Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
or
☐ 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: 000-50502
ROOT9B TECHNOLOGIES, INC.
(Exact
Name of registrant as Specified in Its Charter)
Delaware
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20-0443575
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(State of other jurisdiction of incorporation or
organization)
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(I.R.S. Employer Identification No.)
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4521
Sharon Road
Suite
300
Charlotte,
North Carolina 28211
(Address of principal executive offices)
(704)
521-8077
(Registrant’s telephone number)
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 such filing requirements for
the past 90 days.
☒
Yes ☐ No
Indicate
by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (§232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files.
☒
Yes ☐ No
Indicate by check
mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated
filer”, “accelerated filer”,
“non-accelerated filer”, and “smaller reporting
company” in Rule 12b-2 of the Exchange Act.
Large accelerated
filer
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☐
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Accelerated
filer
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☐
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Non-accelerated
filer
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☐
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Smaller reporting
company
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☒
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☐
Yes ☒ No
Indicate the number
of shares outstanding of each of the registrant’s classes of
common stock, as of the latest practicable date: 84,370,314 shares
of common stock were outstanding as of November 11,
2016.
Table of Contents
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Page
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PART I. FINANCIAL INFORMATION
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Item 1.
Consolidated Financial Statements
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2
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Consolidated
Balance Sheets as of September 30, 2016 (Unaudited) and December
31, 2015
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2
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Consolidated
Statements of Operations (Unaudited) for the Three Months and Nine
Months Ended September 30, 2016 and September 30, 2015
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4
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Consolidated
Statements of Comprehensive Income(Loss) (Unaudited) for the Three
Months and Nine Months Ended September 30, 2016 and September 30,
2015
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5
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Consolidated
Statements of Cash Flows (Unaudited) for the Nine Months Ended
September 30, 2016 and September 30, 2015
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6
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Notes
to Consolidated Financial Statements (Unaudited)
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8
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Item 2.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
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25
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Item 3.
Quantitative and Qualitative Disclosures About Market
Risk
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42
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Item 4.
Controls and Procedures
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42
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PART II. OTHER INFORMATION
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Item 1.
Legal Proceedings
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44
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Item 2.
Unregistered Sales of Equity Securities and Use of
Proceeds
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45
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Item 3.
Defaults Upon Senior Securities
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45
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Item 4.
Mine Safety Disclosures
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45
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Item 5.
Other Information
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45
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Item 6.
Exhibits
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46
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Signatures
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47
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Exhibits / Certifications
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Exhibit
31.1 - CEO
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Exhibit
31.2 - CFO
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Exhibit
32.1 - CEO
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Exhibit
32.2 - CFO
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101.INS
* - XBRL Instance Document.
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101.SCH * -
XBRL Taxonomy Extension Schema Document.
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101.CAL * -
XBRL Taxonomy Extension Calculation Linkbase Document.
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101.DEF * -
XBRL Taxonomy Extension Definition Linkbase Document.
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101.LAB * -
XBRL Taxonomy Extension Label Linkbase Document.
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101.PRE
* - XBRL Taxonomy Extension Presentation Linkbase
Document.
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*
Furnished herewith. XBRL (Extensible
Business Reporting Language) information is
furnished
and not filed or a part of a registration statement or prospectus
for purposes of Sections 11 or 12 of the Securities Act of 1933, as
amended, is deemed not filed for purposes
of Section 18 of the Securities Exchange Act of 1934, as amended,
and otherwise is
not subject to liability under these sections.
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2
PART
I
FINANCIAL INFORMATION
Item
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1. Consolidated
Financial Statements
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ROOT9B TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2016 AND DECEMBER 31, 2015
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(Unaudited)
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September 30,
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December 31,
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2016
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2015
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ASSETS
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CURRENT ASSETS:
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Cash
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$2,032,338
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$795,682
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Accounts
receivable, net of reserve for doubtful accounts
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4,983,565
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3,010,161
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Marketable
securities
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-
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33,366
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Cost
and estimated earnings in excess of billings
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445,729
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357,625
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Prepaid
expenses and other current assets
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740,419
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758,240
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Total current assets
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8,202,051
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4,955,074
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Construction
in Progress - at cost
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341,870
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108,095
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Property
and Equipment - at cost less accumulated depreciation
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3,985,080
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3,782,388
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OTHER ASSETS:
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Goodwill
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13,631,769
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15,676,246
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Intangible
assets - net
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4,525,762
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5,509,642
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Investment
in cost-method investee
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100,000
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100,000
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Deferred
income taxes
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56,409
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56,409
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Cash
surrender value of officers' life insurance
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-
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167,371
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Deposits
and other assets
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209,290
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233,579
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Total other assets
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18,523,230
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21,743,247
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TOTAL ASSETS
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$31,052,231
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$30,588,804
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See Notes to Consolidated Financial Statements
3
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(Unaudited)
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September 30,
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December 31,
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2016
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2015
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LIABILITIES AND STOCKHOLDERS’ EQUITY
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CURRENT LIABILITIES:
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Convertible
Promissory Note Payable, net of debt discount of $0 at September
30, 2016 and $59,307 at December 31, 2015
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$1,600,000
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$1,540,693
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Related
Party Note Payable
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500,000
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-
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Capital
Lease Obligation, current portion
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19,835
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1,500
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Factored
receivables obligation
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1,027,393
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-
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Accounts
payable
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3,039,568
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1,607,166
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Billings
in excess of costs and estimated earnings
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176,170
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217,336
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Accrued
expenses and other current liabilities
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3,073,331
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2,560,048
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Total current liabilities
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9,436,297
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5,926,743
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NONCURRENT LIABILITIES:
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Convertible
Promissory Notes net of debt discounts of $2,072,842 at September
30, 2016 and $0 as of December 31, 2015.
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1,623,158
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-
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Capital
Lease Obligation – net of current portion
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35,072
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2,373
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Derivative
liability
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2,733,149
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3,540,084
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Total noncurrent liabilities
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4,391,379
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3,542,457
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STOCKHOLDERS' EQUITY:
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Preferred
stock, $.001 par value, 4,985,000 shares authorized, no shares
issued or outstanding at September 30, 2016 and December 31,
2015.
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-
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-
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Class
B convertible preferred stock, no liquidation preference $.001 par
value, 2,000,000 shares authorized, no shares issued and
outstanding at September 30, 2016 and December 31, 2015,
respectively.
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-
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-
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Class
C convertible preferred stock, $.001 par value, 2,500,000 shares
authorized, 2,380,952 shares issued and outstanding at September
30, 2016 and December 31, 2015.
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2,381
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2,381
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Common
stock, $.001 par value, 125,000,000 shares authorized, 84,370,314
and 76,990,639 shares issued and outstanding at September 30, 2016
and December 31, 2015, respectively.
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84,372
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77,009
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Additional
paid-in capital
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87,071,033
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77,983,593
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Accumulated
deficit
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(70,252,123)
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(57,080,942)
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Accumulated
other comprehensive income
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318,892
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137,563
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Total stockholders' equity
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17,224,555
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21,119,604
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
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$31,052,231
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$30,588,804
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See Notes to Consolidated Financial Statements
4
ROOT9B TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2016 AND
2015
(Unaudited)
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Three Months Ended
September 30, 2016
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Three Months Ended
September 30, 2015
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Nine Months Ended
September 30, 2016
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Nine Months Ended
September 30, 2015
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NET REVENUE
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$8,571,977
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$6,637,849
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$25,908,590
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$24,122,081
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OPERATING EXPENSES:
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Cost
of revenues
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7,072,845
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5,232,364
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22,410,844
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18,630,208
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Selling,
general and administrative
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4,661,496
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4,537,800
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13,832,055
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13,108,647
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Depreciation
and amortization
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549,727
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417,491
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1,608,010
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1,093,521
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Acquisition
related costs
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-
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-
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-
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649,442
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Total operating expenses
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12,284,068
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10,187,655
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37,850,909
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33,481,818
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LOSS FROM OPERATIONS
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(3,712,091)
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(3,549,806)
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(11,942,319)
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(9,359,737)
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OTHER INCOME (EXPENSE):
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Derivative
(expense) income
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1,089,617
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(22,477)
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1,912,821
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3,768,199
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Goodwill
impairment
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(2,044,477)
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-
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(2,044,477)
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-
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Loss
on extinguishment of debt
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--
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-
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(226,380)
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-
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Interest
expense, net
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(201,110)
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(167,427)
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(460,745)
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(698,068)
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Other
income (expense)
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(94,472)
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(128,667)
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(138,880)
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(39,430)
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Total other income (expense)
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(1,250,442)
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(318,571)
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(957,661)
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3,030,701
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LOSS BEFORE INCOME TAXES
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(4,962,533)
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(3,868,377)
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(12,899,980)
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(6,329,036)
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INCOME TAX BENEFIT (EXPENSE)
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(131,468)
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(157,485)
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(264,723)
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1,881,017
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NET LOSS
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(5,094,001)
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(4,025,862)
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(13,164,704)
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(4,448,019)
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PREFERRED STOCK DIVIDENDS
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-
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-
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(6,857)
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(406,372)
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NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS
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$5,094,001)
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$(4,025,862)
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$(13,171,561)
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$(4,854,391)
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Net loss per share:
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Basic
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$(0.06)
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$(0.05)
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$(0.16)
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$(0.07)
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Diluted
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$(0.06)
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$(0.05)
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$(0.16)
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$(0.07)
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Weighted average number of shares:
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Basic
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84,356,405
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73,807,736
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82,277,509
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68,970,960
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Diluted
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84,356,405
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73,807,736
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82,277,509
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68,970,960
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See
Notes to Consolidated Financial Statements
5
ROOT9B TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2016 AND
2015
(Unaudited)
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Three Months Ended
September 30, 2016
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Three Months Ended
September 30, 2015
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Nine Months Ended
September 30, 2016
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Nine Months Ended
September 30, 2015
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NET LOSS
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$(5,094,001)
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$(4,025,862)
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$(13,164,704)
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$(4,448,019)
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Other Comprehensive:
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Foreign
Currency Translation Gain:
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87,917
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95,806
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181,329
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55,816
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Other Comprehensive Gain:
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87,917
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95,806
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181,329
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55,816
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COMPREHENSIVE LOSS
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$(5,006,084)
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$(3,930,056)
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$(12,983,375)
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$(4,392,203)
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6
ROOT9B TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30 , 2016 AND 2015
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September 30, 2016
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September 30, 2015
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Cash flows from operating activities:
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Net
Loss
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$(13,164,704)
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$(4,448,019)
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Adjustments
to reconcile net (loss) to net cash used in operating
activities:
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Depreciation
and amortization
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1,608,010
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1,093,521
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Amortization
of debt discount
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80,514
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105,016
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(Increase)
decrease in cash surrender value of officers' life
insurance
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(14,466)
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153,831
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Income
from change in value of derivatives
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(1,912,821)
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(3,768,199)
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Goodwill
Impairment
|
2,044,477
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Deferred
income taxes
|
-
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(2,266,814)
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Stock
option / warrant compensation expense
|
832,427
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652,588
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Loss
on extinguishment of debt
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226,380
|
-
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Gain
on sale of assets
|
-
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(79,327)
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Changes
in operating assets and liabilities:
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|
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Accounts
receivable
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(1,973,405)
|
8,227,059
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Costs
and estimated earnings in excess of billings
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(88,105)
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272,717
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Prepaid
expenses
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17,820
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(227,869)
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Deposits
and other assets
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24,289
|
22,843
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Accounts
payable and accrued expenses
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1,947,583
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(3,347,994)
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Factored
receivables obligation
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1,027,393
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(6,395,287)
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Billings
in excess of costs and estimated earnings
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(41,166)
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(368,031)
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Net
cash used in operating activities
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(9,385,774)
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(10,373,965)
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Cash flows from investing activities:
|
|
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Cash paid in
acquisitions net of cash acquired
|
-
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(1,368,825)
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Proceeds on sale of
assets
|
-
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99,828
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Proceeds from
officer’s life insurance policy
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181,837
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-
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Proceeds from sale
of marketable securities
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33,366
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-
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Purchases of
property and equipment and construction in progress
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(1,004,400)
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(2,262,112)
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Net
cash used in investing activities
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(789,197)
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(3,531,109)
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Cash flows from financing activities:
|
|
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Convertible
Debt and Related Party Note Proceeds
|
4,196,000
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-
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Capital
lease payments
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(5,677)
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-
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Warrants
and Options Exercised
|
1,708,532
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2,868,865
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Common
stock issuances
|
5,331,443
|
11,294,449
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Net
cash provided by financing activities
|
11,230,298
|
14,163,314
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Effects of foreign exchange rate changes
|
181,329
|
55,816
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Net increase in cash
|
1,236,656
|
314,056
|
|
|
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Cash - beginning of period
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795,682
|
765,099
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Cash - end of period
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$2,032,338
|
$1,079,155
|
7
SUPPLEMENTAL
DISCLOSURES OF CASH FLOW INFORMATION:
|
|
|
|
|
|
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September 30,
2016
|
September 30,
2015
|
|
|
|
Cash payments
for:
|
|
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Interest
|
$304,266
|
$515,733
|
|
|
|
Income
taxes
|
$51,905
|
$1,370,996
|
|
|
|
Summary of non-cash
investing and financing activities:
|
|
|
Issuance of
10,000,000 shares of common stock in IPSA International Inc.
acquisition
|
|
$13,300,000
|
Issuance of 214,287
shares of common stock for principal and interest on convertible
notes
|
|
$240,000
|
Issuance of common
stock for dividend payment on preferred stock
|
$6,857
|
$406,372
|
Reclassification of
Derivative warrant liability to equity
|
$569,492
|
$3,680,059
|
Fair Value of
warrants issued to induce exercise of Series D
warrants
|
$84,525
|
-
|
Fair Value of
derivative features (warrants) issued to Qualified Purchasers of
common stock
|
$599,228
|
-
|
Fair Value of
warrants issued with 2016 Q3 Convertible Promissory Notes (debt
discount) credited to derivative liabilities
|
$1,076,150
|
-
|
Beneficial
Conversion Feature 2016 Q3 Convertible Promissory Notes (debt
discount) credited to additional paid in capital
|
$1,017,900
|
-
|
Property acquired
under capital lease
|
$56,710
|
-
|
8
ROOT9B TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015
(Unaudited)
Note 1 – Basis of Presentation and General
Information:
The
accompanying unaudited interim consolidated financial statements of
root9B Technologies, Inc. (“root9B” or the
“Company”) have been prepared in accordance with
accounting principles generally accepted in the United States of
America (“GAAP”) and the rules of the Securities and
Exchange Commission (“SEC”) and should be read in
conjunction with the audited consolidated financial statements and
notes thereto contained in the Company’s Annual Report filed
with the SEC on Form 10-K for the year ended December 31, 2015. In
the opinion of management, all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of
consolidated financial position and the consolidated results of
operations for the interim periods presented have been reflected
herein. Notes to the financial statements which would substantially
duplicate the disclosure contained in the audited consolidated
financial statements for fiscal year 2015 as reported in the 10-K
have been omitted.
The
consolidated results of operations for interim periods are not
necessarily indicative of the results expected for future quarters
or the full year.
The
preparation of the Company’s Consolidated Financial
Statements, in conformity with GAAP, requires management to make
estimates and assumptions. These estimates and assumptions affect
the reported amounts of assets and liabilities and the reported
amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
Recent
accounting pronouncements:
In May
2014, the FASB issued ASU 2014-09, “Revenue from Contracts
with Customers (Topic 606).” This guidance requires an entity
to recognize revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those
goods or services. In August 2015, the FASB issued a one-year
deferral of the effective date of ASU 2014-09. ASU 2015-14 requires
application of ASU 2014-09 for annual reporting periods beginning
after December 15, 2017 and early adoption is permitted as of the
original effective date (i.e. for annual reporting periods
beginning after December 16, 2016). The Company has not yet
determined the effect, if any, that the adoption of this standard
will have on the Company’s financial position or results of
operations.
In August
2014, the FASB issued Accounting Standards Update No. 2014-15,
Going Concern (“ASU 2014-15”). ASU 2014- 15 provides
GAAP guidance on management’s responsibility in evaluating
whether there is substantial doubt about a company’s ability
to continue as a going concern and about related footnote
disclosures. For each reporting period, management will be required
to evaluate whether there are conditions or events that raise
substantial doubt about a company’s ability to continue as a
going concern within one year from the date the financial
statements are issued. The standard will be effective for annual
periods ending after December 15, 2016, and interim periods within
annual periods beginning after December 15, 2016. Early application
is permitted for annual or interim reporting periods for which the
financial statements have not previously been issued. Upon adoption
the Company will use the guidance in ASU 2014-15 to assess going
concern uncertainty matters.
In
February 2016, the FASB issued Accounting Standards Update No.
2016-02, Leases (“ASU 2016-02”). ASU 2016-02 is
intended to improve financial reporting about leasing transactions.
The ASU will require organizations that lease assets referred to as
“Lessees” to recognize on the balance sheet the assets
and liabilities for the rights and obligations created by those
leases. The standard will be effective for annual periods ending
after December 15, 2018, and interim periods within annual periods
beginning after December 15, 2018. Early adoption is permitted. The
Company is currently in the process of evaluating the impact that
ASU 2016-02 will have on its financial statements.
9
In
March, 2016 the FASB issued Accounting Standards Update 2016-09,
Stock Compensation (“ASU 2016-09). ASU 2016-09 identifies
areas for simplification in accounting for share-based payment
transactions, including the income tax consequences, classification
of awards as either equity or liabilities, an option to recognize
gross stock compensation expense with actual forfeitures recognized
as they occur, as well as certain classifications on the statement
of cash flows. The standard will be effective for annual periods
beginning after December 15, 2016, and interim periods within those
annual periods. Early adoption is permitted. The Company is currently in the
process of evaluating the impact that ASU 2016-09 will have on its
financial statements.
Since
January 1, 2016, there have been other new accounting
pronouncements and updates to the Accounting Standards
Codification. Each of these updates has been reviewed by Management
who does not believe their adoption has had or will have a material
impact on the Company’s financial position or operating
results.
Note 2 – Summary of Significant Accounting
Policies:
The
Company’s significant accounting policies are outlined in the
Company’s Annual Report filed with the SEC on Form 10-K for
the year ended December 31, 2015.
Note 3 – Fair Value Measurements:
We
measure the fair value of financial assets and liabilities in
accordance with GAAP, which defines fair value, establishes a
framework for measuring fair value, and requires certain
disclosures about fair value measurements.
GAAP
defines fair value as the exchange price that would be received for
an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in
an orderly transaction between market participants on the
measurement date. GAAP also establishes a fair value hierarchy,
which requires an entity to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair
value. GAAP describes three levels of inputs that may be used to
measure fair value:
Level 1
– quoted prices in active markets for identical assets or
liabilities.
Level 2
– quoted prices for similar assets and liabilities in active
markets or inputs that are observable.
Level 3
– inputs that are unobservable (for example the probability
of a capital raise in a “binomial” model used for
derivative liability valuation).
Derivative
Instruments:
We do
not use derivative financial instruments to hedge exposures to
cash-flow, market or foreign-currency risks. However, we have
entered into certain financial instruments and contracts, such as
debt financing arrangements and the issuance of common and
preferred stock with detachable common stock warrants features that
are either i) not afforded equity classification, ii) embody risks
not clearly and closely related to host contracts, or iii) may be
net-cash settled by the counterparty. These instruments are
required to be carried as derivative liabilities, at fair
value.
10
Certain
of our derivative instruments are detachable (or
“free-standing”) common stock purchase warrants issued
in conjunction with debt or common and preferred stock. We estimate
fair values of these derivatives utilizing Level 2 inputs for all
warrants issued, other than those associated with Series C
Preferred Stock and derivative features issued to qualified
investors as part of the Q1 2016 capital raise. Other than the
Series C Preferred Stock warrants and the derivative features
issued to Qualified Purchasers, we use the Black-Scholes option
valuation technique as it embodies all of the requisite assumptions
(including trading volatility, remaining term to maturity, market
price, strike price, and risk free rates) necessary to fair value
these instruments, for they do not contain material “down
round protection” (otherwise referred to as
“anti-dilution” and full ratchet provisions). For the
warrants directly related to the Series C Preferred Stock and the
derivative features issued to Qualified Purchasers, the warrant
contracts do contain “Down Round Protections” and the
“Black-Scholes” option valuation technique does not, in
its valuation calculation, give effect for the additional value
inherently attributable to the “Down Round Protection”
mechanisms in its contractual arrangement. Valuation models and
techniques have been developed and are widely accepted that take
into account the additional value inherent in “Down Round
Protection.” These techniques include “Modified
Binomial”, “Monte Carlo Simulation” and the
“Lattice Model.” The “core” assumptions and
inputs to the “Binomial” model are the same as for
“Black-Scholes”, such as trading volatility, remaining
term to maturity, market price, strike price, and risk free rates;
all Level 2 inputs. However, a key input to the
“Binomial” model (in our case, the “Monte Carlo
Simulation”, for which we engage an independent valuation
firm to perform) is the probability of a future capital raise which
would trigger the Down Round Protection feature. By definition,
this input assumption does not meet the requirements for Level 1 or
Level 2 outlined above; therefore, the entire fair value
calculation for the Series C Common Stock Warrants and the
derivative features issued to Qualified Purchasers are deemed to be
Level 3. This input to the Monte Carlo Simulation model, was
developed with significant input from management based on its
knowledge of the business, current financial position and the
strategic business plan with its best efforts.
As of
December 31, 2015, the Company has determined that the
Black-Scholes model valuation for the Series C warrants was not
materially different than the Binomial model due to the remaining
period before warrant expiration being less than 3 months and the
current market price of the Company’s stock being in excess
of the down round trigger price of $0.77. As a result, the
valuation of the Series C warrants as of December 31, 2015 was
performed using the Black-Scholes model to approximate the Binomial
model valuation. 714,285 of the Series C warrants were never
exercised and expired on March 3, 2016.
The
Company determined that the derivative features issued to the
Qualified Purchasers as part of the Securities Purchase Agreement
executed on March 10, 2016, which included 5,073,863 warrants (See
Note 7), should be recorded as derivative liabilities. However, due
to the 9.9% ownership restrictions at both the execution date and
at September 30, 2016, the warrants to the Qualified Purchasers
were not exercisable. Management has also determined that the
likelihood of the Qualified Purchasers ownership percentage being
reduced below the 9.9% maximum ownership is highly improbable
during the term of the warrants. These factors, along with the
anti-dilution protection, were key inputs in the Monte Carlo
simulation performed by an independent valuation firm.
The
Company determined that the 2,310,000 warrants attached to the
convertible debt issued during the third quarter of 2016 (discussed
in Note 8) should be recorded as derivative
liabilities.
Estimating fair
values of these derivative financial instruments requires the use
of significant and subjective inputs that may, and are likely to,
change over the duration of the instrument with related changes in
internal and external market factors. In addition, option-based
techniques are volatile and sensitive to changes in our trading
market price, the trading market price of various peer companies
and other key assumptions such as the probability of a capital
raise for the Monte Carlo Simulation described above. Since
derivative financial instruments are initially and subsequently
carried at fair value, our operating results will reflect this
sensitivity of internal and external factors.
11
The key
quantitative assumptions related to the Series C Common Stock
Warrants, issued March 3, 2011 that expired on March 3, 2016, were
as follows:
|
December 31,
2015
|
|
|
Expected
Life (Years)
|
0.2
|
Risk
Free Rate
|
0.15%
|
Volatility
|
38.06%
|
Probability
of a Capital Raise
|
100%
|
The key
quantitative assumptions related to the Securities Purchase
Agreement, for the derivative features (warrants) issued to the
Qualified Purchasers issued March 10, 2016 are as
follows:
|
September 30, 2016
|
|
|
Expected
Life (Years)
|
4.4
|
Risk
Free Rate
|
0.96%
|
Volatility
|
69.72%
|
Probability
of a Capital Raise
|
5%
- 95%
|
Financial Assets
and Liabilities Measured at Fair Value on a Recurring
Basis
Financial assets
and liabilities measured at fair value on a recurring basis (for
the Company, only derivative liabilities related to common stock
purchase warrants, issued directly in conjunction with debt and
common and preferred stock are summarized below and disclosed on
the balance sheet under Derivative liability:
|
September 30,
2016
|
||
|
Fair ValueLevel
1
|
Level
2
|
Level
3
|
Derivative
Liability – Common Stock Purchase Warrants:
|
|
|
|
Promissory
Notes
|
$233
|
$233
|
|
Series
D Preferred Stock
|
400,492
|
400,492
|
|
Qualified
Purchaser derivative features (warrants)
|
1,408,738
|
|
$1,408,738
|
Warrants
attached to 2016 convertible notes
|
$923,686
|
$923,686
|
|
Total
|
$2,733,149
|
$1,324,411
|
$1,408,738
|
|
December 31,
2015
|
||
|
Fair ValueLevel
1
|
Level
2
|
Level
3
|
Derivative
Liability – Common Stock Purchase Warrants:
|
|
|
|
Promissory
Notes
|
$2,189
|
$2,189
|
|
Series
D Preferred Stock
|
2,904,849
|
2,904,849
|
|
Series
C Preferred Stock
|
633,046
|
|
633,046
|
Total
|
$3,540,084
|
$2,907,038
|
$633,046
|
12
The
Series C Preferred Stock change in Level 3 value from $633,046 as
of December 31, 2015 to $0 as of September 30, 2016 consisted of a
$493,124 decrease in value, with the balance of $139,922
reclassified to shareholder equity upon the exercise of the
warrants. Due to the impact of the anti-dilution down round
provisions of March 2016 financing, the Qualified Purchaser Level 3
derivative features were valued at $1,408,738 as of September 30,
2016, an increase of $809,510 from the $599,228 valuation as of
their issuance date.
Note 4 – Receivables sold with recourse:
The
Company’s IPSA subsidiary sells certain of its accounts
receivable with full recourse to Advance Payroll Funding Ltd.
(“Advance”). Advance retains portions of the proceeds
from the receivable sales as reserves, which are released to the
Company as the receivables are collected. Proceeds from sales of
such receivables, net of amounts held in reserves, during the
period from January 1, 2016 to September 30, 2016, totaled
$7,771,393. The outstanding balance of full recourse receivables at
September 30, 2016 was $1,540,810 and this amount is included in
Accounts receivable on the consolidated balance sheet. The
outstanding factored receivable obligations as of September 30,
2016 was $1,027,393. The outstanding balance of full course
receivables and factored receivable obligations as of December 31,
2015 was $0. In the event of default, the Company is required to
repurchase the entire balance of the full recourse receivables and
is subject to fees. There are no limits on the amount of accounts
receivable factoring available to the Company under the factoring
agreement. The agreement with Advance automatically renewed for a
two year period on January 10, 2016, with additional 24 month
renewal intervals thereafter. The Company may only terminate the
agreement as of the end of the next maturing term, or may provide
at least sixty days written notice for an early termination of the
agreement. In the event of early termination, the Company
would be subject to an early termination fee calculated as the
average monthly base fees earned by Advance for the three months
having the highest total base fees throughout the previous twelve
months, multiplied by the number of months (or portions thereof)
between the early termination date and the end of the current
term.
Note 5 – Pro-Forma Financial Information
(unaudited):
The
following unaudited pro-forma data summarizes the consolidated
results of operations for the nine months ended September 30, 2015
as if the purchase of IPSA International, Inc. had been completed
on January 1, 2015. The pro-forma financial information is
presented for informational purposes only and is not indicative of
the results of operations that would have been achieved if the
acquisition had taken place on January 1, 2015.
|
Nine Months
Ended
|
|
September 30,
2015
|
Net
revenues
|
$29,154,228
|
Operating
(loss)
|
(8,938,366)
|
Net loss per share
– basic and fully diluted
|
$(0.13)
|
Note 6 - Net Income (Loss) Per Share:
Basic
net income or loss per common share is computed by dividing net
income or loss for the period by the weighted-average number of
common shares outstanding during the period. Diluted net income or
loss per share is computed by dividing net income or loss available
to common stockholders for the period by the weighted-average
number of common and common equivalent shares, such as stock
options, warrants and convertible securities outstanding during the
period. Such common equivalent shares have not been included in the
Company’s computation of net income (loss) per share when
their effect would have been anti-dilutive based on the strike
price as compared to the average trading price or due to the
Company’s net losses attributable to common
stockholders.
13
|
Three Months Ended
September 30,
|
Three Months Ended
September 30,
|
|
2016
|
2015
|
Basic:
|
|
|
Numerator
–net (loss) available to common stockholders
|
$(5,094,001)
|
$(4,025,862)
|
Denominator
– weighted-average shares outstanding
|
84,356,405
|
73,807,736
|
Net
(loss) per share – Basic
|
$(0.06)
|
$(0.05)
|
|
|
|
|
Nine Months Ended
September 30,
|
Nine Months Ended
September 30,
|
|
2016
|
2015
|
Basic:
|
|
|
Numerator
–net income (loss) available to common
stockholders
|
$(13,171,561)
|
$(4,854,391)
|
Denominator
– weighted-average shares outstanding
|
82,277,509
|
68,970,960
|
Net
income (loss) per share – Basic
|
$(0.16)
|
$(0.07)
|
|
|
|
Note 7 – Stockholders’ Equity:
Common
Stock:
Generally, the
Company issues common stock in connection with acquisitions, as a
part of equity financing transactions, as dividends on preferred
stock, upon conversion of preferred shares to common stock and upon
the exercise of stock options or warrants.
During
the nine months ended September 30, 2016, the Company issued common
stock and common stock warrants as a part of the following four
equity financing transactions:
On
January 26, 2016, the Company entered into securities purchase
agreements with a group of accredited investors, pursuant to which
the Company was to issue 227,273 shares of common stock at a
purchase price of $1.10 per share. In addition, the Company issued
warrants to purchase up to 56,818 shares of the Corporation’s
common stock in the aggregate, at an exercise price of $1.50 per
share (the “Warrants”). The Warrants have a term of
five years and may be exercised at any time from or after the date
of issuance and contain customary, structural anti-dilution
protection (i.e., stock splits, dividends, etc.). Upon closing of
this equity financing, the Company received proceeds of
$250,000.
14
On
February 24, 2016, the Company received proceeds of $1,256,782 in
connection with the Company's offer to amend and exercise warrants.
In connection with the offering, warrant holders elected to
exercise a total of 1,142,529 of their $1.125 warrants at a reduced
exercise price of $1.10 per share. The Company issued new warrants
to the participants to purchase 285,654 shares of common stock with
a term of five (5) years and have an exercise price per share equal
to $1.50. The Company incurred fees of $105,407 relative to this
transaction.
On
March 3, 2016 the Company agreed to replace the 480,784 $1.50
warrants from the November 5, 2015, December 23, 2015 and January
26, 2016 financings with 1,923,137 five year warrants at $1.10 per
share. These 1,923,137 warrants are subject to the Company’s
customary, structural anti-dilution protections (i.e. stock splits,
dividends, etc.).
On
March 10, 2016, the Company entered into securities purchase
agreements with accredited investors, advisory clients of
Wellington Management Company, LLP (“Wellington”) and the
Dan Wachtler Family Trust pursuant to which the Company issued
5,076,863 shares of common stock at the purchase price of $1.10 per
share. In addition, the Company issued warrants to purchase
up to 5,076,863 shares of the Company’s common stock in the
aggregate, at an exercise price of $1.10 per share. The
warrants have a term of five years and may be exercised on a
cashless basis. Per the terms of the agreement, other than
Dan Wachtler Family Trust, these purchasers are deemed to be
“Qualified Purchasers” and are subject to the
full-ratchet and anti-dilution protections explained below. Upon
closing of this equity financing, the company received proceeds of
$5,584,549.
In the event, prior to March 10, 2021, the Company issues
“Additional Stock” (as defined in the Qualified
Purchasers Securities Purchase Agreement) for per share
consideration that is less than the Exercise Price of the Qualified
Purchaser warrants, then the Exercise Price of each Warrant shall
be reduced concurrently with such issue, to match the per share
price of the dilutive issuance. Additional Stock as defined in the
Securities Purchase Agreement excludes common stock issued for
exercises of stock options and warrants, conversions of promissory
notes, and certain other adjustments as defined in the
agreement.
Additionally, in
the event, prior to March 10, 2018, the Company issues
“Additional Stock” for a per share consideration of
less than $1.10 resulting in a “Dilutive Issuance” as
defined in the Securities Purchase Agreement, the Company shall
issue shares to the Qualified Purchasers, for no additional
consideration, based on a formula defined in the Securities
Purchase Agreement.
Furthermore, in the
event, prior to March 10, 2018, the Company issues
“Additional Stock” (as defined in the Qualified
Purchasers Warrant Agreement) the number of warrant shares shall be
increased by the number of shares necessary to ensure that the
“Ownership Percentage” immediately following the
issuance of any such shares shall remain equal to the Ownership
Percentage immediately prior to such issuance. Ownership Percentage
is calculated as the 5,073,863 warrant shares issued to Qualified
Investors divided by 141,538,754 fully diluted shares agreed upon
at the issuance date. Additional stock per the Warrant Agreement
excludes all of the same items described above and also excludes
shares issued for a strategic investment between $10 million and
$25 million.
On
August 29, 2016 the Qualified Purchasers agreed that any issuance
of Additional Stock, as defined in the Securities Purchaser
Agreement, will exclude any new common stock or warrant shares
issued as part of the 2016 Q3 Convertible Debt financing, as
discussed in Note 8.
There
was no activity during the three months ended September 30, 2016 to
cause the above referenced dilutive or derivative features to be
initiated.
Qualified
Purchasers cannot exercise their warrants unless their beneficial
ownership of outstanding common stock falls below 9.9%. As of the
March 10, 2016 issuance date and September 30, 2016, the Qualified
Purchasers beneficially owned approximately 14% of the
Company’s common stock, thus, the warrants are not
exercisable. If the Qualified Purchasers ownership of outstanding
common stock falls below 9.9%, they are permitted to exercise
warrants only to the extent that their beneficial ownership reaches
9.9%.
15
Aside
from legal fees, the Company incurred $397,699 in fees, plus the
issuance of 202,955 $1.10 five year warrants, with an exercise
price of $1.10 and in connection with this financing transaction
and this amount is not reflected in the proceeds
above.
The
table below summarizes the common stock and warrant activity
referenced:
|
Common
Shares
|
Warrants
|
January 26, 2016
Securities Purchase Agreement
|
227,273
|
56,818
|
February 24, 2016
Warrant Exercises
|
1,142,529
|
(1,142,529)
|
February 24, 2016
Warrant Issue
|
|
285,654
|
March 3, 2016
Warrants Replaced
|
|
(480,784)
|
March 3, 2016
Warrant Re-Issue
|
|
1,923,137
|
March 10, 2016
Stock Purchase Agreement
|
5,076,863
|
5,076,863
|
Warrants Issued
for Services
|
|
202,955
|
Totals
|
6,446,665
|
5,922,114
|
7%
Series B Convertible Preferred Stock:
During
2010, the Company issued 1,200,000 shares of 7% Series B
Convertible Preferred Stock (“Series B Preferred
Stock”), along with 1,058,940 detachable warrants. The
holders of shares of Series B Preferred Stock were entitled to
receive a 7 percent annual dividend until the shares were converted
to common stock. The warrants, immediately exercisable, are for a
term of five years, and entitle the holder to purchase shares of
common stock at an exercise price of $ 0.77 per share. During the
three months ended March 31, 2015, 880,000 shares of Series B
Preferred Stock were converted into 880,000 shares of common stock.
As of September 30, 2016 and December 31, 2015, no shares of the
Series B Preferred Stock remained outstanding.
The
Class B preferred stock accrued 7 percent per annum dividends. The
dividends began accruing April 30, 2010, and were cumulative.
Dividends were payable annually in arrears. At December 31, 2015,
$6,857 of dividends had accrued on these shares. However, they are
unrecorded on the Company’s books until declared. On February
26, 2016, the Company declared the dividends on its Series B
preferred stock accrued as of December 31, 2015, and the Company
paid the dividends in 4,969 shares of Company common stock during
the three months ended March 31, 2016. There were no accrued
dividends payable as of September 30, 2016.
Series
C Convertible Preferred Stock:
During
2011, the Company issued 2,380,952 shares of Series C Convertible
Preferred Stock; $.001 par value per share (“Series C
Preferred Stock”), along with 8,217,141 warrants. Each share
was priced at $2.10 and, when issued, included 3 warrants at an
exercise price of $0.77 which expire in 5 years. The Series C
Preferred Stock (a) is convertible into three shares of common
stock, subject to certain adjustments, (b) pays 7 percent dividends
per annum, payable annually in cash or shares of common stock, at
the Company’s option, and (c) is automatically converted into
common stock should the price of the Company’s common stock
exceed $2.50 for 30 consecutive trading days. The warrants issued
in connection with the Series C Preferred Stock contain
full-ratchet anti-dilution provisions that required them to be
recorded as a derivative instrument.
16
On
August 11, 2015, the Company executed an Exchange Agreement with
the holders of the Series C Preferred Stock Warrants, replacing the
original $0.77 warrants, with $1.20 warrants, which are not
eligible for exercise until after February 11, 2017 and have an
expiration date of August 11, 2018. Additionally, the Company did
not provide full-ratchet anti-dilution provisions.
On February 9, 2016, the Company entered into a letter agreement
(the “Agreement”) with Miriam Blech and River
Charitable Remainder Unitrust f/b/o Isaac Blech, who together
control all of the Company’s Class C Preferred
Stock. Pursuant to the Agreement, the parties agreed to
postpone payment of the annual dividend on the Company’s
Class C Preferred Stock until five (5) business days following the
day on which the Company holds an annual or special meeting of its
stockholders where the stockholders approve a proposal to increase
the authorized capital stock of the Company.
Associated with the March 10, 2016 common stock financing, Mr.
Isaac Blech and his affiliates agreed that the Company does not
have to reserve shares of common stock for the conversion of their
Series C Preferred Stock and underlying warrants until five (5)
business days following the day on which the Company holds an
annual or special meeting of its stockholders where the
stockholders approve a proposal to increase the authorized capital
stock of the Company. In addition, Mr. Blech and his affiliates
agreed not to convert the Series C Preferred Stock or exercise the
underlying warrants into shares of the Company’s common
stock, until such time as the Company’s stockholders approve
a proposal to increase the authorized capital stock of the
Company.
On August 30, 2016, the Company entered into a letter agreement
(“Consent Agreement”) with Miriam Blech and River
Charitable Remainder Unitrust f/b/o Isaac Blech. Pursuant to the
Consent Agreement, Blech agreed to waive certain rights and
preferences associated with the Series C Preferred Stock. In
addition, Blech agreed that within 5 days of the approval by the
Company’s stockholders of a proposal to either increase the
authorized capital stock of the Company or take such other
corporate action as is necessary and appropriate to reserve such
number of shares of authorized but unissued shares of common stock
for the conversion of all of the Series C Preferred Stock in
accordance with their terms, Blech will convert all of their
respective shares of Series C Preferred Stock into shares of the
Company’s common stock.
As of
September 30, 2016 and December 31, 2015, 2,380,952 shares of the
Series C Preferred Stock remain outstanding.
As
discussed in Note 14, on October 24, 2016, the Company’s
shareholders approved certain measures, measures that, once
implemented by the Board of Directors, will allow the Series C
shareholders to receive dividend payments and convert their
preferred shares into common stock. The Series C warrants will
become exercisable during February 2017.
Stock
Options:
The
Company issued 255,000 stock options for services during the three
months ended September 30, 2016 and 150,000 stock options during
the three months ended September 30, 2015 under the 2008 Stock
Incentive Plan. The Company’s results for the three months
ended September 30, 2016 and 2015, include stock option based
compensation expense of $212,410 and $155,550, respectively. These
amounts are included within selling, general and administrative
expenses on the Consolidated Statements of Operations. There were
no tax benefits recognized with respect to that stock based
compensation during the three months ended September 30, 2016 or
2015.
17
The
fair value of the 255,000 stock options granted during the three
months ended September 30, 2016 were estimated using the Black
Scholes option pricing model and using the following
weighted-average assumptions:
Exercise
price
|
$0.70
- $1.11
|
Risk
free interest rate
|
0.84%
- 1.20%
|
Volatility
|
64.57%
- 80.96%
|
Expected
term
|
2.5 -
5.5 Years
|
Dividend
yield
|
None
|
As of
September 30, 2016 the Company has issued employees 2,114,000
contingent vesting options. The vesting of these options is
contingent on shareholder approval of an increase in the amount of
authorized shares of common stock. At the October 24, 2016 special
stockholders meeting, Stockholders approved an amendment to the
Company’s certificate of incorporation effecting a reverse
stock split of between 1:9 to 1:18 and approved an amendment to the
company’s certificate of incorporation to decrease the
company’s authorized shares of common stock from 125 million
shares to 30 million shares. The net effect of these proposals when
or if they are implemented by the Board will enable an increase its
post reverse stock split authorized share limits. In the event that
the Board does not approve the increase in authorized shares by
December 7, 2016 the options will be cancelled. The Company has
determined that due to the contingent vesting of these options,
they are not included in the Company’s outstanding stock
options at September 30, 2016.
On July
15, 2016 the Company exchanged 300,000 $1.30 stock options and
25,000 $1.45 stock options held by prior members of the
Company’s Board of Directors, for 325,000 $1.50 three year
stock warrants.
As of
September 26, 2016 Mr. Grano, through Centurion Holdings, of which
he is Chairman and CEO, owned 1,036,842 stock options at strike
price of $0.76 per share. Upon approval of the Board of Directors,
528,789 of these stock options were re-issued to Mr. Grano with the
same terms and conditions, with the remaining 508,053 options
cancelled and reissued to Centurion Holdings associates of Mr.
Grano’s as $1.10 five year warrants, with no cashless
exercise provisions.
The
following table represents the activity under the stock incentive
plan as of September 30, 2016 and the changes during each
period:
Options
|
Shares
|
Weighted
Average
Exercise
Price
|
Outstanding at
December 31, 2014
|
11,309,864
|
$0.81
|
Issued
|
3,140,000
|
$1.37
|
Exercised
|
(3,053,397)
|
$0.66
|
Forfeitures
|
(1,036,383)
|
$1.07
|
Outstanding at
December 31, 2015
|
10,360,084
|
$1.01
|
Issued
|
1,136,663
|
$0.97
|
Exercised
|
(702,000)
|
$0.64
|
Forfeitures
|
(2,227,942)
|
$0.92
|
Outstanding at
September 30, 2016
|
8,566,805
|
$1.04
|
18
Warrants:
During
July 2016, the Company issued 325,000 3 year $1.50 warrants as
replacement of cancelled stock options for various members of the
Board of Directors. As described in Note 8, during September 2016,
the Company issued 2,310,000 5 year $0.80 warrants to the 2016 Q3
Convertible Promissory Note investors.
On
September 26, 2016 upon approval of the Board of Directors 508,053
stock options originally issued to Centurion Holdings, of which Mr.
Grano is Chairman and CEO, were cancelled and reissued to Centurion
Holdings associates of Mr. Grano’s, as $1.10 five year
warrants with no cashless exercise provisions.
No
warrants to purchase common stock were exercised during the three
months ended September 30, 2016, and 100,000 warrants were
cancelled.
The
following table represents the warrant activity as of September 30,
2016 and the changes during each period:
Warrants
|
Shares
|
Weighted
Average
Exercise Price
|
Outstanding at
December 31, 2014
|
18,753,060
|
$1.06
|
Issued
|
15,848,643
|
$1.09
|
Exercised
|
(1,546,308)
|
$0.76
|
Cancelled
|
(7,187,642)
|
$0.80
|
Outstanding at
December 31, 2015
|
25,867,753
|
$1.16
|
Issued
|
11,361,662
|
$1.07
|
Exercised
|
(1,712,529)
|
$0.99
|
Cancelled
|
(1,784,595)
|
$2.38
|
Outstanding at
September 30, 2016
|
33,732,291
|
$1.07
|
Note 8 – Notes Payable:
In
April 2016, the Company entered into Note Extension Agreement with
existing note holders who held Promissory Notes for $1,600,000
scheduled to mature on May 21, 2016, whereby the note holders
agreed to extend the maturity date of the Promissory notes to May
21, 2017. As consideration for the extension, the note holders
received 480,000 five year warrants with an exercise price of $1.10
per share. Management determined that this transaction constituted
a debt extinguishment under ASC 470 and the $226,380 fair value of
the warrants was recorded as a loss on extinguishment in the
accompanying financial statements for the nine months ended
September 30, 2016.
19
On
August 22, 2016, Mr. Grano the Company’s Chairman and
CEO, and a shareholder, entered into a Promissory Note with the
Company, whereby Mr. Grano lent the Company $500,000 as a one year
promissory note at an annual interest rate of 4%, with the note and
interest payable upon the August 22, 2017 maturity
date.
In
September 2016 the “Company” entered into an offering
of Secured Convertible Promissory Notes (the “Notes”)
with an aggregate principal amount of up to $10,000,000, along with
warrants to purchase shares (the “Warrant Shares”) of
the Company’s common stock, par value $0.001 per share (the
“Common Stock”), representing fifty percent (50%)
warrant coverage (the “Warrants”), to certain
accredited investors (the “Investors”), in a private
placement, pursuant to a securities purchase agreement (the
“Agreement”) by and between the Company and each
Investor. As of September 30, 2016 the Company completed the sale
Notes with a total amount of $3,696,000, along with Warrants to
purchase 2,310,000 shares of Common Stock. The term of each Note is
three years after issuance (the “Maturity Date”). Each
Note accrues interest at a rate of 10% per annum, payable on each
March 31, June 30, September 30 and December 31, commencing
December 31, 2016 until the earlier of (i) the entire principal
amount being converted or (ii) the Maturity Date. The interest
payments shall be made in either cash or, at the holder’s
option, in shares of Common Stock (the “Interest Payment
Shares”) at a per share price equal to 85% of the average
daily volume weighted average price of the Common Stock during the
five consecutive trading day period immediately prior to the
interest payment date, but in no event less than $0.80 per
share.
Following the date
which is six months after the date of issuance, at the election of
the holder, all principal and interest due and owing under each
Note is convertible into shares of Common Stock at a conversion
price equal to $0.80 (the “Conversion Shares” and,
together with the Warrant Shares and the Interest Payment Shares,
the “Shares”). The conversion price is subject to
adjustment for stock splits, stock dividends, combinations, or
similar events. Pursuant to a security agreement entered into
concurrently with the Investors, the Notes are secured by
substantially all of the Company’s assets, subject to certain
exceptions including the assets related to and held by IPSA
International, Inc., a wholly-owned subsidiary of the Company
(“IPSA”). The Company may prepay any portion of the
outstanding principal amount of any Note and any accrued and unpaid
interest, with the prior written consent of the holder, by paying
to the holder an amount (the “Prepayment Amount”) equal
to (i) if the prepayment date is prior to the first anniversary of
the date of issuance (the “Anniversary Date”), (1) the
unpaid principal to be repaid plus (2) any accrued but unpaid
interest plus (3) an amount equal to the interest which has not
accrued as of the prepayment date but would accrue on the principal
to be repaid during the period beginning on the prepayment date and
ending on the Anniversary Date of the then-outstanding principal
amount of that Note or (ii) if the prepayment date is after the
Anniversary Date, (1) the unpaid principal to be repaid plus
(2) any accrued but unpaid interest plus (3) an amount equal to
one-half of the interest which has not accrued as of the prepayment
date but would accrue on the principal to be repaid during the
period beginning on the prepayment date and ending on the Maturity
Date.
Pursuant to the
terms of both the Notes and the Warrants, a holder may not be
issued Shares if, after giving effect to the conversion of the
Notes or exercise of the warrants, as applicable, the holder,
together with its affiliates, would beneficially own in excess of
9.99% of the outstanding shares of Common Stock. In addition, in
the event the Company consummates a consolidation or merger with or
into another entity or other reorganization event in which the
Common Stock is converted or exchanged for securities, cash or
other property, or the Company sells, assigns, transfers, conveys
or otherwise disposes of all or substantially all of its assets or
the Company (other than the sale, merger or asset sale of IPSA) or
another entity acquires 50% or more of the outstanding Common
Stock, then following such event, (i) at their election within 30
days of consummation of the transaction, the holders of the Notes
will be entitled to receive the Prepayment Amount, and (ii) the
holders of the Warrants will be entitled to receive upon exercise
of such Warrants the same kind and amount of securities, cash or
property which the holders would have received had they exercised
the Warrants immediately prior to such transaction. Any successor
to the Company or surviving entity shall assume the Company’s
obligations under the Notes and the Warrants.
20
As of
the note and warrant issue dates, the Company has available
2,000,000 shares of Common Stock for issuances to be allocated, pro
rata, among the Purchasers of the Notes and Warrants at the Initial
Closing. With, or within 30 days after, the consummation of a such
a consolidation or merger, the Company or any Successor Entity, at
the Holder’s option shall purchase or exchange for cash or an
equal amount of securities or property all or any portion of any
related warrants from the Holder, by paying the Holder an amount
equal to the Black Scholes Value of the remaining unexercised
portion of such warrant on the date of such a consolidation or
merger.
Excluding the
2,000,000 shares discussed above, the Notes shall not be
convertible into Common Stock (nor any interest paid in Common
Stock), and the Warrants shall not be exercisable for Common Stock,
until the Company has a sufficient number of shares of Common Stock
available for issuance to permit full conversion or exercise of the
Notes and Warrants, respectively. On October 24, 2016 (See Note 14)
the Company held a special stockholders meeting at which time the
Stockholders approved an amendment to its certificate of
incorporation in order to, among other things, provide for a
sufficient number of authorized shares of Common Stock to permit
the full conversion or exercise, as applicable. If the Company had
failed to obtain such stockholder approval on or prior to December
31, 2016, a holder could, at its option any time through January
31, 2017, require the Company to repurchase all or any portion of
the holder’s (i) Note (or the amount outstanding thereunder),
or (ii) Warrant, at an amount of cash equal to the Black Scholes
Value of the remaining unexercised portions of such Warrant on
December 31, 2016.
Due to
the potential for cash settlement as of the warrant issuance dates
and as of September 30, 2016, the fair value of the warrants were
recorded as a derivative liability. Should the Board approve the
change in the Company’s authorized shares as discussed above
and in Note 14, the fair value of these warrants will be marked to
market through such effective date, and the balance will be
reclassified to equity.
In
recording the proceeds of the Convertible Debt Liability, the
Company determined that the $3,696,000 in investment proceeds must
be allocated between the notes and warrants, based on the fair
value of the warrants, with the intrinsic value of the beneficial
conversion feature of the notes along with the fair value of the
warrants, being recorded as a debt discount. The Company calculated
this debt discount value to be $2,094,150, which was recoded as a
deduction in the Convertible Debt Liability on the Company’s
balance sheet as of September 30, 2016. The debt discount is being
amortized as interest expense over the three year term of the
notes. In September 2016, the Company recognized $21,200 in
interest expense associated with this amortization.
Note 9 – Segment Information:
The
Company operates in three business segments: the Cyber Solutions
segment, the IPSA / Business Advisory Solutions segment and the
Energy Solutions segment. The Cyber Solutions segment provides
cyber security and advanced technology training services,
operational support and consulting services. The IPSA / Business
Advisory Solutions (IPSA/BAS) segment, which includes IPSA as of
February 9, 2015, provides anti-money laundering operational,
advisory and consulting services, investigative due diligence
services and advisory services in the following areas: risk, data,
organizational change and cyber. The Energy Solutions segment
works with customers to assess, design
and install processes and automation to address energy regulation,
strategy, cost, and usage initiatives.
21
The
performance of the business is evaluated at the segment level.
Cash, debt and financing matters are managed centrally. These
segments operate as one from an accounting and overall executive
management perspective, though each segment has senior management
in place; however, they are differentiated from a marketing and
customer presentation perspective, though cross-selling
opportunities exist and continue to be pursued. Condensed summary
segment information follows for the three and nine months ended
September 30, 2016 and 2015.
|
Three Months Ended September 30, 2016
|
|||
|
Cyber Solutions
|
Energy Solutions
|
IPSA / Business Advisory Solutions
|
Total
|
|
|
|
|
|
Revenue
|
$1,501,831
|
$506,566
|
$6,563,580
|
$8,571,977
|
Income (loss) from Operations before Overhead
|
$(2,232,579)
|
$(115,323)
|
$(71,404)
|
$(2,419,306)
|
Allocated Corporate Overhead
|
226,500
|
76,397
|
989,888
|
1,292,785
|
Loss from Operations
|
$(2,459,079)
|
$(191,720)
|
$(1,061,292)
|
$(3,712,091)
|
|
Three Months Ended September 30, 2015
|
|||
|
Cyber Solutions
|
Energy Solutions
|
IPSA / Business Advisory Solutions
|
Total
|
|
|
|
|
|
Revenue
|
$939,584
|
$422,566
|
$5,275,699
|
$6,637,849
|
Income (loss) from Operations before Overhead
|
$(955,926)
|
$(167,116)
|
$(807,092)
|
$(1,930,134)
|
Allocated Corporate Overhead
|
241,151
|
106,257
|
1,272,264
|
1,619,672
|
Loss from Operations
|
$(1,197,077)
|
$(273,373)
|
$(2,079,356)
|
$(3,549,806)
|
|
Nine Months Ended September 30, 2016
|
|||
|
Cyber Solutions
|
Energy Solutions
|
IPSA / Business Advisory Solutions
|
Total
|
|
|
|
|
|
Revenue
|
$3,303,919
|
$1,143,281
|
$21,461,390
|
$25,908,590
|
Income (loss) from Operations before Overhead
|
$(6,987,265)
|
$(417,228)
|
$(344,517)
|
$(7,749,010)
|
Allocated Corporate Overhead
|
534,740
|
185,040
|
3,473,529
|
4,193,309
|
Loss from Operations
|
$(7,522,005)
|
$(602,268)
|
$(3,818,046)
|
$(11,942,319)
|
|
|
|
|
|
Assets
|
$5,479,033
|
$1,616,781
|
$26,000,894
|
$33,096,708
|
|
Nine Months Ended September 30, 2015
|
|||
|
Cyber Solutions
|
Energy Solutions
|
IPSA / Business Advisory Solutions *
|
Total
|
|
|
|
|
|
Revenue
|
$2,050,862
|
$1,497,205
|
$20,574,014
|
$24,122,081
|
Income (loss) from Operations before Overhead
|
$(3,095,326)
|
$(508,921)
|
$67,076
|
$(3,537,171)
|
Allocated Corporate Overhead
|
1,160,809
|
385,237
|
4,276,520
|
5,822,566
|
Loss from Operations
|
$(4,256,135)
|
$(894,158)
|
$(4,209,444)
|
$(9,359,737)
|
|
|
|
|
|
Assets
|
$4,848,306
|
$2,542,983
|
25,696,894
|
$33,088,183
|
●
IPSA revenues and
expenses were consolidated effective as of February 9, 2015;
therefore, the results of operations for 2015 reflect the results
as of the February 9, 2015 acquisition date.
22
Note 10 – Commitments and Contingencies:
Platte
River Insurance Company (“Platte River”) instituted an
action on April 8, 2015, in the United States District Court for
the District of Massachusetts in which Platte River claims that the
Company signed as a co-indemnitor in support of surety bonds issued
by Platte River on behalf of Prime Solutions for the benefit of
Honeywell pursuant to Prime Solutions, Inc.’s
(“Prime”) solar project located in Worcester
Massachusetts (the “Prime Contract”). The Company
filed its answer to the complaint, denying the allegations of
Platte River. On February 1, 2016 the Company received a demand
letter from Platte River for immediate payment of an $868,617 claim
under the terms of the co-indemnity agreement. The Company
continued to deny the allegations and did not agree to the demand.
The Company’s maximum liability exposure under the bond was
$1,412,544, if Prime failed to meet its contracted obligations. In
October 2014, the Company determined it probable that Prime did
fail to meet its contracted obligations under the Prime Contract,
and therefore, the potential existed that the Company would have to
meet outstanding Prime Contract obligations. On April 11, 2016, the
Company settled this litigation with an agreement to pay $650,000,
an amount that was initially accrued as a Selling, General and
Administrative expense on the Consolidated Statement of Operations
during 2014. Per the settlement agreement, the Company paid
$325,000 on April 19, 2016. The original settlement agreement was
modified and the remaining $325,000 was paid in two installments,
$162,500 on July 15, 2016 and $162,500 on August 1, 2016. As of
September 30, 2016 $0 remained in accrued expenses and other
current liabilities.
The
Company and two senior executives of the Company are named as
defendants (the “Defendants”) in a class action
proceeding filed on June 23, 2015, in the U.S. District Court
for the Central District of California. On September 24,
2015, the U.S. District Court for the Central District of
California granted a motion to
transfer the lawsuit to the United States District Court for the
District of Colorado. On October 14, 2015, the Court
appointed David Hampton as Lead Plaintiff and approved
Hampton’s selection of the law firm Levi & Korsinsky LLP
as Lead Counsel. Plaintiff filed an Amended Complaint on
January 4, 2016. The Amended Complaint alleges violations of
the federal securities laws on behalf of a class of persons who
purchased shares of the Company’s common stock between
October 17, 2014 and June 15, 2015. In general, the Amended
Complaint alleges that false or misleading statements were made or
that there was a failure to make appropriate disclosures concerning
the Company’s cyber security business and products. On
February 18, 2016, the Company filed a motion to dismiss
Plaintiff’s Amended Complaint. Plaintiff filed an opposition
to the motion to dismiss and the Company replied on May 4, 2016. On
August 3, 2016, the U.S. Magistrate Judge issued a recommendation
that the Court grant Plaintiff’s motion to strike certain
exhibits from Defendants’ motion to dismiss, and on August 4,
2016, the U.S. Magistrate Judge issued a recommendation that the
Court grant in part and deny in part Defendants’ motion to
dismiss the Amended Complaint. On September 21, 2016 the
United States District Court for the District of Colorado
dismissed, with prejudice, the class action suit. On October 21,
2016 the plaintiffs filed a notice of appeal to the decision. The
clerk of the court notified the parties of the filing for appeal
and recorded the opening on November 7, 2016. The Plaintiff’s
have 40 days thereafter to file their brief, and the Defendants
then have 30 days there after to respond to the Plaintiff’s
brief. We cannot predict the outcome of this appeal; however,
the Company believes the appeal lacks merit. No liability has
been recorded in the financial statements for this
matter.
Note 11 – Related Party Transactions:
Centurion Holdings,
of which Mr. Grano, the Company’s Chairman and CEO, and a
shareholder, has a sublease agreement for a portion of its office
in New York with IPSA. The lease is at market rates of $21,609 per
month and constitutes IPSA’s New York Office. The lease
expires during August 2018.
On
August 22, 2016, Mr. Grano the Company’s Chairman and CEO,
and a shareholder, entered into a Promissory Note with the Company,
whereby Mr. Grano lent the Company $500,000 as a one year
promissory note at an annual interest rate of 4%, with the note and
interest payable upon the August 22, 2017 maturity
date.
On
August 25, 2016, Joseph J. Grano, Jr., the Company's Chief
Executive Officer, and Dan Wachtler, Chief Executive Officer of
IPSA International, a wholly-owned subsidiary of the Company,
voluntarily agreed to reduce each of their respective annual base
salaries to $250,000. Mr. Grano also agreed to cancel any bonus
payments that may have otherwise been earned, until such time as
the Company is profitable.
On
September 26, 2016 Mr. Grano, through Centurion Holdings, of which
he is Chairman and CEO, owned 1,036,842 stock options at strike
price of $0.76 per share. Upon approval of the Board of Directors,
528,789 of these stock options were re-issued to Mr. Grano with the
same terms and conditions, with the remaining 508,053 options
cancelled and reissued to Centurion Holdings associates of Mr.
Grano’s as $1.10 five year warrants with no cashless exercise
provisions.
23
Note 12 – Liquidity and Capital Resources:
As of
September 30, 2016, we had cash and cash equivalents of $2,032,338,
compared to $795,682 at December 31, 2015, an increase of
$1,236,656. The increase is primarily attributable to the proceeds
from the equity financing transactions and warrant and stock option
exercises and convertible debt and related party loans during the
first nine months of 2016 which totaled approximately $11,200,000,
offset by the net cash used in operations and investing of
approximately $10,000,000.
Our
objective from a liquidity perspective is to use operating cash
flows to fund day to day operations. In both the first nine months
of 2016 and 2015 we did not achieve this objective, as cash flow
from operations in the first nine months of 2016 and 2015 has been
the net use of $9.4 million and $10.4 million, respectively. Our
high use of cash has been predominantly caused by competitive
pricing pressures decreasing gross margins for the IPSA/BAS
business segments, costs for the ramp up of root9B, our cyber
security subsidiary, the cyber solutions employee base and capital
costs associated with the build out of the Adversarial Pursuit
Center and other expansion related costs.
New
IPSA and Cyber Solutions client engagements in the first nine
months of 2016, while increasing revenues for the three months
ended September 30, 2016 versus 2015, have not scaled to the
revenue and gross margin levels that the Company expected in
providing sufficient resources to significantly improve the
Company’s liquidity position. Continued investments in the
Cyber Solutions business segment and the reduced revenue and gross
margin forecasts have resulted in the Company’s need to raise
additional capital.
On
August 22, 2016 the Company announced its strategic intent to focus
on the root9B cybersecurity business and the approval of the
Company’s Board of Director’s to evaluate the
divestiture of the IPSA International and remaining components of
the Energy Solutions business. The Company is in the process of
assessing the feasibility and possible sale prices of these
business segments. The Company has yet to determine a price at
which it would be willing to sell these business segments and, as
such, no assurances can be made as to their eventual
sale.
In an
attempt to improve the marketability of the Company’s common
stock, on October 24, 2016 the Company’s Stockholders
approved an amendment to the Company’s certificate of
incorporation approving a reverse stock split of between 1:9 to
1:18 and approved an amendment to the company’s certificate
of incorporation to decrease the company’s authorized shares
of common stock from 125 million shares to 30 million shares. The
net effect of these proposals when or if they are implemented by
the Board will enable the Company to increase its post reverse
stock split authorized share limit and satisfy the Company’s
conversion and exercise obligations under the Company’s
current outstanding securities and provide the company with greater
flexibility to raise additional capital when it is
needed.
In
addition to a possible divesture of the IPSA International and
remaining components of the Energy Solutions business, the Company
continues to pursue the sale of the remaining $6 million
convertible promissory notes with attached warrants, as discussed
in Note 8, as well as other available options for obtaining
additional financing. No assurances can be given that the Company
will be successful in obtaining the necessary financing. Without
additional funding, the issues of not generating material revenue
increases and having negative operating cash flows, among other
issues, raise substantial doubt about our ability to continue as a
“going concern.”
Note 13 – Goodwill and Intangibles Impairment:
The
Company completes an annual impairment analysis each year by
applying both Step 1 and Step 2 tests, as applicable, according to
FASB ASC 350. The annual impairment testing date has been October
1st and
typically the Company would record any impairment arising from such
tests in the 4th quarter. Based upon
a mid-year review of the IPSA, BAS and Cyber Solutions business
unit growth plans, management accelerated the timing of this
analysis to the 3rd quarter of 2016. In
determining impairment charges, the Company uses a discounted cash
flow approach and engaged an outside valuation form to assist the
Company
As a
result of the impairment testing, during the three months ended
September 30, 2016 the Company recorded a goodwill impairment
write-down of $2,044,477 for the BAS business segment, reducing the
goodwill valuation to $273,301 from $2,317,778 as of June 30, 2016.
No impairment charges were required for the IPSA and Cyber
Solutions business units.
Note 14 – Subsequent Events:
On
October 24, 2016 the Company held a special stockholders meeting at
which time the Stockholders approved an amendment to the
Company’s certificate of incorporation effecting a reverse
stock split of between 1:9 to 1:18 and approved an amendment to the
company’s certificate of incorporation to decrease the
company’s authorized shares of common stock from 125 million
shares to 30 million shares. The net effect of these proposals when
or if they are implemented by the Board will enable to increase its
post reverse stock split authorized share limits and satisfy the
Company’s conversion and exercise obligations under the
Company’s current outstanding securities and provide the
company with greater flexibility to raise additional capital when
it is needed. In addition, the Company has filed a preliminary
listing application with NASDAQ Capital Markets. No assurance can
be given that after the proposed stock split is authorized by the
Board the Company will meet the listing requirements of NASDAQ
Capital Markets.
24
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
CAUTIONARY
STATEMENT ON FORWARD-LOOKING INFORMATION
Statements
in this Form 10-Q, including the information incorporated by
reference herein, that are not historical in nature, including
those concerning the Company’s current expectations about its
future requirements and needs, are “forward-looking”
statements as defined in Section 21E of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”)
and the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are identified by words such as
“may,” “should,” “expects,”
“provides,” “anticipates,”
“assumes,” “can,” “meets,”
“could,” “intends,” “might,”
“predicts,” “seeks,” “would,”
“believes,” “estimates,”
“plans” or “continues.” Although we believe
that the expectations reflected in such forward-looking statements
are reasonable at the time they are made, you are cautioned that
forward-looking information and statements are subject to various
risks and uncertainties, many of which are difficult to predict and
generally beyond our control. Risks and uncertainties could cause
actual results and developments to differ materially from those
expressed in, or implied or projected by, forward-looking
information and statements provided here or in other disclosures
and presentations. Those risks and uncertainties include, but are
not limited to, the risks listed in Part I – Item 1A of our
Annual Report on Form 10-K for 2015. We do not undertake any
obligation to update or revise any forward-looking information or
statements.
The
following discussion should be read in conjunction with our
financial statements and the related notes included in this Form
10-Q.
When
this report uses the words “we,” “us,”
“our,” “root9B,” and the
“Company,” they refer to root9B Technologies, Inc.
“SEC” refers to the Securities and Exchange
Commission.
The
following discussion summarizes the significant factors affecting
our results of operations and financial condition for the three
month periods ended September 30, 2016 and September 30, 2015
(“third quarter of 2016 ” and “third quarter of
2015 ”, respectively) and the nine month periods ended
September 30, 2016 and 2015. This discussion should be read in
conjunction with, and is qualified by, the financial statements
included in this Report, the financial statements for the fiscal
year ended December 31, 2015 (“2015”), and
Management’s Discussion and Analysis of Financial Condition
and Results of Operations (“MD&A”) contained in our
Annual Report on Form 10-K for 2015.
OVERVIEW
We
are a provider of cyber security, business advisory services,
principally in regulatory risk mitigation, and energy and controls
solutions. We help clients in diverse industries improve
performance, comply with complex regulations, reduce costs,
leverage and integrate technology, manage risk, and stimulate
growth. Our primary focus is using our expertise on issues related
to four key areas for customers; (i) Cyber security, (ii) anti
money laundering and investigative due diligence services, (iii)
regulatory, risk, and compliance initiatives, and (iv) energy
services. We work with our customers to assess, design, and
provide customized advice and solutions that are tailored to
address each client’s particular needs. We provide solutions
and services to a wide variety of organizations including Fortune
500 companies, medium-sized businesses, and governmental
entities.
On
August 22, 2016 the Company announced its strategic intent to focus
on the root9B cybersecurity business and the approval of the
Company’s Board of Director’s to evaluate the
divestiture of the IPSA International and remaining components of
the Energy Solutions business. The Company is in the process of
assessing the feasibility and possible sale prices of these
business segments. The Company has yet to determine a price at
which it would be willing to sell these business segments and as
such no assurances can be made as to their eventual
sale.
25
Our
results of operations for the third quarter of 2016 and the third
quarter of 2015 are highlighted in the table below and discussed in
the following paragraphs:
|
3 Months Ended September 30,
|
|||
|
2016
|
% of Net Revenue
|
2015
|
% of Net Revenue
|
Net
Revenue
|
$8,571,977
|
|
$6,637,849
|
|
Operating
Expenses:
|
|
|
|
|
Cost
of revenues
|
7,072,845
|
82.5%
|
5,232,364
|
78.8%
|
Selling,
general & administrative
|
4,661,496
|
54.4%
|
4,537,800
|
68.4%
|
Depreciation
and amortization
|
549,727
|
6.4%
|
417,491
|
6.3%
|
Total
operating expenses
|
12,284,068
|
143.3%
|
10,187,655
|
153.5%
|
Loss
from Operations
|
(3,712,091)
|
-43.3%
|
(3,549,806)
|
-53.5%
|
Other
Income (Expense):
|
|
|
|
|
Derivative
income (expense)
|
1,089,617
|
12.7%
|
(22,477)
|
-0.4%
|
Goodwill
Impairment
|
(2,044,477)
|
-23.9%
|
|
|
Interest
expense, net
|
(201,110)
|
-2.4%
|
(167,427)
|
-2.5%
|
Other
income (expense)
|
(94,472)
|
-1.1%
|
(128,667)
|
-1.9%
|
Total
other income (expense)
|
(1,250,442)
|
-14.6%
|
(318,571)
|
-4.8%
|
Loss
Before Income Taxes
|
(4,962,533)
|
-57.9%
|
(3,868,377)
|
-58.3%
|
Income
Tax Benefit (Expense)
|
(131,468)
|
-1.5%
|
(157,485)
|
-2.4%
|
Net
Loss
|
(5,094,001)
|
-59.4%
|
(4,025,862)
|
-60.7%
|
|
|
|
|
|
Net
Loss Attributable to Common Stockholders
|
$(5,094,001)
|
-59.4%
|
$(4,025,862)
|
-60.7%
|
26
Comparison of the three months ended September 30, 2016 to the
three months ended September 30, 2015
Net Revenue
Total
revenue for the quarter ended September 30, 2016 was $8,571,977 as
compared to $6,637,849 for the quarter ended September 30, 2015, a
net increase of $1,934,128, or 29.1%. Revenue by segment was as
follows:
|
Three Months Ended September 30
|
|
|
|
2016
|
2015
|
% growth
|
|
|
|
|
Cyber
Solutions
|
$1,501,831
|
$939,584
|
59.8%
|
|
|
|
|
IPSA/Business
Advisory Solutions:
|
|
|
|
Without
IPSA
|
1,365,171
|
1,851,791
|
-26.3%
|
IPSA
|
5,198,409
|
3,423,908
|
51.8%
|
Total
IPSA/Business Advisory Solutions
|
6,563,580
|
5,275,699
|
24.4%
|
|
|
|
|
Energy
Solutions
|
506,566
|
422,566
|
19.9%
|
|
|
|
|
Total
Revenue
|
$8,571,977
|
$6,637,849
|
29.1%
|
|
|
|
|
Cyber Solutions Segment
Revenue
for the CS segment for the quarter ended September 30, 2016
increased $562,247 or 59.8% as compared to the quarter ended
September 30, 2015. The primary reason for the increase in revenue
is due to a $558,595 or 118% increase in training revenue, a
$228,389 or 97% increase in operations center revenue, offset by a
$224,735 or 97% decrease in cyber tools revenue as compared to
quarter ended September 30, 2015. The increase in training and
operations center revenue reflects the results of recent sales
efforts.
IPSA / Business Advisory Solutions Segment
Revenue
for the IPSA / BAS segment for the quarter ended September 30, 2016
increased $1,287,881 or 24.4% as compared to the quarter ended
September 30, 2015. Revenue for the IPSA segment increased
$1,774,501 or 51.8% for the quarter ended September 30, 2016 as
compared to the quarter ended September 30, 2015. Revenue for the
BAS segment decreased $486,620 or 26.3%. The IPSA revenue increase
is related primarily to Anti-Money Laundering (AML) risk advisory,
operational, investigative and remedial services revenue from new
clients. The decline in revenue for the BAS segment was due to a
decline in revenue from existing customers, increased pricing
competition from larger business advisory service providers and an
inability to timely replace existing customer revenue reductions
with new customers and projects.
In
August 2016 the Company announced its intent to evaluate the
divestiture of the IPSA International business.
Energy Solutions Segment
Revenue
for the ES segment for the quarter ended September 30, 2016
increased $84,000 or 19.9% as compared to the quarter ended
September 30, 2015. This increase in revenue is reflective of a
temporary increase in solar controls revenue associated with a new
contract. In the latter half of 2014, the Company announced that it
was de-emphasizing the energy business, this shift in strategy and
the resulting sale of its assets in the first quarter of 2015,
continues to have a negative impact on this segments revenue
growth.
27
In
August 2016, the Company announced its strategic intent evaluate
the divestiture of the remaining components of the Energy Solutions
business
Gross Margin
Gross
margin (revenue less cost of revenues, defined as all costs for
billable personnel in the IPSA / BAS business segment and the
direct cost of goods and subcontract services for the CS and ES
segments) increased $93,647 or 6.7% to $1,499,132 for the quarter
ended September 30, 2016 from $1,405,485 for the quarter ended
September 30, 2015. As a percentage of revenue, gross margin
decreased to 17.5% of revenues in the third quarter of 2016 from
21.2% in the third quarter of 2015. The main reasons for the
decrease in gross margin relate to the Cyber Solutions gross margin
decreasing $313,510 to ($419,675), the IPSA / BAS gross margin
increasing $472,746 to $1,928,169 and the ES segment gross margins
decreasing $65,589 to ($9,362), which are discussed
below.
For the
Cyber Segment, the gross margin decrease of $313,510 relates to a
revenue increase of $562,247, being offset by a $875,757 increase
cost of sales: $521,447 related to increased employee head count
and expenses, and $354,310 related to increases in costs associated
with the continued investment in future revenue driving resources
and the expansion of the cyber proprietary platform, which were
charged to cost of revenues.
The
IPSA / BAS Segment gross margin increase of $472,746 is the result
of a $1,287,699 revenue increase being offset by $857,194 in
increased cost of revenue related to direct employee expenses,
$245,268 in increased cost of revenue related sub-contractor
expenses, and other project related directly billable expenses
decreasing $287,325.
The
Energy Solutions Segment gross margin decrease of $65,589 relates
to a $84,000 revenue increase being offset by a $149,589 increase
in non-employee sub-contractor and project related direct materials
related cost of revenue expenses, the result being various
unprofitable client projects during the quarter ended September 30,
2016.
Selling, General and Administrative Expenses
Selling, general
and administrative (“SG&A”) expenses increased to
$4,661,496 in the third quarter of 2016 from $4,537,800 in the
third quarter of 2015, an increase of $123,696 or 2.7%. As a
percentage of net revenue, SG&A expenses decreased to 54.4% in
the third quarter of 2016 as compared to 68.4% in the third quarter
of 2015. The decrease in SG&A expenses as a percentage of
revenue was due primarily to the increase in 2016 third quarter
revenue versus 2015. By business segment the $123,696 increase
breaks out as follows: the IPSA/BAS segment decreased $294,642, the
ES segment decreased $64,506, the CS segment increased $854,216 and
Corporate Overhead decreased $371,372. The Company accounts for and
manages expenses as those directly related to a business segment
and corporate overhead expenses which includes executive
compensation, back office functions, such as finance and human
resources, and other administrative costs. Expenses related to
these groups are discussed below.
Cyber Segment
SG&A expenses
in the CS segment increased to $1,631,598 in the third quarter of
2016 as compared to $777,382 in the third quarter of 2015, an
increase of $854,216 or 109.9%. The increase is primarily due to
increased labor costs of approximately $505,000, increased travel
of $45,000, increased professional services and advertising
expenses of $168,000 and increased rent and utilities expense of
$136,000. Labor costs and travel expense increased during the third
quarter of 2016 as, in anticipation of future growth in the cyber
segment, the Company continues to invest in additional sales and
marketing and other operating CS resources. Rent expense increased
as the Company leased additional new office/training facilities. CS
expenses as a percentage of segment revenue increased to 108.6% in
the third quarter of 2016 from 82.7% in the third quarter of
2015.
28
IPSA / BAS Segment
SG&A expenses
in the IPSA / BAS segment decreased to $1,649,237 in the third
quarter of 2016 as compared to $1,943,878 in the third quarter of
2015, an decrease of $294,641 or 15.2%. Most of this decrease
relates to reduced SG&A headcount and employee related
expenses. IPSA / BAS expenses as a percentage of segment revenue
decreased to 25.1% in the third quarter of 2016 from 36.9% in the
third quarter of 2015, primarily due to reduced employee related
expenses and an increase in segment revenue.
ES Segment
SG&A expenses
in the ES segment decreased to $96,526 in the third quarter of 2016
as compared to $202,215 in the third quarter of 2015, a decrease of
$105,689 or 52.3%. The decrease is primarily attributable to
reduced employee and professional services expenses. Due primarily
to control of operating expenses, ES expenses as a percentage of
segment revenue decreased to 19.1% in the third quarter of 2016
from 47.9% in the third quarter of 2015.
Corporate Overhead
Corporate Overhead
SG&A expenses decreased to $1,284,135 in the third quarter of
2016 from $1,614,325 in the third quarter of 2015, a decrease of
$330,190 or 19.9%. The main drivers of the decrease were a
reduction in personnel and labor costs of $200,000, an increase in
stock option expense for employees and directors of $57,000, an
decrease in Directors fees and expenses of $60,000, an increase in
business insurance costs of $47,000, and a $165,000 net decrease in
professional services and other corporate expenses.
Other Income (Expense)
Other
Income (Expense) for the third quarter of 2016 resulted in an
expense of $1,250,442 as compared to expense of $318,571 in the
third quarter of 2015. The main component of the increase in other
income (expense) is the non-cash derivative (expense) income and
other income and is discussed below.
Derivative (expense) income
From
May 2010 through the first quarter of 2013, the Company issued
Series B Preferred Stock, Debentures, Series C Preferred Stock, 7%
Convertible Redeemable Promissory Notes, and Series D Preferred
Stock, all with detachable common stock purchase warrants deemed to
be derivative instruments. These warrants are recorded as
derivative liabilities and “marked-to-market” based on
fair value estimates at each reporting date. Collectively, these
derivatives were valued at an estimated fair value of $400,492 at
September 30, 2016, with an decrease in value since June 30, 2016
of $1,454,226, being recognized as derivative (non-cash) expense on
the consolidated statement of operations for the third quarter of
2016.
The
issuance of the derivative features issued to Qualified Purchasers
during the first quarter of 2016 had an estimated value of
$1,408,738 as of September 30, 2016, with the increase in value
since June 30, 2016 of $338,293 being recognized as derivative
(non-cash) expense on the consolidated statement of operations for
the third quarter of 2016.
29
The
issuance of the derivative features issued to the Convertible
Promissory Note holders during the third quarter of 2016 had an
estimated value of $923,686 as of September 30, 2016, with the
derivative (non-cash) expense being recognized on the consolidated
statement of operations for the third quarter of 2016.
For the
quarter ended September 30, 2015, the change in derivative
valuation for the like period was non-cash income of
$1,089,617
Goodwill Impairment
As a
result of the impairment testing, during the three months ended
September 30, 2016 the Company recorded a goodwill impairment
write-down of $2,044,477 for the BAS business segment, reducing the
goodwill valuation to $273,301 from $2,317,778 as of June 30, 2016.
No impairment charges were required for the IPSA and Cyber
Solutions business units.
Other income (expense)
Other
income (expense) decreased to an expense of ($94,472) in the third
quarter of 2016 as compared to an (expense) of $128,667 in the
third quarter of 2015. During the third quarter of 2016, the
Company had miscellaneous other income, and realized losses on the
conversion to US dollars on the payment of IPSA accounts receivable
in foreign currency amounts greater than the carrying value of the
original invoice totaling ($8,401), and unrealized losses on the
conversion to US dollars on the payment of IPSA accounts receivable
in foreign currency amounts greater than the carrying value of the
original invoice of ($86,071).
Interest Expenses
Interest expense
increased to $201,110 in the third quarter of 2016 versus $167,427
in the third quarter of 2015.
Income Tax Benefit (Expense)
The
Company had an income tax expense for the third quarter of 2016 of
$131,468 compared to a $157,485 of expense during the third quarter
of 2015. The effective tax rate was (1.44)% in the third quarter of
2016 and (24.3)% in the third quarter of 2015. The Company’s
first quarter tax expense relates primarily to pre-tax net income
from IPSA’s Canadian subsidiary.
Preferred Stock Dividends
The
Company has two series of Convertible Preferred Stock which pay
dividends at annual specified rates. The two series are: 7% Series
B Convertible Preferred Stock and the Series C Convertible
Preferred Stock, which has a 7% dividend rate. There were no
dividends paid during the third quarter of 2016 or
2015.
Common Stock Dividend
No
dividend for common stock has been declared during the quarter
ended September 30, 2016, and the Company does not anticipate
declaring dividends in the foreseeable future.
30
Comparison of the nine months ended September 30, 2016 to the nine
months ended September 30, 2015
Our
results of operations for the first nine months of 2016 and the
first nine months of 2015 are highlighted in the table below and
discussed in the following paragraphs:
|
Nine Months Ended September 30,
|
|||
|
2016
|
% of Net Revenue
|
2015
|
% of Net Revenue
|
Net
Revenue
|
$25,908,590
|
|
$24,122,081
|
|
Operating
Expenses:
|
|
|
|
|
Cost
of revenues
|
22,410,844
|
86.5%
|
18,630,208
|
77.2%
|
Selling,
general & administrative
|
13,832,055
|
53.4%
|
13,108,647
|
54.4%
|
Depreciation
and amortization
|
1,608,010
|
6.2%
|
1,093,521
|
4.5%
|
Acquisition
related costs
|
-
|
0.0%
|
649,442
|
2.7%
|
Total
operating expenses
|
37,850,909
|
146.1%
|
33,481,818
|
138.8%
|
Loss
from Operations
|
(11,942,319)
|
-46.1%
|
(9,359,737)
|
-38.8%
|
Other
Income (Expense):
|
|
|
|
|
Derivative
income
|
1,912,821
|
7.4%
|
3,768,199
|
15.6%
|
Goodwill
Impairment
|
(2,044,477)
|
-7.9%
|
|
|
Loss
on extinguishment of debt
|
(226,380)
|
-0.9%
|
-
|
-
|
Interest
expense, net
|
(460,745)
|
-1.8%
|
(698,068)
|
-2.8%
|
Other
income (expense)
|
(138,880)
|
-0.6%
|
(39,430)
|
-0.2%
|
Total
other income
|
(957,661)
|
-3.7%
|
3,030,701
|
12.6%
|
Loss
Before Income Taxes
|
(12,899,980)
|
-49.8%
|
(6,329,036)
|
-26.2%
|
Income
Tax Benefit (Expense)
|
(264,723)
|
-1.0%
|
1,881,017
|
7.8%
|
Net
Loss
|
(13,164,704)
|
-50.8%
|
(4,448,019)
|
-18.4%
|
Preferred
Stock Dividends
|
(6,857)
|
-0.0%
|
(406,372)
|
-1.7%
|
Net
Loss Attributable to Common Stockholders
|
$(13,171,561)
|
-50.8%
|
$(4,854,391)
|
-20.1%
|
Comparison of the nine months ended September 30, 2016 to the nine
months ended September 30, 2015
The
result of operations described below includes the Cyber Solutions
(“CS”) and the Energy Solutions (“ES”)
segments for the nine months ended September 30, 2016 and 2015. We
acquired IPSA International, Inc. on February 9, 2015 and this new
business is included in the IPSA Business Advisory Solutions
(“IPSA/BAS”) segment as of the acquisition
date.
31
Net Revenue
Total
revenue for the nine months ended September 30, 2016 was
$25,908,590 as compared to $24,122,081 for the nine months ended
September 30, 2015, a net increase of $1,786,509, or 7.4%. Revenue
by segment was as follows:
|
Nine Months Ended September 30
|
|
|
|
2016
|
2015
|
% growth
|
|
|
|
|
Cyber
Solutions
|
$3,303,919
|
$2,050,862
|
61.1%
|
|
|
|
|
IPSA/Business
Advisory Solutions:
|
|
|
|
Without
IPSA
|
3,983,964
|
6,717,338
|
-40.7%
|
IPSA
|
17,477,426
|
13,856,676
|
26.1%
|
Total
IPSA/Business Advisory Solutions
|
21,461,390
|
20,574,014
|
4.3%
|
|
|
|
|
Energy
Solutions
|
1,143,281
|
1,497,205
|
-23.6%
|
|
|
|
|
Total
Revenue
|
$25,908,590
|
$24,122,081
|
7.4%
|
|
|
|
|
Cyber Solutions Segment
Revenue
for the CS segment for the nine months ended September 30, 2016
increased $1,253,057 or 61.1% as compared to the nine months ended
September 30, 2015. The primary reason for the increase in revenue
is due to a $1,242,083 or 203% increase in operations center
revenue. The other areas of revenue, mostly training, recorded a
net increase of $10,977 in revenue during the nine months ended
September 30, 2016 as compared to nine months ended September 30,
2015. The increase in operations center revenue reflects the
results of more recent sales efforts.
IPSA / Business Advisory Solutions Segment
Revenue
for the IPSA / BAS segment for the nine months ended September 30,
2016 increased $887,376 or 4.3% as compared to the nine months
ended September 30, 2015. Revenue for the IPSA segment increased
$3,620,750 or 26.1% for the nine months ended September 30, 2016 as
compared to the nine months ended September 30, 2015, which for
this segment only included revenue from the acquisition date of
February 9, 2015 through September 30, 2015. Revenue for the BAS
segment, excluding the contribution of the IPSA acquisition, for
the nine months ended September 30, 2016, decreased $2,733,374 or
40.7% as compared to the nine months ended September 30,
2015.
The
IPSA revenue increase is related primarily to Anti-Money Laundering
(AML) risk advisory, operational, investigative and remedial
services revenue from new clients. The decline in revenue for the
BAS segment was due to a decline in revenue from existing
customers, increased pricing competition from larger business
advisory service providers and an inability to timely replace
existing customer revenue reductions with new customers and
projects.
On a
pro-forma basis, comparing the IPSA revenues of the first nine
months of 2016 with the first nine months of 2015, as if the IPSA
acquisition had taken place on January 1, 2015, IPSA revenues
decreased $1,411,522 or 7.5% from a pro-forma $18,888,948 in the
first nine months of 2015 to $17,477,426 in the first nine months
of 2016.
In
August 2016 the Company announced its intent to evaluate the
divestiture of the IPSA International business.
Energy Solutions Segment
Revenue
for the ES segment for the nine months ended September 30, 2016
decreased $353,924 or 23.6% as compared to the nine months ended
September 30, 2015. This decline in revenue is reflective of the
continued shift in strategy and repositioning that was announced in
September 2014, when the Company decided to de-emphasize the energy
business and, as a result the assets of the energy audit business
were sold in the first quarter of 2015. This continued shift in the
Company’s strategy was the primary reason for the decline in
revenue.
32
In
August 2016 the Company announced its intent to evaluate the
divestiture of the remaining components of the Energy Solutions
business.
Gross Margin
Gross
margin (revenue less cost of revenues, defined as all costs for
billable personnel and direct cost of goods and subcontract
services, decreased $1,994,127 or 36.3% to $3,497,746 for the nine
months ended September 30, 2016 from $5,491,873 for the nine months
ended September 30, 2015. As a percentage of revenue, gross margin
decreased to 13.5% of revenues in the first nine months of 2016
from 22.8% in the first nine months of 2015. The main reasons for
the decrease in gross margin relate to the Cyber Solutions gross
margin decreasing $958,956 to ($2,015,150), the IPSA / BAS gross
margin decreasing $715,160 to $5,588,863 and the ES segment gross
margins decreasing $320,011 to ($75,967) which are discussed
below.
For the
Cyber Segment, the gross margin decrease of $958,956 relates to a
revenue increase of $1,253,057, being offset by a $2,212,013
increase cost of sales: $1,570,865 related to increased employee
expenses and $641,148 related to increases in costs associated with
the continued investment in future revenue driving resources and
the expansion of the cyber proprietary platform, which were charged
to cost of revenues.
The
IPSA / BAS Segment gross margin decrease of $715,160 is the result
of a $887,376 revenue increase, offset by $732,173 in increased
employee expenses, $1,064,276 in increased sub-contract labor
expenses and a $193,913 decrease in direct project
expenses.
The
Energy Solutions Segment gross margin decrease of $320,011 relates
to a $353,924 revenue decrease being offset by a $33,913 decrease
in non-employee related cost of revenue expenses.
Selling, General and Administrative Expenses
Selling, general
and administrative (“SG&A”) expenses increased to
$13,832,055 in the first nine months of 2016 from $13,108,647 in
the first nine months of 2015, an increase of $723,408 or 5.5%. As
a percentage of net revenue, SG&A expenses increased to 53.1%
in the first nine months of 2016 as compared to 54.4% in the first
nine months of 2015. By business segment the $723,408 increase
breaks out as follows: the IPSA/BAS segment decreased $474,866, the
ES segment decreased $385,794, the CS segment increased $2,690,213
and Corporate Overhead decreased $1,106,146. The Company accounts
for and manages expenses as those directly related to a business
segment and corporate overhead expenses which includes executive
compensation, back office functions, such as finance and human
resources, and other administrative costs. Expenses related to
these groups are discussed below.
33
Cyber Segment
SG&A expenses
in the CS segment increased to $4,575,096 in the first nine months
of 2016 as compared to $1,884,883 in the first nine months of 2015,
an increase of $2,690,213 or 142.7%. The increase is primarily due
to increased labor costs of approximately $2,093,000, increased
travel and continuing employee education and training of $224,000,
increased professional services of $291,000 and increased rent and
utilities expense of $82,000. Labor costs and travel expense
increased during the first nine months of 2016 as the Company
continues to grow and build out CS resources and expertise as the
Company positions for future growth in the cyber segment. Rent
expense increased as the Company leased additional office/training
facilities. CS expenses as a percentage of segment revenue
increased to 138.5% in the first nine months of 2016 from 91.9% in
the first nine months of 2015.
IPSA / BAS Segment
SG&A expenses
in the IPSA / BAS segment decreased to $4,902,687, in the first
nine months of 2016 as compared to $5,377,553 in the first nine
months of 2015, an decrease of $474,866 or 8.8%. Most of this
decrease relates to decreased employee headcount offset by slight
increases in employee travel, professional services, rent, and
utilities. IPSA / BAS expenses as a percentage of segment revenue
decreased to 22.8% in the first nine months of 2016 from 26.1% in
the first nine months of 2015, primarily due to the decrease in
expenses.
ES Segment
SG&A expenses
in the ES segment decreased to $304,588 in the first nine months of
2016 as compared to $690,382 in the first nine months of 2015, a
decrease of $385,794 or 55.9%. The decrease is primarily
attributable to employee and non-revenue related professional
services expenses. ES expenses as a percentage of segment revenue
decreased to 26.6% in the first nine months of 2016 from 46.1% in
the first nine months of 2015, primarily due to the decrease in
segment revenue and and expenses.
Corporate Overhead
Corporate Overhead
SG&A expenses decreased to $4,049,685 in the first nine months
of 2016 from $5,155,830 in the first nine months of 2015, a
decrease of $1,106,146 or 21.5%. The main drivers of the decrease
were a reduction in personnel and labor costs of $998,000, an
increase in stock option expense for employees and directors of
$193,000, an decrease in Directors fees and expenses of $124,000,
an increase in business insurance costs of $49,000, an $226,000 net
decrease in professional services and other corporate
expenses.
Acquisition related costs
On
February 6, 2015, the Company entered into an Agreement and Plan of
Merger with IPSA International, Inc. (“IPSA”). On
February 9, 2015, the Company and IPSA consummated and closed the
Merger. During the first nine months of 2015, the Company incurred
one-time charges for legal, accounting and advisory fees of
$649,442 related to the merger transaction.
34
Other Income (Expense)
Other
Income (Expense) for the first nine months of 2016 resulted in
expense of $798,248 as compared to income of $3,030,701 in the
first nine months of 2015. The main component of the decrease in
other income (expense) is the non-cash derivative (expense) income,
non-cash loss on the extinguishment of debt and other income and is
discussed below.
Derivative (expense) income
From
May 2010 through the first quarter of 2013, the Company issued
Series B Preferred Stock, Debentures, Series C Preferred Stock, 7%
Convertible Redeemable Promissory Notes, and Series D Preferred
Stock, all with detachable common stock purchase warrants deemed to
be derivative instruments. These warrants are recorded as
derivative liabilities and “marked-to-market” based on
fair value estimates at each reporting date. Collectively, these
derivatives were valued at an estimated fair value of $400,492 at
September 30, 2016.
The
issuance of the derivative features issued to Qualified Purchasers
during the first quarter of 2016 had an estimated value of
$1,408,738 as of September 30, 2016.
The
issuance of the derivative features issued to the Convertible
Promissory Note holders during the third quarter of 2016 had an
estimated value of $923,686 as of September 30, 2016, with the
derivative (non-cash) expense being recognized on the consolidated
statement of operations for the third quarter of 2016.
The
change in value of these derivative instruments resulted in the
recognition of non-cash derivative income totaling $1,912,821 for
the nine months ended September 30, 2016, compared to $3,768,199
for the nine months ended September 30, 2015.
Goodwill
As a
result of the impairment testing, during the three months ended
September 30, 2016 the Company recorded a goodwill impairment
write-down of $2,044,477 for the BAS business segment, reducing the
goodwill valuation to $273,301 from $2,317,778 as of June 30, 2016.
No impairment charges were required for the IPSA and Cyber
Solutions business units.
Extinguishment of Debt
The
April 2016, Note Extension Agreement the Company executed with
existing note holders who held Promissory Notes for $1,600,000
scheduled to mature on May 21, 2016, whereby the note holders
agreed to extend the maturity date of the Promissory notes to May
21, 2017, also granted the note holders to receive 480,000 five
year warrants with an exercise price of $1.10 per share. The value
of these warrants as of the grant date resulted in a non-cash
expense of $226,380 during the nine months ended September 30,
2016.
Other income (expense)
Other
income (expense) decreased to an expense of ($138,880) in the first
nine months of 2016 as compared to an expense of $(39,430) in the
first nine months of 2015. During the first nine months of 2016,
the Company had miscellaneous other income, realized gains on the
change in carrying value of term life insurance and realized gains
on the conversion to US dollars on the payment of IPSA accounts
receivable in foreign currency amounts greater than the carrying
value of the original invoice totaling $33,743, offset by
unrealized losses on the conversion to US dollars on the payment of
IPSA accounts receivable in foreign currency amounts greater than
the carrying value of the original invoice of
($172,623).
35
Income Tax Benefit (Expense)
The
Company had an income tax expense for the nine months ended
September 30, 2016 of ($264,723) compared to a $1,881,017 income
tax benefit for the nine months ended September 30, 2015. The
effective tax rate was (1.61)% in the first nine months of 2016 and
(30.1)% in the first nine months of 2015. The Company’s 2016
tax expense relates primarily to pre-tax net income from
IPSA’s Canadian subsidiary.
As a
part of the purchase price allocation for the IPSA acquisition, the
Company recorded net deferred tax assets, which were recorded on
IPSA’s books at the time of acquisition, of approximately
$556,000. In connection with the purchase price allocation, the
Company recorded a deferred tax liability of approximately
$2,842,000, with a corresponding increase to goodwill, for the tax
effect of the acquired identifiable intangible assets from IPSA.
This liability was recorded as there will be no future tax
deductions related to the acquired intangibles but they will be
amortized as described above for financial reporting
purposes.
Prior
to the acquisition, the Company had determined that it was more
likely than not that some portion or all of its deferred tax assets
would not be realized and therefore had recorded a valuation
allowance for the full amount of its deferred tax assets (which
were $7,543,910 at December 31, 2014). Upon the acquisition, the
Company evaluated the likelihood that the acquired deferred tax
assets and liabilities would be realized and as a result of that
evaluation, recorded an increase to the valuation allowance of
approximately $474,000 related to the acquired deferred tax assets
and recorded a reduction to the valuation allowance of
approximately $2,842,000 related to the deferred tax liability
associated with the acquired identifiable intangible assets. The
net amount of these two adjustments to the Company’s
valuation allowance against its net deferred tax assets was
approximately $2,368,000 and is included in the income tax benefit
on the Company’s consolidated statement of operations for the
nine months ended September 30, 2015.
Preferred Stock Dividends
The
Company has two series of Convertible Preferred Stock which pay
dividends at annual specified rates. The two series are: 7% Series
B Convertible Preferred Stock and the Series C Convertible
Preferred Stock, which has a 7% dividend rate. See further
discussion on the Convertible Preferred Stock in Note 8 to the
Financial Statements. Dividends paid during the first nine months
of 2016 to Series B shareholders were 4,969 shares of common stock,
valued at $6,857. Dividends paid during the first nine months of
2015, which were paid in common stock, were valued at issuance as
follows: to Series B, 36,369 shares valued at $56,372, and to
Series C, 225,807 shares valued at $350,000.
Common Stock Dividend
No
dividend for common stock has been declared as of the nine month
period ended September 30, 2016, and the Company does not
anticipate declaring dividends in the foreseeable
future.
Critical
Accounting Policies
Our
financial statements have been prepared in accordance with
accounting policies generally accepted in the United States of
America. Our discussion and analysis of our financial condition and
results of operations are based on these financial statements. The
preparation of these financial statements requires the application
of accounting policies in addition to certain estimates and
judgments by our management. Our estimates and judgments are based
on currently available information, historical results and other
assumptions we believe are reasonable. Actual results could differ
from these estimates.
36
The
Company’s significant accounting policies are outlined in the
Company’s Annual Report filed with the SEC on Form 10-K for
the year ended December 31, 2015.
Recent
Accounting Pronouncements
In May
2014, the FASB issued ASU 2014-09, “Revenue from Contracts
with Customers (Topic 606).” This guidance requires an entity
to recognize revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those
goods or services. In August 2015, the FASB issued a one-year
deferral of the effective date of ASU 2014-09. ASU 2015-14 requires
application of ASU 2014-09 for annual reporting periods beginning
after December 15, 2017 and early adoption is permitted as of the
original effective date (i.e. for annual reporting periods
beginning after December 16, 2016). The Company has not yet
determined the effect, if any, that the adoption of this standard
will have on the Company’s financial position or results of
operations.
In August
2014, the FASB issued Accounting Standards Update No. 2014-15,
Going Concern (“ASU 2014-15”). ASU 2014- 15 provides
GAAP guidance on management’s responsibility in evaluating
whether there is substantial doubt about a company’s ability
to continue as a going concern and about related footnote
disclosures. For each reporting period, management will be required
to evaluate whether there are conditions or events that raise
substantial doubt about a company’s ability to continue as a
going concern within one year from the date the financial
statements are issued. The standard will be effective for annual
periods ending after December 15, 2016, and interim periods within
annual periods beginning after December 15, 2016. Early application
is permitted for annual or interim reporting periods for which the
financial statements have not previously been issued. Upon adoption
the Company will use the guidance in ASU 2014-15 to assess going
concern uncertainty matters.
On
February 25, 2016, the FASB issued Accounting Standards Update No.
2016-02, Leases (“ASU 2016-02”). ASU 2016-02 is
intended to improve financial reporting about leasing transactions.
ASU 2016-02 affects companies that lease assets such as real
estate, airplanes, and manufacturing equipment. The ASU will
require organizations that lease assets referred to as
“Lessees” to recognize on the balance sheet the assets
and liabilities for the rights and obligations created by those
leases. The standard will be effective for annual periods ending
after December 15, 2018, and interim periods within annual periods
beginning after December 15, 2018. Early adoption will be permitted
for all companies and organizations upon issuance of the standard.
The Company is currently in the process of evaluating the impact
that ASU 2016-02 will have on its financial
statements.
In
March, 2016 the FASB issued Accounting Standards Update 2016-09.
Stock Compensation (“ASU 2016-09). ASU 2016-09 identifies
areas for simplification in accounting for share-based payment
transactions, including the income tax consequences, classification
of awards as either equity or liabilities, an option to recognize
gross stock compensation expense with actual forfeitures recognized
as they occur, as well as certain classifications on the statement
of cash flows. The standard will be effective for annual periods
beginning after December 15, 2016, and interim periods within those
annual periods. Early adoption is permitted. The Company is currently in the
process of evaluating the impact that ASU 2016-09 will have on its
financial statements.
Since
January 1, 2016, there have been several other new accounting
pronouncements and updates to the Accounting Standards
Codification. Each of these updates has been reviewed by Management
who does not believe their adoption has had or will have a material
impact on the Company’s financial position or operating
results.
37
Liquidity
and Capital Resources
As of
September 30, 2016, we had cash and cash equivalents of $2,032,338,
compared to $795,682 at December 31, 2015, an increase of
$1,236,656. The increase is primarily attributable to the proceeds
from the equity financing transactions and stock option and warrant
exercises during the first nine months of 2016 which totaled
approximately $11,200,000, offset by the net cash used in
operations and capital expenditures of approximately
$10,000,000.
Our
objective from a liquidity perspective is to use operating cash
flows to fund day to day operations. In both the first nine months
of 2016 and 2015 we did not achieve this objective, as cash flow
from operations in the first nine months of 2016 and 2015 has been
the net use of $9.4 million and $10.4 million, respectively. Our
high use of cash has been predominantly caused by increased cost of
revenues / decreased gross margins caused by increased competitive
pricing pressures for the IPSA/BAS business segments, costs for the
ramp up of root9B, our cyber security subsidiary, the cyber
solutions employee base and capital costs associated with the build
out of the Adversarial Pursuit Center and other expansion related
costs.
The
Company continues to explore various financing alternatives to
provide additional liquidity, including an evaluation of the
possible divestiture of the IPSA International and remaining
components of the Energy Solutions business. The funding of the
first and third quarters of 2016 provided relief for near term
liquidity pressures. New IPSA and Cyber Solutions client
engagements in the first nine months of 2016, while increasing
revenues, have not yet scaled to levels that the Company expected
in providing sufficient resources to significantly improve the
Company’s liquidity position. Continued investments in the
Cyber Solutions business segment and the reduced expectations have
resulted in the Company’s need to raise additional
capital.
Working
capital was ($1,234,246) and ($971,669) at September 30, 2016 and
December 31, 2015, respectively, a decrease of $262,577 The
decrease is driven primarily by the increases in accounts
receivable offset by increases in accounts payable and factored
accounts receivable obligations.
Non-current
liabilities at September 30, 2016 are $4,391,379, and primarily
consist of a derivative liability related to the September 30, 2016
valuation of outstanding common stock purchase warrants and
derivative instruments issued to Qualified Purchasers of
$2,733,149, and long-term debt obligations of
$1,658,230.
Shareholders’
Equity was $17,224,555 at September 30, 2016 (representing 55.5% of
total assets), compared to a balance at December 31, 2015 of
$21,119,604.
Cash Flows from Operating Activities
During
the first nine months of 2016, net cash used in operating
activities was $9,385,774 as compared to net cash used in operating
activities of $10,373,965 during the first nine months of 2015, a
decrease of $988,191. The net cash used during the nine months
ended September 30, 2016 was primarily attributable to: i) the net
loss of $12,008,030, ii) the net increase in accounts receivable of
approximately $1,973,000, iii) an increase in accounts payable and
accrued expenses of $1,948,000, iv) proceeds from factored
receivables of $1,027,000, and v) non-cash operating and
depreciation and amortization expenses of $1,608,000.
Cash Flows from Investing Activities
Cash
used in investing activities during the nine month period ended
September 30, 2016 was $789,197 and was primarily due to leasehold
improvements and capital expenditures for root9B, LLC and an IPSA
office.
38
Cash Flows from Financing Activities
Cash
provided by financing activities of $11,230,298 for the first nine
months of 2016 was due to the net proceeds from equity financing
transactions of $5,331,443, net cash received upon the exercise of
stock options and warrants of $1,708,532 and net proceeds from
long-term debt obligations of $4,190,323
The
Company will need to raise additional funds in order to fund
operations. Financing transactions, may include the issuance of
equity or debt securities, and obtaining credit facilities, or
other financing mechanisms. However, if the trading price of our
common stock declines, or if the Company continues to incur losses,
this could make it more difficult to obtain financing through the
issuance of equity or debt securities. Furthermore, if we issue
additional equity or debt securities, stockholders will likely
experience additional dilution or the new equity securities may
have rights, preferences or privileges senior to those of existing
holders of our common stock. The inability to obtain additional
financing may restrict our ability to grow and may affect
operations of the Company, its ability to retain and hire critical
staff and revenue producing sub-contractors, and will raise
substantial doubt about our ability to continue as a “going
concern.”
Off-Balance-Sheet Arrangements
As of
September 30, 2016, and during the nine month period then ended,
there were no other transactions, agreements or other contractual
arrangements to which an unconsolidated entity was a party under
which we (1) had any direct or contingent obligation under a
guarantee contract, derivative instrument, or variable interest in
the unconsolidated entity, or (2) had a retained or contingent
interest in assets transferred to the unconsolidated
entity.
As of
September 30, 2016, the Company has issued employees 2,114,000
contingent vesting options. The vesting of these options is
contingent on shareholder approval of an increase in the amount of
authorized shares of common stock. In the event that the
shareholders do not approve the increase in authorized shares by
December 7, 2016, the options will be cancelled. The Company has
determined that due to the contingent vesting of these options,
they are not included in the Company’s outstanding stock
options at September 30, 2016.
Outlook
In the
latter half of 2014, the Company announced that it was
de-emphasizing the energy business and repositioning itself as a
cybersecurity and regulatory risk mitigation business. In August
2016 the Company announced its strategic intent to further its
focus on the root9B cybersecurity business.
The
Company acquired root9B, its wholly owned cybersecurity business at
the end of 2013. In 2014, root9B began expanding the number of
subject matter experts it employs and developed and enhanced its
offensive and defensive cyber operations platforms and tools. These
efforts resulted in the development of: i) Orion, an Active
Adversary Pursuit (HUNT) platform, ii) Orkos, which identifies
compromised credentials and supports predictive remediation, iii)
Cerberus, which provides host based security analytics and breach
monitoring, and iv) Event Horizon, which provides non attributable
network access that allows users to connect to a secure managed
tunnel for web, e-mail and file transfers. The Adversary Pursuit
Center (APC), root9B’s 24/7 manned cyber security center,
opened in September 2015. The APC combines internal and external
threat intelligence feeds to drive pursuit operations and perimeter
defense within client networks. We believe that root9B’s
Orion Hunt Platform and other tools will provide a distinct
advantage by allowing customers to focus on identifying potential
threats before significant data breaches occur rather than
remediation after the occurrence. We are still in the early stages
of commercialization and while we believe that our recent business
development and sales efforts, enhanced by the opening of the APC
in September 2015, will lead to new and expanding client
opportunities, there can be no assurances that our continued
efforts to commercialize our new products offerings and grow
root9B’s revenues will be successful.
39
In
February 2015, the Company acquired IPSA International, Inc., an
international risk mitigation consulting firm. IPSA is an
established business with operations at a number of locations in
and outside of the United States. IPSA’s revenue has
historically been generated through a small number of anti-money
laundering clients who have traditionally accounted for
approximately 80% of total revenue. As these large customer
engagements conclude or as new engagements begin, IPSA’s
revenue can experience dramatic swings. In order to decrease this
dependency, we are focusing efforts on growing IPSA’s other
revenue lines, particularly investigations related to the issuance
of second passports in Antigua, St Kitts and other emerging
markets, which are expected to provide increased revenue stability.
When we acquired IPSA, we combined our Business Advisory Solutions
unit with IPSA and that combined entity accounted for approximately
84% of our revenues for 2015, 77% in the quarter ended September
30, 2016 and 83% in the first nine months of 2016.
On
August 22, 2016 the Company announced its strategic intent to focus
on the root9B cybersecurity business and the approval of the
Company’s Board of Director’s to evaluate the
divestiture of the IPSA International and remaining components of
the Energy Solutions business. The Company is in the process of
assessing the feasibility and possible sale prices of these
business segments. The Company has yet to determine a price at
which it would be willing to sell these business segments and as
such no assurances can be made as to their eventual
sale.
During
the quarter ended September 30, 2016 the Company also announced the
following management changes related to the strategic intent to
focus the Company on the root9B cybersecurity business, i) Daniel
Wachtler, previously CEO of the IPSA International business unit,
was named Chief Operating Officer and President of the Company; ii)
Eric Hipkins, CEO of the root9B cybersecurity business unit was
named to the Board of Directors, and iii) Brian King, formally
Chief Operating Officer of the Company announced his resignation.
Mr. Grano, currently CEO and Chairman of the Board of Directors
announced that he will seek his successor to coincide with the end
of contract as CEO in May 2017.
For the
past several quarters, the Company has been experiencing negative
cash flow and has used periodic financings to invest in growing
root9B operations and maintain its operations. New IPSA and Cyber
Solutions client engagements in the first nine months of 2016,
while resulting in increased revenues during the three months ended
September 30, 2016 versus 2015, have not yet scaled to levels that
the Company expected in providing sufficient resources to
significantly improve the Company’s liquidity position.
Continued investments in the Cyber Solutions business segment and
the reduced revenue and gross margin forecasts have resulted in the
Company’s need to raise additional capital.
In
addition to a possible divesture of the IPSA International and
remaining components of the Energy Solutions business, the Company
continues to pursue completion of the remaining $10 million
Convertible Debt funding, and other available options for obtaining
additional financing. No assurances can be given that the Company
will be successful in obtaining the necessary financing. Without
additional funding, the issues of not generating material revenue
increases and having negative operating cash flows, among other
issues, raise substantial doubt about our ability to continue as a
“going concern.”
40
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
The
Company’s primary market risk exposures consist of interest
rate risk associated with borrowings. Management believes that
interest rate fluctuations will not have a material impact on the
Company’s results of operations.
Market fluctuation impact on assets
For the
nine months ending September 30, 2016, the valuation of the
Variable Life Insurance policies had an investment gain of $14,466.
During the three months ended June 30, 2016 the Company surrendered
these Variable Life Insurance policies receiving net proceeds of
$181,837.
Equity Market Risks
The
trading price of our common stock has been and is likely to
continue to be volatile and could be subject to wide fluctuations.
Such fluctuations could impact our decision or ability to utilize
the equity markets as a potential source of our funding needs in
the future.
We have
experienced substantial and continuing losses from operations.
These are the result of increased gross margin pressure and
increases in selling, general and administrative expenses incurred
in preparation for growth. We expect that our cyber security
operations will increase revenues and help move the Company to
profitability from operations, of which there can be no
assurance.
In an
attempt to improve the marketability of the Company’s common
stock the Company’s Stockholders approved an amendment to the
Company’s certificate of incorporation effecting a reverse
stock split of between 1:9 to 1:18 and approved an amendment to the
company’s certificate of incorporation to decrease the
company’s authorized shares of common stock from 125 million
shares to 30 million shares. The net effect of these proposals when
or if they are implemented by the Board is that the Company will
increase its authorized share capital which will enable the Company
to satisfy the Company’s conversion and exercise obligations
under the Company’s current outstanding securities and
provide the company with greater flexibility to raise additional
capital when it is needed.
We will
need to obtain additional financing in 2016 to support our future
operations and there can be no assurance that we will be able to
obtain financing, or if obtained, on terms favorable to the
Company. Failure to obtain the same will adversely affect the
operations of the Company.
Item
4.
|
Controls
and Procedures
|
We
maintain disclosure controls and procedures that are designed to
provide reasonable assurance that information required to be
disclosed in our periodic reports to the SEC 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 management,
including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required
disclosures.
Management has
concluded that that Company’s internal control over the
timely preparation of financial statements, the recording of
complex derivative instruments (including stock options and
warrants), and utilization of third party consultants or
specialists for valuation services was inadequate during the
quarter ended September 30, 2016.
41
The
Company is currently taking the following steps to enhance internal
controls surrounding the aforementioned items:
●
The Company is
reviewing workflow, documentation, and staff experience and
training related to stock option and warrant valuations and proper
reporting in accordance with accounting principles generally
accepted in the United States of America.
●
The Company is
evaluating the need for additional staff personnel or the
utilization of a third party consulting firm to assist with the
preparation of consolidated financial statements and analysis of
complex accounting transactions.
●
The Company is
evaluating its processes and procedures to ensure third party
valuation specialists are utilized in a more timely and effective
manner.
●
The Company will
also revise its internal disclosure review timelines to ensure that
management reviews are completed in a timely manner.
42
PART
II
OTHER
INFORMATION
Item
1.
|
Legal Proceedings
|
Platte
River Insurance Company (“Platte River”) instituted an
action on April 8, 2015, in the United States District Court for
the District of Massachusetts in which Platte River claims that the
Company signed as a co-indemnitor in support of surety bonds issued
by Platte River on behalf of Prime Solutions for the benefit of
Honeywell pursuant to Prime Solutions, Inc.’s
(“Prime”) solar project located in Worcester
Massachusetts (the “Prime Contract”). The Company
filed its answer to the complaint, denying the allegations of
Platte River. On February 1, 2016 the Company received a demand
letter from Platte River for immediate payment of an $868,617 claim
under the terms of the co-indemnity agreement. The Company
continued to deny the allegations and did not agree to the demand.
The Company’s maximum liability exposure under the bond was
$1,412,544, if Prime failed to meet its contracted obligations. In
October 2014, the Company determined it probable that Prime did
fail to meet its contracted obligations under the Prime Contract,
and therefore, the potential existed that the Company would have to
meet outstanding Prime Contract obligations. On April 11, 2016, the
Company settled this litigation with an agreement to pay $650,000,
an amount that was initially accrued as a Selling, General and
Administrative expense on the Consolidated Statement of Operations
during 2014. Per the settlement agreement the Company paid $325,000
on April 19, 2016. The original settlement agreement was modified
and the remaining $325,000 was paid in two installments, $162,500
on July 15, 2016 and $162,500 on August 1, 2016. As of September
30, 2016 $0 remained in accrued expenses and other current
liabilities.
The Company and two senior executives of the
Company are named as defendants in a class action proceeding filed
on September 23, 2015, in the U.S. District Court for the
Central District of California. On September 24, 2015, the
U.S. District Court for the Central District of California granted
a motion to transfer the lawsuit to the United States District
Court for the District of Colorado. On October 14, 2015, the
Court appointed David Hampton as Lead Plaintiff and approved
Hampton’s selection of the law firm Levi & Korsinsky LLP
as Lead Counsel. Plaintiff filed an Amended Complaint on
January 4, 2016. The Amended Complaint alleges violations of
the federal securities laws on behalf of a class of persons who
purchased shares of the Company’s common stock between
October 17, 2014 and September 15, 2015. In general, the
Amended Complaint alleges that false or misleading statements were
made or that there was a failure to make appropriate disclosures
concerning the Company’s cyber security business and
products. On February 18, 2016, the Company filed a motion to
dismiss Plaintiff’s Amended Complaint. Plaintiff filed an
opposition to the motion to dismiss and the Company replied on May
4, 2016. On August 3, 2016, the U.S. Magistrate Judge issued a
recommendation that the Court grant Plaintiff’s motion to
strike certain exhibits from Defendants’ motion to dismiss,
and on August 4, 2016, the U.S. Magistrate Judge issued a
recommendation that the Court grant in part and deny in part
Defendants’ motion to dismiss the Amended Complaint. On
September 21, 2016 the United States District Court for the
District of Colorado dismissed, with prejudice, the class action
suit. On October 21, 2016 the plaintiffs filed a notice of appeal
to the decision. The clerk of the court notified the parties of the
filing for appeal and recorded the opening on November 7, 2016. The
Plaintiff’s have 40 days thereafter to file their brief, and
the Defendants then have 30 days there after to respond to the
Plaintiff’s brief. We cannot predict the outcome of
this appeal; however, the Company believes the appeal lacks
merit. No liability has been recorded in the financial
statements for this matter.
43
Item
2
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
Other
than those previously reported on Form 8-K, no unregistered
securities were sold or issued during the period ended September
30, 2016.
Item
3
|
Defaults
Upon Senior Securities
|
None.
Item
4.
|
Mine
Safety Disclosures
|
Not
Applicable.
Item
5.
|
Other
Information
|
Additional Risk
Factor
WE
HAVE CONTINUED TO EXPERIENCE SIGNIFICANT LOSSES FROM
OPERATIONS
We have
experienced substantial and continuing losses from operations.
These are the result of declining revenues and increases in
selling, general and administrative expenses incurred in
preparation for growth.
Because
of the time needed to build root9B and IPSA revenues, and the
selling, general and administrative expenses of the Company, for
the past several quarters, the Company has been experiencing
negative cash flow and has used periodic financings to invest in
growing root9B operations and maintain its operations. New IPSA and
Cyber Solutions client engagements in the first nine months of
2016, while increasing revenues during the three months ended
September 30, 2016 versus 2015, have not yet scaled to levels that
the Company expected in providing sufficient resources to
significantly improve the Company’s liquidity position.
Continued investments in the Cyber Solutions business segment and
the reduced revenue and gross margin forecasts have resulted in the
Company’s need to raise additional capital.
The
Company continues to pursue available options for obtaining
additional financing. No assurances can be given that the Company
will be successful in obtaining the necessary financing. Failure to
obtain the same will adversely affect the operations of the
Company, its ability to retain and hire critical staff and revenue
producing sub-contractors, and raises substantial doubt about our
ability to continue as a “going concern.”
44
Item
6. Exhibits
10.1
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|
Promissory
Note, dated August 17, 2016, issued to Joseph J. Grano,
Jr.(incorporated by reference to Exhibit 10.1 to the Current Report
on Form 8-K of the Company filed with the Commission on August 22,
2016)
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|
|
|
10.2
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|
Separation
Agreement and Release effective as of September 1, 2016, by and
between Brian King and the Company (incorporated by reference to
Exhibit 10.1 to the Current Report on Form 8-K of the Company filed
with the Commission on September 7, 2016).
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|
|
|
10.3
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|
|
|
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10.4
|
|
Form of
Secured Convertible Promissory Note (incorporated by reference to
Exhibit 10.2 to the Current Report on Form 8-K of the Company filed
with the Commission on September 12, 2016)
|
|
|
|
10.5
|
|
Form of
Common Stock Purchase Warrant (incorporated by reference to Exhibit
10.3 to the Current Report on Form 8-K of the Company filed with
the Commission on September 12, 2016).
|
|
|
|
10.6
|
|
Form of
Security Agreement (incorporated by reference to Exhibit 10.4 to
the Current Report on Form 8-K of the Company filed with the
Commission on September 12, 2016).
|
|
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|
10.7
|
|
Waiver
of Anti-Dilution Rights, dated August 29, 2016 (incorporated by
reference to Exhibit 10.5 to the Current Report on Form 8-K of the
Company filed with the Commission on September 12,
2016).
|
|
|
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|
Certification
of Principal Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Sec. 1350).
|
|
|
|
|
|
Certification
of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Sec. 1350).
|
|
|
|
|
|
Written
Statement of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
|
|
|
|
|
|
Written
Statement of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
|
|
|
|
|
101.INS *
|
|
XBRL
Instance Document.
|
|
|
|
101.SCH *
|
|
XBRL
Taxonomy Extension Schema Document.
|
|
|
|
101.CAL *
|
|
XBRL
Taxonomy Extension Calculation Linkbase Document.
|
|
|
|
101.DEF *
|
|
XBRL
Taxonomy Extension Definition Linkbase Document.
|
|
|
|
101.LAB *
|
|
XBRL
Taxonomy Extension Label Linkbase Document.
|
|
|
|
101.PRE *
|
|
XBRL
Taxonomy Extension Presentation Linkbase Document.
|
*
Furnished herewith. XBRL (Extensible Business Reporting Language)
information is furnished and not filed or a part of a registration
statement or prospectus for purposes of Sections 11 or 12 of the
Securities Act of 1933, as amended, is deemed not filed for
purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, and otherwise is not subject to liability under these
sections.
45
SIGNATURES
In
accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
|
|
ROOT9B
TECHNOLOGIES, INC.
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|
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(Registrant)
|
|
DATE:
November 21, 2016
|
By:
|
/s/
Joseph J. Grano, Jr.
|
|
|
|
Joseph
J. Grano, Jr.
|
|
|
|
Chief
Executive Officer
|
|
|
|
|
|
DATE:
November 21, 2016
|
By:
|
/s/
Michael J. Effinger
|
|
|
|
Michael
J. Effinger
|
|
|
|
Chief
Financial Officer
|
|
46