

In addition, the stock market in general, including companies whose stock is listed on The NASDAQ Capital Market, have experienced extreme price and volume fluctuations that have often been disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of our actual operating performance.

The failure to maintain compliance with The Nasdaq Capital Market listing standards could result in delisting and adversely affect the market price and liquidity of our common stock.

Our common stock is currently traded on The Nasdaq Capital Market under the symbol “ADAT”. If we fail to meet any of the continued listing standards of The Nasdaq Capital Market, our common stock will be delisted from The Nasdaq Capital Market. These continued listing standards include specifically enumerated criteria, such as a $1.00 minimum closing bid price and a minimum stockholders’ equity requirement, which requires listed companies to maintain stockholders’ equity of at least $2.5 million.

On January 28, 2015, we received a staff deficiency letter from The Nasdaq Stock Market notifying us that for the prior 30 consecutive business days, the closing bid price per share of our common stock was below the $1.00 minimum bid price requirement for continued listing on The Nasdaq Capital Market, as required by Listing Rule 5550(a)(2) (the “Bid Price Rule”). Nasdaq provided us with 180 calendar days, or until July 27, 2015, to regain compliance with the Bid Price Rule. To regain compliance with the Bid Price Rule, the closing bid price of our common stock must meet or exceed $1.00 per share for a minimum of ten consecutive business days during the 180 day grace period.

 

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Subsequently, on May 28, 2015, we received a second staff deficiency letter from The Nasdaq Stock Market notifying us that we did not comply with Nasdaq Listing Rule 5550(b)(1), the minimum stockholders’ equity requirement for continued listing on the Nasdaq Capital Market, which requires listed companies to maintain stockholders’ equity of at least $2.5 million. Nasdaq provided us with 45 calendar days, to submit a plan to regain compliance with the minimum stockholders’ equity standard. Pursuant to an extension granted by the staff, we submitted our compliance plan on July 21, 2015.

On July 29, 2015, we received a determination letter from the staff of The Nasdaq Stock Market stating that the company has not regained compliance with The Nasdaq Capital Market minimum bid price of $1.00 requirement for continued listing set forth in Nasdaq Listing Rule 5550(a)(2). The Nasdaq determination letter also stated that the company is not eligible for an additional 180-day extension to regain compliance with the minimum bid price rule because the company does not meet the minimum stockholders’ equity initial listing requirement for the Nasdaq Capital Market. The determination letter also stated that the Company did not maintain a minimum $2.5 million in stockholders equity for continued listing and did not meet the alternatives of market value of listed securities or net income as required under Listing Rule 5550(b) and that such deficiency serves as an additional basis for delisting. Pursuant to the determination letter, we requested a hearing to appeal this determination on August 5, 2015, and were granted a hearing on September 10, 2015. At the hearing we presented our plan to regain compliance with both the minimum bid price requirement of Listing Rule 5550(a)(2) and the minimum shareholders’ equity requirement of Listing Rule 5550(b)(1).

On September 16, 2015, we received written notice that the Nasdaq Hearings Panel (the “Panel”) granted our request to remain listed on The NASDAQ Stock Market, LLC, subject to the condition that, on or before January 25, 2016, we shall announce and inform the Panel that the company’s proposed business combination has closed and that NASDAQ’s Listing Qualifications Staff (the “Staff”) has approved the combined entity’s application for initial listing on NASDAQ. In its written notice, the Panel stated that during the granted exception period the company must promptly notify the Panel of any significant developments, particularly any event, condition or circumstance that may impact its ability to meet the terms of the exception granted by the Panel and that the Panel reserves the right to reconsider the granted exception in such an instance. The company is diligently working to timely satisfy the terms of the Panel’s decision; however, there can be no assurance that the company will be able to do so. In the event that the company is unable to meet the exception requirement, the Panel will issue a final determination to delist the company’s shares and suspend trading of the company’s shares on The Nasdaq Capital Market.

If our common stock were to be delisted from The Nasdaq Capital Market, trading of our common stock most likely will be conducted in the over-the-counter market on an electronic bulletin board established for unlisted securities such as the OTC Bulletin Board. Such trading will reduce the market liquidity of our common stock. As a result, an investor would find it more difficult to dispose of, or obtain accurate quotations for the price of, our common stock and the price of our common stock could suffer a significant decline. Delisting may also impair our ability to raise capital. If our common stock is delisted from The Nasdaq Capital Market and the trading price remains below $5.00 per share, trading in our common stock might also become subject to the requirements of certain rules promulgated under the Exchange Act, which require additional disclosure by broker-dealers in connection with any trade involving a stock defined as a “penny stock” (generally, any equity security not listed on a national securities exchange or quoted on Nasdaq that has a market price of less than $5.00 per share, subject to certain exceptions). Many brokerage firms are reluctant to recommend low-priced stocks to their clients. Moreover, various regulations and policies restrict the ability of shareholders to borrow against or “margin” low-priced stocks, and declines in the stock price below certain levels may trigger unexpected margin calls. Additionally, because brokers’ commissions on low-priced stocks generally represent a higher percentage of the stock price than commissions on higher priced stocks, the current price of the common stock can result in an individual shareholder paying transaction costs that represent a higher percentage of total share value than would be the case if our share price were higher. This factor may also limit the willingness of institutions to purchase our common stock. Finally, the additional burdens imposed upon broker-dealers by these requirements could discourage broker-dealers from facilitating trades in our common stock, which could severely limit the market liquidity of the stock and the ability of investors to trade our common stock.

Since we have not paid dividends on our common stock, you may not receive income from this investment.

We have not paid any dividends on our common stock since our inception and do not contemplate or anticipate paying any dividends on our common stock in the foreseeable future. Earnings, if any, will be used to finance the development and expansion of our business. Accordingly, you may have to sell some or all of your common stock in order to generate cash from your investment. You may not receive a gain on your investment when you sell our common stock and may lose the entire amount of your investment.

 

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Trading in our stock over the last twelve months has been limited, so investors may not be able to sell as much stock as they want at prevailing prices.

The average daily trading volume in our common stock for the three months ended September 30, 2015 was approximately 278,000 shares. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices. Moreover, the market price for shares of our common stock may be made more volatile because of the relatively low volume of trading in our common stock. When trading volume is low, significant price movement can be caused by the trading in a relatively small number of shares. Volatility in our common stock could cause stockholders to incur substantial losses.

Additional financings could result in dilution to existing stockholders and otherwise adversely impact the rights of our common stockholders.

As stated above, we require additional financings in order to obtain additional capital with which to operate our business. Any such financings will dilute the percentage ownership interests of our stockholders and may adversely affect our earnings and net book value per share. In addition, we may not be able to secure any such additional financing on terms acceptable to us, if at all. We have the authority to issue additional shares of common stock and preferred stock, as well as additional classes or series of warrants or debt obligations which may be convertible into any one or more classes or series of ownership interests. We are authorized to issue 190 million shares of common stock and 5 million shares of preferred stock. Subject to compliance with the requirements of the NASDAQ Stock Market, such securities may be issued without the approval or other consent of our stockholders.

We filed a “shelf” registration statement on Form S-3 with the Securities and Exchange Commission in August 2012, which was declared effective by the Commission in December 2012. There is approximately $29 million available for future issuances under this registration statement, subject to SEC limitations. This disclosure shall not constitute an offer to sell or a solicitation of an offer to buy the securities, nor shall there by any sale of these securities in any jurisdiction in which an offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction. Any offer of the securities will be solely by means of the prospectus included in the registration statement and one or more prospectus supplements that will be issued at the time of the offering.

In the event that any future financing should be in the form of, be convertible into or exchangeable for, equity securities, and upon the conversion or exercise of such securities, investors may experience additional dilution. Moreover, we may issue undesignated shares of preferred stock, the terms of which may be fixed by our board of directors and which terms may be preferential to the interests of our common stockholders. We have issued preferred stock in the past, and our board of directors has the authority, without stockholder approval, to create and issue one or more additional series of such preferred stock and to determine the voting, dividend and other rights of holders of such preferred stock. Any debt financing, if available, may involve restrictive covenants that impact our ability to conduct our business. The issuance of any of such series of preferred stock or debt securities may have an adverse effect on the holders of common stock.

The number of shares of our common stock outstanding has increased substantially as a result of our recent financings, and the exercise or conversion of the warrants and shares of preferred stock issued in these transactions could result in further dilution to holders of our common stock and adversely impact the market price of our common stock.

During and subsequent to our fiscal year ended June 30, 2015 and the first quarter of fiscal year 2016, we completed several transactions that have resulted in our issuance of a substantial number of shares of common stock and securities convertible into, or exercisable for, additional shares of common stock. The issuance of these securities has resulted in substantial dilution to stockholders who held our common stock prior to such transactions and will result in additional dilution in the future if shares of convertible preferred stock are converted into common stock and common stock purchase warrants are exercised. The conversion of preferred shares and the exercise of warrants could also adversely affect the market price of our common stock if the holders of these securities immediately sell some or all of the shares of common stock issued upon conversion or exercise or there is a perception in the market that the holders of a large number of shares intend to sell their shares.

In February 2015, the company entered into a securities purchase agreement with an accredited investor pursuant to which we issued a promissory note in the aggregate principal amount of $100,000 and common stock purchase warrants to purchase up to 80,000 shares of common stock for gross proceeds of $100,000. The warrants vest in equal monthly installments over twelve months if the notes are outstanding and, subject to vesting requirements, are exercisable for a period of 54 months commencing on the six month anniversary of the issuance date at an initial exercise price of $1.01 per share. Although the securities purchase agreement we entered into with this investor contemplated a second closing for $900,000, the second closing did not occur and we did not receive the additional funds. The vested warrants related to this transaction were exchanged for warrants issued in connection with the June 8, 2015 transaction discussed below.

 

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On February 17, 2015, in a separate transaction, the company issued a short-term promissory note in the aggregate principal amount of $950,000 and warrants to purchase 99,500 shares of common stock to an accredited investor for gross proceeds of $950,000. The warrants are exercisable for a period of 54 months commencing on the six month anniversary of the issuance date and have an initial exercise price of $1.01 per share. On April 3, 2015, the company entered into an amendment agreement with this investor to extend the maturity date of this note from March 19, 2015 to July 2, 2015 and to grant the holder the right to exchange the principal amount of the short-term note (and unpaid interest thereon) into the securities of the company sold in the next financing, as defined in the amendment agreement. This investor subsequently agreed not to participate in the convertible debt financing for which a closing was held June 8, 2015 and in consideration of such election, the participation right was modified to allow him to exchange such note for comparable securities in an alternative transaction. In consideration of waivers previously granted by the holder of potential events of default under the short-term note and the amendment to extend the maturity date, the company agreed to issue the holder warrants to purchase 3,166,667 shares of common stock of the company. The warrants are exercisable for a period of 54 months commencing six months following the date of issuance and have an exercise price equal to $0.31 per share. The holder of the short-term note is an entity controlled by Douglas B. Luce, the brother of J. David Luce, a member of the board of directors of the company. Through a series of amendments, the maturity date of this note was further extended on multiple occasions to on or about November 13, 2015. The company is engaged in ongoing discussions and negotiations with the holder of this note in order to seek modifications to the terms of the obligation, including extensions of the repayment date. The company anticipates that in order to complete these negotiations, it will be required to grant conversion rights and/or issue additional warrants.

On April 24, 2015, the company issued a short-term promissory note in the aggregate principal amount of $500,000 to Lazarus Investment Partners LLLP, the beneficial owner of approximately 29.4% of our common stock immediately prior to the note transaction, for gross proceeds of $500,000. In consideration for this loan, the company agreed to reduce the exercise price on approximately 6,233,600 warrants held by Lazarus to $0.25, based on the most recent closing bid price of the common stock prior to the note transaction, and to extend the expiration date of the warrants to October 25, 2019. Through a series of amendments, the maturity date of this note was further extended on multiple occasions to on or about November 13, 2015. The company is engaged in ongoing discussions and negotiations with the holder of this note in order to seek modifications to the terms of the obligation, including extensions of the repayment date. The company anticipates that in order to complete these negotiations, it will be required to grant conversion rights and/or issue additional warrants.

On June 8, 2015, the company issued an aggregate principal amount of $900,000 of senior secured convertible debentures and common stock purchase warrants to purchase 3,626,667 shares of common stock. Subject to certain limitations, the debentures are convertible at any time at the option of the holder into shares of our common stock at an initial conversion price of $0.25 per share. Each debenture matures on the one-year anniversary of the issuance date. The warrants are exercisable for a period of 54 months commencing on the six month anniversary of the issuance date at an initial exercise price of $0.30 per share. Although the securities purchase agreement we entered into with this investor contemplated a second closing for up to $2.1 million, the second closing did not occur.

On August 7, 2015, the company issued a senior secured note in the aggregate principal amount of $320,000 to MKA 79, LLC, an entity affiliated with J. David Luce, a member of the company’s board of directors. In consideration of the loan, the company agreed to reduce the exercise price on approximately 5,474,829 warrants held by MKA 79 and an affiliate to $0.17, based on the most recent closing bid price of the common stock prior to the note transaction, and to extend the expiration date of the warrants to December 13, 2019.

In September 2015, the company has issued promissory notes in the aggregate principal amount of $525,000 to accredited investors in a private transaction. The notes are unsecured and are not convertible into equity securities of the company. The notes bears interest at 20% per annum, payable in arrears, and are due upon the earlier of (i) September 18, 2016, or (ii) within 30 days of the closing of a sale of equity or debt securities of the company, or series of closings, as part of the same transaction, of equity or debt securities within a period of 90 days, in the gross amount of at least $5,000,000 in cash proceeds. The company also issued the investors warrants to purchase an aggregated of 1,050,000 shares of common stock. The warrants are exercisable commencing twelve months following their issuance for a period of 54 months at an exercise price of $0.30 per share. These closings are part of an offering of up to $1 million of notes and 2 million warrants.

In October 2015, the company issued promissory note in the aggregate principal amount of $450,000 to Peachstate Medical Holdings LLC, d/b/a AEON Clinical Laboratories. The note is unsecured and is not convertible into equity securities of the company. The note bears interest at 20% per annum, payable in arrears, and is due upon the earlier of (i) October 28, 2016, or (ii) within 30 days of the closing of a sale of equity or debt securities of the company, or series of closings, as part of the same transaction, of equity or debt securities within a period of 90 days, in the gross amount of at least $5,000,000 in cash proceeds. The company also issued the investor warrants to purchase an aggregate of 1,000,000 shares of common stock. The warrants are exercisable commencing twelve months following their issuance for a period of 54 months at an exercise price of $0.30 per share.

 

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Due to our need for additional capital, we may be required to issue additional shares of common stock or securities convertible into or exercisable for common stock at prices reflecting a dilution to existing stockholders. We may seek to obtain capital from the holders of existing warrants or convertible securities by reducing the exercise or conversion prices and may include additional issuance of equity securities. All of these potential transactions may result in dilution to existing stockholders.

Our executive officers, directors and significant stockholders will be able to influence matters requiring stockholder approval

As of the date of this report, our executive officers, directors and largest shareholder (Lazarus Investment Partners, LLLP) possess beneficial ownership (without, however, giving effect to any limitations on the ability of such persons to convert shares of Series D preferred stock or exercise warrants) of approximately 44.9% of our common stock and within this amount, Lazarus Investment Partners beneficially owns approximately 29.0% of our outstanding common stock. Due to such ownership position, these persons have increased influence over the outcome of future stockholder votes, including the election of directors and other significant business matters that require stockholder approval, and their interests may differ from the interests of other stockholders. This concentration of ownership may also have the effect of delaying, preventing or deterring a change in control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale or merger of our company and may negatively affect the market price of our common stock. These transactions might include proxy contests, tender offers, mergers or other business combinations or purchases of common stock that could give our stockholders the opportunity to realize a premium over the then-prevailing market price for shares of our common stock. In addition, the sale of these shares of common stock may adversely affect the market price of our common stock and our stock price may decline substantially.

The exercise of our outstanding options and warrants, or conversion of our outstanding shares of convertible preferred stock, may depress our stock price and dilute your ownership of the company.

As of September 30, 2015, the following options, restricted stock units and warrants were outstanding:

 

•

Stock options to purchase 5,577,000 shares of common stock at exercise prices ranging from $0.18 to $9.00 per share, not all of which are immediately exercisable. The weighted average exercise price of the outstanding stock options is $1.09 per share. These stock options are employee and non-executive director options.

 

•

Warrants to purchase 34,769,000 shares of common stock with a weighted average exercise price of $.67 per share.

 

•

An aggregate of 883,000 unvested restricted stock units.

In addition, there are currently outstanding 28,000 shares of our Series B convertible preferred stock which the holder may convert into shares of our common stock at a conversion price equal to $2.80 per share. Accordingly, the outstanding 28,000 shares of Series B convertible preferred stock are presently convertible into an aggregate of 250,000 shares of our common stock, which will be available for immediate resale in accordance with the provisions of Rule 144 under the Securities Act. Further, there are currently outstanding 665,000 shares of Series D preferred stock, which are initially convertible into an aggregate of 6,125,024 shares of common stock at the initial conversion rate of $1.08571 per share commencing six months after the original issue date of the Series D preferred stock (exclusive of any additional shares of common stock that we may elect to issue in lieu of paying cash dividends on the Series D preferred stock). Shares of common stock issued upon conversion of Series D preferred stock may be resold from time to time by a holder in accordance with Rule 144 under the Securities Act.

Further, on June 8, 2015, we issued a principal amount of 900,000 of senior secured convertible debentures and common stock purchase warrants. Subject to certain limitations, the debentures are convertible at any time at the option of the holder into an initial amount of 3.6 million shares of our common stock at an initial conversion price of $0.25 per share. The conversion rate of these debentures is subject to adjustment, including if we issue or sell shares of its common stock or other equity securities for a price per share that is less than the conversion price then in effect, in which event the conversion price will be decreased to equal 85% of such lower price.

To the extent that these securities are exercised or converted, or we issue additional common shares, dilution to our stockholders will occur. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of these securities can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than the exercise and conversion terms provided by those securities. Further, in the event the conversion price of our outstanding convertible debentures or shares of convertible preferred stock is lower than the actual trading price on the day of conversion, the holders could immediately sell their converted common shares, which would have a dilutive effect on the value of the outstanding common shares. Furthermore, the significant downward pressure on the trading price of our common stock as preferred stock or debentures holders converted these securities and sell the common shares received on conversion could encourage short sales by the holders of preferred stock or other security holders. This would place further downward pressure on the trading price of our common stock. Even the mere perception of eventual sales of common shares issued on the conversion of the shares of preferred stock or debentures could lead to a decline in the trading price of our common stock.

 

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Our currently outstanding shares of convertible preferred stock or the issuance of additional shares of preferred stock could adversely affect the rights of the holders of shares of our common stock.

We have issued a total of 28,000 shares of Series B preferred stock and 665,000 shares of Series D preferred stock and our board is authorized to issue up to an additional 4,307,000 shares of preferred stock without any further action on the part of our stockholders. Pursuant to our certificate of incorporation, our board has the authority to fix and determine the voting rights, rights of redemption and other rights and preferences of preferred stock. Our board may, at any time, authorize the issuance of a series of preferred stock that would grant to holders the preferred right to our assets upon liquidation, the right to receive dividend payments before dividends are distributed to the holders of common stock, and the right to the redemption of the shares, before the redemption of our common stock, which may have a material adverse effect on the rights of the holders of our common stock. In addition, our board, without further stockholder approval (but subject to the rules of the Nasdaq Stock Market) may, at any time, issue large blocks of preferred stock. Pursuant to the certificates of designations governing the rights and preferences of our outstanding shares of Series B preferred stock and Series D preferred stock, each share of preferred stock has certain rights and preferences, including the right to receive dividends in preference to our common stockholders. In addition, we must obtain the approval of the holders of a majority of the shares of outstanding convertible preferred stock in order to: (i) amend, alter or repeal any provisions of our Certificate of Incorporation which would materially adversely affect any of the preferences, rights, powers or privileges of such preferred stock (ii) create, authorize or issue any other class or series of preferred stock on a parity with, or having greater or preferential rights than, the outstanding convertible preferred stock, (iii) redeem, repurchase or otherwise acquire for value, or set aside for payment or make available for a sinking fund for the purchase or redemption of, any stock ranking junior to on a parity with the outstanding convertible preferred stock, or (iv) enter into any agreement which would prohibit or restrict our right to pay dividends on the outstanding convertible preferred stock. The need to obtain the approval of holders of our convertible preferred stock before taking these actions could impede our ability to take certain actions that management or our board may consider to be in the best interests of our stockholders. Any failure to obtain such approval could limit our business flexibility, harm our business and result in a decrease in the value of our common stock or convertible preferred stock.

We have granted liens on all of our assets to the holders of the certain debt instruments and the senior secured convertible debentures we have issued include additional provisions that could adversely affect the interests of the holders of our common stock. If we are required to repay our outstanding debt securities on their scheduled due date, our financial condition may be adversely affected.

On June 8, 2015, we entered into definitive agreements relating to a private placement of up to a principal amount of $3.0 of senior secured convertible debentures (the “Convertible Debentures”) and common stock purchase warrants. An initial closing for an aggregate principal amount of $900,000 of these debentures and warrants to purchase 3,626,667 shares of common stock was held on June 8, 2015. A final closing of up to $2.1 million of these debentures and warrants to purchase 8,400,000 shares of common stock was expected to occur prior to June 24, 2015, but did not transpire.

Subject to certain exceptions, the Convertible Debentures rank senior to our existing and future indebtedness and these debentures mature on the one-year anniversary of the issuance date. Subject to certain limitations, the Convertible Debentures are convertible at any time at the option of the holder into shares of our common stock at an initial conversion price of $0.25 per share. If we issue or sell shares of our common stock, rights to purchase shares of its common stock, or securities convertible into shares of its common stock for a price per share that is less than the conversion price then in effect, the conversion price will be decreased to equal 85% of such lower price. Similarly, the warrants issued with the Convertible Debentures have an initial exercise price of $0.30, but such exercise price is subject to adjustment if we issue or sell shares of our common stock or other securities convertible into or exercisable for shares of common stock for a price per share that is less than the conversion price of the Convertible Debentures. The Convertible Debentures bear interest at 9% per annum with interest payable upon maturity or on any earlier redemption date. If we are unable to consummate an additional financing prior to the maturity date of the Convertible Debentures, we will be required to repay these securities, which may have an adverse effect on our cash position. In addition, the Convertible Debentures are secured by a first priority lien on our assets related to our “Inscrybe Referral and Order Management” and “Inscrybe Hospital Discharge” solutions (the “Inscrybe Solutions Business”) in accordance with, and subject to, a security agreement between us and the investors.

The Convertible Debentures contain covenants and events of default customary for similar transactions. Accordingly, without the consent of the holders of the Convertible Debentures we must comply with certain restrictions against incurring additional indebtedness and granting additional security interests on our assets. Among the defined events of default are defaults of our payment obligations, breach of any material covenant or representation of the Convertible Debentures or the related transaction agreements, and the commencement of proceedings under applicable U.S. federal or state bankruptcy, insolvency, reorganization or other similar

 

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laws either against us or by us. Upon the occurrence of an event of default under the Convertible Debentures, a holder may require us to repay all or a portion of the Convertible Debentures in cash, at a price equal to 110% of the principal and accrued and unpaid interest. If we are unable to repay the Convertible Debentures when due, or upon an event of default, the holders could foreclose on our encumbered assets.

In addition, in August 2015, we issued a senior secured promissory note (the “August Note”) in the aggregate principal amount of $320,000 to MKA 79, LLC, in a private transaction. The August Note is due and payable on December 31, 2015 and interest shall accrue on the August Note at the rate of 10.0% per annum. The August Note is not convertible into any of our equity securities and it contains terms and events of default customary for similar transactions. Accordingly, without the consent of the holder of the August Note we must comply with certain restrictions against incurring additional indebtedness and granting additional security interests on our assets. The events of default defined in the August Note include customary terms, including a default of our payment obligation, a breach of material terms of the August Note and the commencement of bankruptcy proceedings. The August Note is secured by a first priority lien on certain of our assets, as described in a security agreement entered into between the company and the purchaser, which collateral consists of those of our assets other than those covered by the security agreement we entered into with the holders of the Convertible Debentures. In consideration of the loan, we agreed to amend certain of the terms of the existing 5,474,829 Common Stock Purchase Warrants currently held by the lender and an affiliate. In amending these warrants, we agreed to reduce the exercise price of such warrants to $0.17 and to extend the expiration date of the warrants to December 13, 2019. The initial exercise prices of these warrants were between $0.95 and $1.34. The Purchaser is an entity affiliated with J. David Luce, a member of the Company’s board of directors.

Provisions in our charter documents and Delaware law could discourage or prevent a takeover, even if an acquisition would be beneficial to our stockholders.

Provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include:

 

•

authorizing the issuance of “blank check” preferred that could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt;

 

•

prohibiting cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; and

 

•

advance notice provisions in connection with stockholder proposals that may prevent or hinder any attempt by our stockholders to bring business to be considered by our stockholders at a meeting or replace our board of directors.

Together these provisions may delay, deter or prevent a change in control of us, adversely affecting the market price of our common stock.

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

a) Sales of Unregistered Securities

Except as previously reported and as described elsewhere in this Quarterly Report on Form 10-Q, we did not sell unregistered securities during the quarter ended September 30, 2015.

As of September 30, 2015 we issued options to purchase an aggregate of 496,768 shares of common stock to our non-executive directors that elected to receive options and in October 2015, we issued an aggregate of 43,980 restricted shares of our common stock to non-executive directors that elected to receive shares of common stock in lieu of the cash fees earned for their service as members of our board of directors pursuant to our 2011 Omnibus Equity Incentive Plan. The options are exercisable for a period of ten years at an exercise price of $0.29 per share. Such securities were issued for service on our board during the quarter ended September 30, 2015. These securities were issued pursuant to the exemption from registration provided by Section 4 (a)(2) of the Securities Act of 1933, as amended.

b) Not applicable

c) Repurchase of Equity Securities

We did not repurchase any of our equity securities during the three months ended September 30, 2015.

 

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Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

As of November 12, 2015, the company entered into an agreement, dated September 25, 2015, with the holder of a majority-in-interest of the convertible debentures and common stock purchase warrants issued pursuant to that certain Securities Purchase Agreement dated as of May 29, 2015 (the “Amendment Agreement”). Pursuant to the Amendment Agreement, the parties agreed to (i) further amend the Securities Purchase Agreement in order to modify certain covenants including a deferral of the date by which the Company was required to seek the approval of its shareholders of the issuance of all of the shares of common stock underlying the convertible debentures and warrants in excess of 19.99% of the Company’s issued and outstanding common stock on the initial closing date, in accordance with the rules of the Nasdaq Stock Market and (ii) amend that certain Registration Rights Agreement dated as of May 29, 2015 to defer the date by which the Company was required to file the registration statement in accordance with the terms of the Registration Rights Agreement to a date no later than February 17, 2016.

Item 6. Exhibits

The following exhibits are filed herewith or incorporated by reference. A management contract or compensation plan or arrangement is indicated with (*).

 

Incorporated by Reference

Exhibit Number

Exhibit Description

Form

Filing Date

Exhibit

Filed Herewith

4.1

Form of Promissory Note issued to MKA 79, LLC dated August 7, 2015

8-K

8/12/15

4.1

4.2

Warrant Amendment Agreement dated August 7, 2015 between Authentidate Holding Corp. and MKA 79, LLC

8-K

8/12/15

10.2

4.3

Form of Note issued August 26, 2015

8-K

8/28/15

10.1

4.4

Form of Note issued September 18, 2015

8-K

9/24/15

4.1

4.5

Form of Warrant issued September 18, 2015

8-K

9/24/15

4.2

4.6

Form of Note issued October 28, 2015

X

4.7

Form of Warrant issued October 28, 2015

X

10.1*

Employment Agreement with William P. Henry

10-K

10/13/15

10.49

10.2*

Security Agreement between the Company and MKA79, LLC dated August 7, 2015

8-K

8/12/15

10.1

10.3

Form of Purchase Agreement dated September 15, 2015

8-K

9/24/15

10.1

10.4

Amendment to Lease dated September 15, 2015

10-K

10/13/15

10.56

10.5*

Employment Letter with Ian C. Bonnet dated September 28, 2015

8-K

9/30/15

10.1

10.6

Note Extension Agreement with VER 83, LLC dated October 30, 2015

X

10.7

Note Extension Agreement with Lazarus Investment Partners LLLP dated October 30, 2015

X

10.8

Form of Note Purchase Agreement dated October 28, 2015

X

10.9

Second Amendment to Securities Purchase Agreement and Registration Rights Agreement, entered into on November 12, 2015

X

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

X

 

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31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002								X
32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002								X
101.1		The following financial information from the Authentidate Holding Corp.’s Quarterly Report on Form 10-Q for the fiscal quarter September 30, 2015, formatted in XBRL (eXtensible Business Reporting Language) and filed electronically herewith: (i) the Condensed Consolidated Balance Sheets; (ii) the Condensed Consolidated Statements of Operations and Comprehensive Operations; (iii) the Condensed Consolidated Statements of Cash Flows; and, (iv) the Notes to Condensed Consolidated Financial Statements.								X

 

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SIGNATURES

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

 

						AUTHENTIDATE HOLDING CORP.
November 13, 2015						/s/ Ian C. Bonnet
Date						Ian C. Bonnet
						Chief Executive Officer and President
						/s/ William A. Marshall
						William A. Marshall
						Chief Financial Officer and Treasurer

 

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