ITEM 1. BUSINESS
Organizational History
We were formed in Delaware
on June 26, 1972 as OCR Corporation, underwent a series of name changes and businesses and on April 25, 2008 changed our name to
Texas Wyoming Drilling, Inc. On January 26, 2016, we entered into an Equity Exchange Agreement (the “EEA”) whereby
we acquired all of the issued and outstanding membership interests in Drone USA, LLC in exchange for 440,425,388 shares of our
common stock and 250 shares of Series A preferred stock, subsequent and pursuant to our completing a 1-for-150 share reverse stock
split on all issued and outstanding common stock which resulted in total issued and outstanding shares of common stock of 6,368,224
immediately prior to this issuance. In connection with the EEA, 1,253,202 shares of common stock were relinquished and an additional
44,042,539 shares of common stock were issued pursuant to a previous settlement agreement. In connection with the EEA, effective
January 26, 2016, we accepted the resignation of Margaret Cadena, the former Chief Executive Officer and Board member, and Richard
Kugelman, Dr. Robert Michet, and Dr. David Durkin, the remaining former officers and Board members, and appointed Michael Bannon
as Chief Executive Officer, President, Chairman and Board member and Dennis Antonelos as Chief Financial Officer, Secretary, Treasurer,
and Board member. Dennis Antonelos resigned as our CFO and as a member of our Board on July 10, 2017 and Michael Bannon was appointed
as CFO. On May 19, 2016, we changed our name to Drone USA, Inc., we changed our ticker symbol to DRUS, and we completed a 1-for-12
share reverse stock split on all issued and outstanding common stock, with a record date of May 24, 2016, which resulted in total
issued and outstanding shares of common stock of 40,841,517 on June 17, 2016 when all round lot issuances were completed.
We are currently traded
on the OTCQB market under the symbol DRUS.
On June 1, 2016, we
entered into an agreement with BRVANT Technologic Solutions ("BRVANT"), a company in Brazil that develops and manufactures
UAV systems, embedded systems and simulators for commercial and military customers. We acquired exclusive rights to BRVANT's UAV
technology and intellectual property relating to its UAV technology. As consideration for the agreement, Dr. Rodrigo Kuntz Rangel,
BRVANT’s CEO, was appointed to the position of Chief Technology Officer (CTO) and issued a stock option grant for 2,000,000
shares of common stock in Drone USA. We have the option to acquire ownership of all outstanding capital stock of BRVANT for additional
consideration of $1 million, but we have not made a decision to make that purchase at this time. The agreement with BRVANT provided
the Company a turnkey line card of proven, advanced low-altitude UAVs to begin selling immediately.
On August 18, 2016,
we entered into a Settlement Agreement with Rockwell Capital Partners, Inc. (“Rockwell”) in connection with a section
3(a)(10) transaction under the Securities Act where we issued to Rockwell a convertible note in the principal amount of $102,102.74.
To limit the number of our shares that Rockwell would have to sell and thus limit the potential pressure on the trading price of
our common stock, in August 2016 we issued 68,500 shares to Rockwell, of which 11,500 were a settlement fee and the balance were
for repayment of $58,165 of the convertible note, and in the first quarter of fiscal 2017 issued an additional 460,200 shares for
the remaining note balance as part of the Settlement Agreement for a total of 528,700 shares issued to Rockwell.
In September 2016,
we entered into an agreement with the Portuguese Government (Secretaria do Mar, Ciência e Tecnologia –“SMCT”),
the national aviation authority of Portugal (Navegação Aérea de Portugal – “NAV”) and Aeroportos
de Portugal (airports’ management authority – “ANA”) enabling us to fly and test UAVs at the Portugese
airport of Santa Maria Island, in the Azores archipelago. The agreement is for five years and will automatically renew unless written
notification is provided by one of the parties within 180 days of the renewal date. We are one of five companies to have such access,
and the only non-Portuguese company to have such access. We will test and develop UAVs for operations over land and sea but have
not yet tested any UAVs in Portugal. We further expect to assist the Azores Regional Government over the coming years that is expected
to have a growing demand for UAV technology for environmental monitoring at sea, fisheries control and scientific research, including
for climate change.
In September 2016,
Drone USA registered with the U.S. State Department and met the requirements of the Arms Export Control Act and International Traffic
in Arms Regulations ("ITAR"). The registration allows us to apply for export, and temporary import, of product, technical
data, and services related to defense articles.
On September 9, 2016,
Howco became a wholly owned subsidiary of Drone USA. We acquired all of its issued and outstanding shares held by Paul Charles
("Chuck") Joy and Kathryn B. Joy, the founders and officers of Howco, for $3,500,000, a warrant for 500,000 shares of
Drone USA common stock with an exercise price of $0.01 per share, and earnout consideration, the funds for which were received
from the TCA loan discussed below. We paid $2,600,000 in cash and issued a note to the sellers for $900,000. Howco is a supplier
of spare and replacement parts to the United States Federal Government and commercial customers worldwide with expertise in Defense
Logistics Agency, TACOM, NECO and other Department of Defense acquisition groups. Howco understands the entire contract and administration
management process for Federal Government contracts and supply chain logistics for its Federal Government customers as well as
prime contractors with Federal Government contracts. Chuck Joy and Kathryn Joy have been retained under contract for a term of
two years, a salary of $125,000 and a tiered bonus-structure that is dependent on the gross margin performance of Howco in the
subsequent 12 and 24 month periods immediately following the acquisition. Prior to the acquisition, Howco reported revenues of
approximately $18.78 million and $24.86 million, and net income of approximately $903,000 and $1,013,000, for the period from October
1, 2015 through September 9, 2016 and the year ended September 30, 2015, respectively. For the year ended September 30, 2017, three
customers accounted for approximately 65%, 12% and 11% of Howco’s total sales. The customers are the Defense Logistics Agency-Columbus,
Defense Logistics Agency-Richmond and the Defense Logistics Agency-Philadelphia, respectively. Howco’s dependence on three
significant customers, all part of the Federal Government, is a risk for its ability to maintain or increase its future revenues
since the loss of one or both could have significant adverse financial consequences for Howco and Drone USA.
On November 17, 2016,
we entered into a sublease with ESAero for a period of two years commencing February 1, 2017, of office space and engineering design
space of approximately 10,000 square feet at a monthly cost of $15,000. The sublease is at 3580 Sueldo Street, San Luis Obispo,
CA 93401. We have not made any lease payments since inception of this sublease and do not intend to use this facility since it
was based, in large part, on the relationship that we had with a former employee, Paulo Ferro, with whom we are now in litigation
following our termination of him. We could be found to be in default of our obligations under the lease and have accrued on our
financial statements all $360,000 that we would owe under the lease through its full term.
In November 2016, we
demonstrated our quadcopter system for a NATO member country and have submitted a proposal for 600 Shadow quadcopter systems, priced
at approximately $40,000 per system, totaling $24 million. This NATO member country plans to use the quadcopters for ISR purposes.
We were not awarded the contract but were encouraged by this NATO company representatives to submit proposals for the second and
third tranches of this order in 2018 and 2019, respectively, where each tranche is expected to equal or exceed the magnitude of
the first tranche.
In December 2016, we
reached a verbal agreement to integrate a leading camera and software application into our precision agriculture platform that
we are developing for commercial release. At this time we are in the development and testing phase of the platform and camera integration.
The platform is being tested on commercial farms in Brazil.
On January 7, 2017,
we entered into an agreement with Ardour Capital Investments, LLC (“Ardour”) to provide advisory and capital raising
services for a fee of $22,500 that was paid over three months. In addition, we will pay them for any capital investments they introduce
to us that invest in us a fee of 7% of the total dollar amount raised as cash compensation and a warrant equal to 3% of the total
shares issued in the transaction at an exercise price equal to 110% of the transaction market price. Ardour also will receive a
cash fee of 3% of gross proceeds received from any straight debt-related transaction. In the event Ardour advises us in connection
with any merger, acquisition or divestiture in whole or part of any of our assets or the acquisition of any target company and/or
its assets, we will pay Ardour a cash success fee equal to 5% on the first $10,000,000 of Transaction Value (as defined in the
agreement with Ardour), 4% on the next $5,000,000 of Transaction Value, 3% on the next $5,000,000 of Transaction Value and 2% on
the balance of the total Transaction Value. The agreement remains in effect until written notice of termination by the Company 30 prior to the termination date.
On February 13, 2017,
we entered into an agreement with Continental Advisory Services, LLC (“Continental”) to receive due diligence services
with regards to securing debt financing for unspecified, potential business combinations, for an initial term of 180 days from
February 17, 2017. Total fees for these services are $50,000, with $15,000 payable upon signing and the remaining $35,000 payable
on May 10, 2017. In May 2017, the Company cancelled the agreement, and as of June 15, 2017 the Company has not paid the $35,000
that was due on May 10, 2017. We are contesting the remaining unpaid balance.
On February 17, 2017,
we entered into an agreement with Caro Partners, LLC (“Caro”) to receive consulting services consisting of introductions
to sources of financing, investor relations and public relations services, for a period of six months from February 17, 2017. In
connection with the agreement, we agreed to issue 400,000 vested shares of common stock for a payment of $200 and to pay Caro consulting
fees of $10,000 per month. The shares were valued on the February 17, 2017 measurement date at $0.23 per share or a total of $92,000
based on the quoted trading price which we will recognize over the six month service period. In June 2017, upon renewal of the
agreement, the Company issued an additional 400,000 vested shares of common stock to this entity as payment for consulting services
rendered valued at $93,160, or $0.2329 per share, based on the quoted trading price.
On March 28, 2017,
we entered into an agreement with TCA Global Credit Master Fund, LP (“TCA”) to receive a range of advisory services,
particularly assistance with preparation of a business plan and financing strategies, for a total of $1,200,000. If we are quoted
on a listed exchange, TCA will accept a single preferred share convertible into common stock never to exceed 4.99% of the total
issued and outstanding shares of our common stock. The number of shares issued will be set at 100% of the amount due up to availability
and subject to a make-whole provision. We have expensed this fee and recorded this as an accrued liability – advisory fee
as of March 31, 2017.
In April 2017, we demonstrated
our quadcopter system for various police departments in the State of Connecticut. As a result of our marketing efforts in the state,
in May 2017, we received a purchase order from a Connecticut police department for one of our Shadow quadcopters. The UAV is scheduled
for delivery to the police department in February 2018.
In June 2017, we entered
into an agreement with an investment bank to provide placement agent services on an exclusive basis as it relates to a private
placement (“the placement”). The agreement calls for the investment bank to receive 9% of the gross proceeds of the
placement and 2.5% warrant coverage of the amount of raised. The warrants shall entitle the investment bank to purchase securities
of the Company at a purchase price equal to 110% of the implied price per share of the placement or 100% of the public market closing
price of the Company’s common stock on the date of the placement, whichever is lower. The warrants shall have a term of five
years after the closing of the placement. The agreement expired on September 30, 2017, but we have continued to rely on them for
sources of capital and have paid them in accordance with the terms of the prior agreement.
On November 15, 2017,
we executed a Liability Purchase Term Sheet with Livingston Asset Management (“Livingston”) under which Livingston
agreed to purchase up to $10,000,000 that we owe to our creditors through direct purchase of the debts from our creditors in return
for (i) a convertible note issued by the Company in the principal amount of $50,000 bearing interest of 10% per year to cover certain
legal fees and other expenses of Livingston that matures in six months and is convertible into shares of our common stock at a
30% reduction off the lowest closing bid price for 20 trading days prior to the date of conversion, (ii) a convertible note subject
to these same terms as the convertible note issued to Livingston payable to Scottsdale Capital Advisors in the principal amount
of $15,000 as a placement agent fee and (iii) the right of Livingston to retain 30% of any negotiated reduction off the face amount
of the liability we owe to such creditors. Following a court judgment for the liabilities purchased by Livingston, we will issue
free trading shares of our common stock under section 3(a)(10) of the Securities Act to Livingston in the amount of such judgment
in a series of tranches so that Livingston will not own more than 9.99% of our outstanding shares per tranche.
On December 6, 2017,
we received a purchase order from a Fortune 500 company for 15 drones at a total purchase price of $21,979.50.
Growth Strategy
Our parent company
intends to focus on primary drone sales, counter-drone technology sales, drone training and piloted licensed services.
Drone Sales
When we walk into a
police station, a firehouse or a business our primary goal is to match the perfect drone or drones to that customer. To accomplish
this, we have aligned with several drone manufacturers, so we can offer a whole line card of drones. We desire to be the “DroneRUS
”
of the drone world offering a wide variety of drones at different price points from simple surveillance drones that can fly between
20 minutes and up to one hour, follow a speeding car, avoid obstacles while chasing the speed car such as trees and buildings and
re acquire the car if lost. We desire to be our customers’ one-stop shop for all their drone needs.
Counter-Drone Technology
Sales
Unfortunately, we will
all witness the inevitable increase of illegal drone use by drug dealers, terrorists and other unsavory people. For this reason,
we have partnered with two counter-drone technology companies to offer drone detection, drone signal jamming and drone system takeover
technology that will ultimately aid law enforcement, U.S. industry and our U.S. Government and state governments in combating illegal
drones. The market for counter-drone technology could possibly rival the drone market in the not too distant future.
Drone Operator Training
We have partnered
with DARTDrones to offer drone training throughout the continental United States. In February 2017, DARTDrones received an investment
offer on Shark Tank from Mark Cuban.
https://www.dartdrones.com/
When signing up for a class, our customers present the
coupon “DRONEUSA15” and they will receive a 15% discount on all DARTDrones training. The in-person training includes
basic flight training, aerial mapping and modeling
,
FAA 107 remote pilot test prep and aerial roof inspection training.
The online training includes drones for beginners, aerial photography, starting a drone business, Part 107 remote pilot test prep.
Licensed Piloted
Services
We understand that
some police departments and businesses will not want to establish drone programs, employ FAA Part 107 pilots or own their own drones.
For this reason, we provide a number of services such search and rescue, utility inspection, real estate marketing, construction,
engineering and agriculture. When a service call is received, we respond immediately with a licensed pilot equipped with drones
and charged batteries ready to perform the mission requested.
Acquisitions
Acquisitions also are
an important pillar to our overall growth strategy, providing revenue, earnings, infrastructure and synergies. We seek opportunities
with innovative and commercially proven technologies primarily in the UAV industry. We seek profitable firms that complement our
overall strategy. We are currently evaluating companies worldwide.
An important element
of our mergers and acquisitions strategy is to acquire companies with complementary capabilities/technologies and an established
customer base in our target markets. We believe that the customer base of each potential acquisition will present an opportunity
to cross-sell solutions to the customer base of other acquired companies. We are looking to expand our public sector clients beyond
what the Howco acquisition has brought us. Public sector customers provide very large multi-year contracts that we believe can
provide secure revenue visibility typically for three to five years. Based on our experience in government contracting, we
have a core competency in bidding on government requests for proposals (RFPs). We are actively seeking companies that have built
a backlog with various government agencies that can complement our existing contracts through Howco.
Drone USA's Products and Services
Drone USA’s strategy
is to acquire, license, and/or resell UAV technology, precluding the risks, time involved, and capital required with traditional
research and development. Our agreement with BRVANT provided us a turnkey line card of proven products to begin selling immediately
into government and commercial markets. Currently, we sell the following products, exclusively licensed from BRVANT:
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1.
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Shadow: Quadcopter UAV
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3.
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Delta-Eye: Fixed-wing UAV
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4.
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Cardinal: Fixed-wing UAV
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5.
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Pegasus: Fixed-wing UAV
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6.
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Cyclops: Fixed-wing UAV
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7.
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Hawkeye: Fixed-wing UAV
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In addition, we have
reseller agreements in place with the following companies that will allow us to sell the following drones:
Company: ATI
Drones: Patrolbot, Patrolbot
XL and Agbot
Company: Draganfly
Drones: Commander, Guardian,
X4-P
Company: Aero Surveillance
Drones: ASF15, ASF 50
ASF 300
Company: DJI
Drones: Mavic
Pro Platinum,Phantom Pro +, Inspire 2, Spark
Drone's Markets
The market for commercial
drones has grown significantly over the last several years and is expected to continue doing so following the release of recent
rules by the FAA for commercial drone use. The FAA in its discussion of the new rules governing commercial drones stated that that
the drone rules could generate more than $82 billion and create more than 100,000 jobs over the next 10 years. The Teal Group estimated
that the global commercial UAV marketplace reached $387 million in 2016 and projects the market to reach $6.5 billion by 2025 with
a CAGR of 32.6%.
The military has transformed
into a smaller, more agile fighting force in need of a network of technologies to provide improved observation, communication and
precision targeting of combat troop locations, which are often embedded in dense population centers or dispersed in remote locations.
According to the Teal Group, the global military UAV marketplace reached $2.8 billion in 2016 and is expected to generate more
than $9.8 billion in UAV purchases by 2025 with a CAGR of 14.4%.
The markets for our
systems on a stand-alone basis and/or combined with other payloads relates to the following applications, among others:
Government Markets
:
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1.
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International and U.S. federal, state and local governments as well as U.S. and foreign government agencies, including the
U.S. Department of Defense (“DoD”), U.S. Drug Enforcement Agency (“DEA
”
), U.S. Homeland Security,
U.S. Customs and Border Patrol, U.S. Environmental Protection Agency (“EPA”), U.S. Department of State, U.S. Federal
Emergency Management Agency (“FEMA”), U.S. and state departments of transportation, penitentiaries, and police forces;
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2.
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Military, including U.S. Army Space and Missile Defense Agency (“SMDC”) and U.S. Air Force installations;
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3.
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ISR including Joint Improvised Explosive Device Defeat Organization (“JIEDDO”);
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4.
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Border security monitoring, including U.S. Homeland Security, to deter and detect illegal entry;
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5.
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Drug enforcement along U.S. borders;
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6.
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Monitoring environmental pollution and sampling air emissions; and
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7.
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Vehicle traffic monitoring, including aerial speed enforcement by state and local law enforcement agencies.
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Commercial Markets
:
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2.
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Agriculture monitoring, including monitoring crop health, field monitoring to reduce costs and increase yields;
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3.
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Security for large events, including crowd management;
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4.
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Natural disaster instant infrastructure to support first responders;
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5.
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Oil pipeline monitoring and exploration; and
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6.
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Atmospheric and climate research.
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7.
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TV and media production mobile communications systems, expanding on-site reporting capabilities to include aerial videography
and photography;
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8.
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Surveying, mapping and photogrammetry;
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9.
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Biological control for agriculture;
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10.
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Utilities inspection.
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Market research media
analysts have found that there is a widening gap between growing a UAV fleet and UAV infrastructure development, especially in
such sectors as training; service, support and maintenance and data management. This gap creates a number of market opportunities
for UAV vendors, both large defense contractors and small technology companies. According to UAV Market Research, military procurement
of UAVs, including unmanned aircrafts and payloads, makes the Department of Defense the single largest consumer of UAV technology
in the world. We believe that the U.S. Government will continue to invest in UAVs as much as needed to keep its dominance, both
technologically and to demonstrate its power, in the next decades.
Given the growth and
demand in this market, we believe that UAV’s will be a universal tool for government bodies and agencies, particularly focused
on law enforcement. Police departments have spent hundreds of millions of dollars to buy firearms, armored cars and electronic
surveillance gear, according to the annual reports submitted by local and state agencies to the Justice Department’s Equitable
Sharing Program. Police and law enforcement agencies purchase an expensive mix of high-tech military products, in particular electronic
surveillance equipment, for both their technological innovations for supporting their efforts to promote public and citizen confidence
by demonstrating their receptiveness to new practices of upholding the law and protecting the public well-being.
Howco's Business
Howco is a premier
supplier of spare and replacement parts to a wide variety of Federal Government agencies, U.S. military prime contractors and commercial
customers worldwide. Founded in 1990 and located in Vancouver, Washington, Howco's services encompass bid solicitation, contract
management, packaging and logistics for construction, transportation, mining and heavy equipment spare and replacement parts to
customers worldwide utilizing a wide variety of supply chain solutions. Howco was the winner of the 2012 United States’ Department
of Defense Logistics Agency’s Bronze Supplier Award. Howco reported revenues of approximately $24 million and $18 million,
and net income of approximately $252,000 and $902,000, for the year ended September 30, 2017, and the period from October 1, 2015
through September 9, 2016, prior to our acquisition of Drone USA, respectively.
Howco's Government
Services Contracts
Howco enters into various
types of contracts with our customers, such as Indefinite Delivery, Indefinite Quantity (IDIQ), Cost-Plus-Fixed-Fee (CPFF) Level
of Effort (LOE), Cost-Plus-Fixed-Fee (CPFF) Completion, Cost-reimbursement (CR), Firm-Fixed-Price (FFP), Fixed-Price Incentive
(FPI) and Time-and-Materials (T&M). Approximately 91% of Howco’s and revenues are FFP and approximately 11% of its revenues
are IDIQ.
IDIQ contracts provide
for an indefinite quantity of services or stated limits of supplies for a fixed period. They are used when the customer cannot
determine, above a specified minimum, the precise quantities of supplies or services that the government will require during the
contract period. IDIQs help streamline the contract process and speed service delivery. IDIQ contracts are most often used for
service contracts and architect-engineering services. Awards are usually for base years and option years. The customer places delivery
orders (for supplies) or task orders (for services) against a basic contract for individual requirements. Minimum and maximum quantity
limits are specified in the basic contract as either a number of units (for supplies) or as dollar values (for services).
CPFF LOE contracts
will be issued when the scope of work is defined in general terms requiring only that the contractor devote a specified LOE for
a stated time period. A CPFF completion contract will be issued when the scope of work defines a definite goal or target
which leads to an end product deliverable (e.g., a final report of research accomplishing the goal or target).
CR contracts provide
for payment of allowable incurred costs, to the extent prescribed in the contract. These contracts establish an estimate of total
cost for the purpose of obligating funds and establishing a ceiling that the contractor may not exceed (except at its own risk)
without the approval of the contracting officer and are suitable for use only when uncertainties involved in contract performance
do not permit costs to be estimated with sufficient accuracy to use any type of fixed-price contract.
FFP contract will be
issued when acquiring supplies or services on the basis of definite or detailed specifications and fair and reasonable prices can
be established at the outset.
FPI target delivery
contract will be issued when acquiring supplies or services on the basis of reasonably definite or detailed specifications and
cost can be reasonably predicted at the outset wherein the cost risk will be shared. A firm target cost, target profit, and profit
adjustment formula will be negotiated to provide a fair and reasonable incentive and a ceiling that provides for the contractor
to assume an appropriate share of the risk.
T&M contracts provide
for acquiring supplies or services on the basis of (i) direct labor hours at specified fixed hourly rates that include wages, overhead,
general and administrative expenses, and profit; and (ii) actual cost for materials. A customer may use this contract when it is
not possible at the time of placing the contract to estimate accurately the extent or duration of the work or to anticipate costs
with any reasonable degree of confidence.
Market Size
According to Todd Harrison,
author of “Analysis of the FY 2017 Budget,” one-third of the DoD budget request, $184.4 billion, is for procurement
and research, development, test, and evaluation (“RDT&E”). The U.S. Government spends a portion of this budget
on the shipping of replacement parts annually.
Intellectual Property
We review each of our
intellectual properties and make a determination as to the best means to protect such property, by trademark, by copyright, by
patent, by trade secret, or otherwise. We believe that we have taken appropriate steps to protect our intellectual properties,
based on our evaluation of the factors unique to each such property, but cannot guarantee that this is the case.
Regulatory Matters
The use of unmanned
aerial vehicles for commercial purposes is governed by the Federal Aviation Administration (“FAA
”
). On
August 29, 2016, the new FAA rules took effect for commercial use of small drones. Under the FAA rules commercial drones must be
under 55 pounds and be registered with the FAA. The rules require a new "remote pilot certificate", daylight-only operations
30 minutes before official sunrise and 30 minutes after official sunset, a requirement that all flights travel at a maximum groundspeed
of 100 miles per hour remain, below 400 feet or within 400 feet of a structure and yield the right of way to other aircraft. Under
the FAA rules, drone pilots must be at least 16 years old or be supervised by an adult with a remote pilot certificate. The pilot
must also maintain "visual line of sight" with the drone at all times, among other requirements. The new rules also require
that any drone-related incident that results in at least $500 worth of damage or causes serious injury be reported to the FAA within
10 days. The new restrictions can be waived, but pilots will need to apply directly to the FAA for an exemption and/or a waiver.
Competition
Drone USA
We believe that the
principal competitive factors in the markets for UAVs include product performance, features, acquisition cost, lifetime operating
cost, ease of use, integration with existing equipment, size, mobility, quality, reliability, customer support, brand and reputation.
We intend to acquire companies that give us a competitive advantage with our prospective government and commercial customers.
The market leaders
in UAV manufacturing are mostly international and are located in tech hubs. Asia has the most UAV manufacturers currently in operation.
Chinese manufacturer DJI is the market leader in the mid to high end recreational platform, followed by French based Parrot with
a mid-market recreational platform, and several companies such as XAircraft American based in the United States, with low to mid-market
recreational platforms. In addition, in the United States there are large defense contractors, among them Boeing, Northrup Grumman,
TCOM, Raytheon, Lockheed Martin, ISL, ILC Dover, Compass Systems, Raven Aerostar and American Blimp Corporation offering military
grade free flying drones to the U.S. Government. There is also potential competition from commercial grade tethered drone systems
which remain tethered to the ground via a high strength armored tether, such as offered by Elistair located in Lyon, France and
Cyphy Works Inc. located in Danvers, Massachusetts.
Howco
The business of supplying
spare and replacement parts to Federal Government agencies, U.S. military prime contractors and commercial customers is very competitive.
Among our U.S. based competitors are JGILS that supplies parts manufactured by Fairbanks Morse/Coltec and other brands, Ohio
Cat that supplies Caterpillar parts, and Kampi Components and Brighton Cromwell, both of which compete with us in several brands.
Employees
We have 15 full-time
employees, two of whom are with Drone USA and 13 of whom are with Howco, and two part-time employees with Howco. We have no labor
union contracts and believe relations with our employees are satisfactory.
Debt Instruments
On April 1, 2016, we
entered into a revolving line of credit with Key Bank. This revolving line of credit is in the amount of $50,000, and is personally
guaranteed by our Chief Executive Officer ("CEO"). The loan bears interest at a fluctuating rate equal to the prime rate,
currently 3.50%, plus 4.25%. As of September 30, 2017, the balance of the line of credit is approximately $49,000.
We have an $840,000
convertible note dated December 11, 2015, payable with Abatement Industries Group, Inc. (“AIG”), an entity controlled
by our CEO. The Note bears interest at an annual rate of 7% with a maturity date of June 11, 2017, at which time all unpaid principal
and interest is due. In June 2017, the maturity date of the note was extended to December 11, 2017. The holder of the note has
the option to convert the outstanding principal and accrued interest, in whole or in part, into shares of common stock at a conversion
price equal to the volume weighted average price per share of common stock for the 30-day period prior to conversion. As of September
30, 2017, the note payable has not been converted and the balance of the note is approximately $688,000, and accrued interest was
approximately $78,000. The Company and AIG agreed to extend repayment of the note for six months until June 11, 2018.
We issued a convertible
note dated July 1, 2016, payable to our CEO for $117,000. The note bears interest at an annual rate of 7% with a maturity rate
of January 1, 2018. The holder of the note has the option to convert the outstanding principal and accrued interest, in whole or
in part, into shares of common stock at a conversion price equal to the volume weighted average price per share of common stock
for the 30-day period prior to conversion. As of September 30, 2017, the note payable has not been converted and the balance of
the note is approximately $122,000, and accrued interest was approximately $10,700. The Company and our CEO extended this note
for six months until July 2, 2018.
In connection with
the acquisition of Howco on September 9, 2016, we issued a note payable to the sellers in the amount of $900,000. The note bears
an interest of 5.5% and all unpaid principal and accrued interest is due on September 9, 2017. The note is in default and is accruing
interest at 8% per year. The note is subordinated to the TCA loan described below. As of September 30, 2017, the note payable has
a balance of approximately $900,000 with accrued interest of approximately $54,000.
Effective September
13, 2016, we entered into a senior secured credit facility agreement (the “Credit Facility” or the “Agreement”)
with TCA Global Credit Master Fund L.P (“TCA”) to provide capital for the acquisition of HowCo. We can borrow up to
$6,500,000, with an initial loan at closing of $3,500,000. The Credit Facility is secured by substantially all our assets and our
subsidiaries and bears interest at a rate of 18%, requires monthly payments of $52,500 which is interest only starting on October
13, 2016 through February 13, 2017, and monthly payments, including interest and principal, of $298,341 starting on March 13, 2017
through maturity on March 13, 2018. Events of default are defined in the Agreement. In the event of default the note balance will
bear interest at 25%. In connection with this Agreement, we are obligated to pay additional advisory fees of $850,000 payable in
the form of cash or common stock in accordance with the terms of the Agreement. We were also required to reserve 7,000,000 shares
of common stock related to this transaction. The reserved shares will be released upon the satisfaction of the loan. In the event
TCA makes additional loans under the Agreement, we agree to pay additional advisory fees under similar terms as the $850,000 fee.
Under the terms of the Credit Facility, except in limited circumstances, we are not permitted to encumber any of our assets, sell
any shares of common stock or incur additional indebtedness without TCA's prior written consent. All of our assets, including the
assets of Howco, are secured by the TCA credit facility, which could be sold by TCA to satisfy the debt we owe it should we not
be able to repay TCA in full.
As of March 31, 2017,
we issued to TCA 539,204 shares of common stock in satisfaction of the $850,000 advisory fees in accordance with the terms of the
Credit Facility. Based upon the value of the shares, at the time TCA sells the shares, we may be required to redeem unsold shares
for the difference between the $850,000 and TCA’s sales proceeds. Accordingly, the $850,000 has been reflected as a current
liability as of September 30, 2017. Notwithstanding anything contained in the Agreement to the contrary, in the event TCA has not
realized net proceeds from the sale of Advisory Fee Shares equal to at least the Advisory Fee by the earlier to occur of: (A) the
twelve (12) month anniversary of the Effective Date; (B) the occurrence of an Event of Default; or (C) the Maturity Date, then
at any time thereafter, TCA shall have the right, upon written notice to us, to require that we redeem all Advisory Fee Shares
then in TCA’s possession for cash equal to the Advisory Fee, less any cash proceeds received by TCA from any previous sales
of Advisory Fee Shares, if any. In the event such redemption notice is given by TCA, we shall redeem the then remaining Advisory
Fee Shares in TCA’s possession for an amount of Dollars equal to the Advisory Fee, less any cash proceeds received by TCA
from any previous sales of Advisory Fee Shares, if any, payable by wire transfer to an account designated by TCA within five (5)
Business Days from the date TCA delivers such redemption notice to us. As of September 30, 2017, the note payable has not been
converted and the balance of the note was $3,500,000 and accrued interest was $169,417. The Credit Facility is only convertible
upon default or mutual agreement by both parties. Once a default occurs the note will be accounted for as stock settled debt at
its fixed monetary value and any shares issued upon conversion are also subject to a make whole provision similar to that described
above for the $850,000. On March 13, 2017, we defaulted on the monthly principal and interest payment of $298,341. On April 13,
2017, the Company received a default notice from the lender and was given a 10-day period to cure the default. The note became
convertible and the interest rate increased to 25% (default rate) upon expiration of the default cure period, as the default was
not cured. From March to December 2017, the Company has not made the required monthly contracted payments. We have been in discussions
with TCA and TCA has agreed informally to work with us to achieve our business plan as long as we are continuing to make progress
in that regard.
In June 2016, we opened
a credit card account with American Express Bank. Payment of the entire balance is due monthly upon receipt of the statement. The
card has been cancelled and as of September 30, 2017 has a current unpaid balance of approximately $191,000. We have established
a payment plan in December 2017 with American Express to retire this debt obligation.
On August 18, 2016,
we entered into a Settlement Agreement with Rockwell Capital Partners, Inc. (“Rockwell”) in connection with a section
3(a)(10) transaction under the Securities Act where we issued to Rockwell a convertible note in the principal amount of $102,102.74.
To limit the number of our shares that Rockwell would have to sell and thus limit the potential pressure on the trading price of
our common stock in August 2016 we issued 68,500 shares of our common stock to Rockwell, of which 11,500 were a settlement fee
and the balance were for payment of $58,105 of the convertible note, and in the first quarter of fiscal 2017 issued an additional
460,200 shares for the remaining balance of the note as part of the Settlement Agreement for a total of 528,700 shares issued to
Rockwell.
In October 2016, we
opened a revolving credit card account with Capital One Financial Corporation. The credit card has a limit of $5,000. As of September
30, 2017, the credit card is active and the balance of the credit card was approximately $1,800.
In November 2016, we
opened a credit card account with Bank of America. Payment of the entire balance is due monthly upon receipt of the statement.
The credit card has a limit of $100,000 and as of September 30, 2017, the credit card is active, and the balance was approximately
$36,000.
On October 5, 2017,
the Company entered into a Securities Purchase Agreement with Power Up Lending Group Ltd. (“Power Up”) under which
the Company received approximately $78,500 net of $21,500 of fees and expenses in return for issuing a convertible promissory note
(the “Note”) in the principal amount of $100,000. Power Up received a right of first refusal for the first nine months
from the date of the Note to provide any debt or equity financing less than $150,000. The Note bears interest at 10% per annum
and has a maturity date of July 15, 2018. The Note may be prepaid at a premium ranging from 112% to 137% depending on the length
of time following the date of the Note. The Note is convertible after 180 days into shares of the Company’s common stock
at a discount of 35% of the average of the two lowest closing bid prices of Drone USA’s common stock 15 days prior to the
date of conversion and the maximum number of shares issued to Power Up may not exceed 4.99% of the issued and outstanding shares
of the Company’s common stock. The Note is subject to customary default provisions, including a cross default provision.
The Company’s CEO entered into a confession of judgment in the principal amount of the Note.
On November 9,
2017, the Company, received a first tranche payment of $75,500, net of original issue discount of $10,500 and issue costs of
$19,000, under the terms of a Securities Purchase Agreement dated October 25, 2017, with Crown Bridge Partners, LLC
(“Crown Bridge”) under which the Company issued to Crown Bridge a convertible note in the principal amount of
$315,000 and a warrant as a commitment fee for that number of shares of the Company’s common stock equal to the product
of on-third of the face value of each tranche divided by $0.35. The convertible note (the “Crown Bridge Note”)
issued to Crown Bridge is in the principal amount of $315,000, has an original issue discount of $31,500, bears interest of
12% per annum, has a maturity date of 12 months from the date of each tranche of payments under the Crown Bridge Note with
future tranches being at the discretion of Crown Bridge, the conversion rate for any conversion of unpaid principal and
interest under the Crown Bridge Note is at a 35% discount to the lowest market price of the shares of the Company’s
common stock within a 20 day trading period prior to the date of conversion subject to certain exceptions under the terms of
the Crown Bridge Note.
On November 15, 2017,
we executed a Liability Purchase Term Sheet with Livingston Asset Management (“Livingston”) under which Livingston
agreed to purchase up to $10,000,000 that we owe to our creditors through direct purchase of the debts from our creditors in return
for (i) a convertible note issued by the Company in the principal amount of $50,000 bearing interest of 10% per year to cover certain
legal fees and other expenses of Livingston that matures in six months and is convertible into shares of our common stock at a
30% reduction off the lowest closing bid price for 20 trading days prior to the date of conversion, (ii) a convertible note subject
to the same terms as the convertible note issued to Livingston payable to Scottsdale Capital Advisors in the principal amount of
$15,000 as a placement agent fee.
On November 28, 2017,
the Company received a payment of $84,000, net of issue costs of $23,500, under the terms of a Securities Purchase Agreement dated November 20, 2017, with Labrys
Fund, LP (“Labrys”) under which the Company issued to Labrys (i) a convertible note (the “Labrys Note”)
in the principal amount of $107,500 that bears interest of 10% per annum and (ii) 335,938 shares of the Company’s common
stock as a commitment fee which will be returned to the Company in the event that it pays all unpaid principal and interest under
the Labrys Note within 180 days of November 20, 2017. The Labrys Note has a maturity date of nine months and a conversion rate
for any unpaid principal and interest at a 35% discount to the market price subject to certain exceptions set forth under the terms
of the Labrys Note.
On December 7, 2017, the Company received a payment of $79,000, net of original issue discount of $5,800 and
issue costs of $20,200, under the terms of a Securities Purchase Agreement dated November 21, 2017, with EMA Financial, LLC (“EMA
Financial”) under which the Company issued to EMA Financial a convertible note (the “EMA Note”) in the principal
amount of $105,000 that bears interest of 10% per annum. The EMA Note has a maturity date of 12 months and a conversion rate for
any unpaid principal and interest and a conversion price which is the lower of (i) the closing sales price of the Company’s
common stock on the trading day immediately preceding the date of funding and (ii) a 35% discount to (a) the lowest sales price
of the shares of the Company’s common stock within a 20 day trading period including and immediately preceding the conversion
date or (b) the lowest bid price on the conversion date, whichever is lower.
On December 13, 2017,
we received a payment of $63,000, net of an original issue discount of $7,500 and issue costs of $12,000, under the terms of a
Securities Purchase Agreement dated December 8, 2017, with Morningview Financial, LLC (“Morningview Financial”) under
which we issued to Morningview Financial a convertible note (the “Note”) in the principal amount of $82,500 that bears
interest of 12% per annum. The Note has a maturity date of 12 months and a conversion rate for any unpaid principal and interest
and a conversion price which is a 35% discount to the lowest sales price of our shares of common stock within a 20-day trading
period including and immediately preceding the conversion date. The conversion rate is further reduced under certain events, including
if the closing sales price is less than $0.05 in which case the conversion rate is a 45% discount under the terms set forth above.
No shares of our common stock can be issued to the extent Morningview Financial would own more than 4.99% of our outstanding shares
of common stock. We also are required at all times to have authorized and reserved eight times the number of shares that is actually
issuable upon full conversion or adjustment of the Note (based on the conversion price of the Note in effect from time to time).
The Note is subject to customary default provisions and also includes a cross-default provision as well as default being triggered
if our Trading Price as that term is defined in the Note is less than $.0001 or if a money judgment, writ or similar process shall
be entered or filed against us or any of its subsidiaries for more than $50,000, and shall remain unvacated, unbonded or unstayed
for a period of 20 days unless otherwise consented to by the holder of the Note. We are entitled to prepay the Note between the
issue date until 180 days from its issuance at a premium of 135% of the unpaid principal and interest.
Emerging Growth Company
We are and we will
remain an "emerging growth company" as defined under The Jumpstart Our Business Startups Act (the “JOBS Act”),
until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenues equal or exceed $1 billion
(subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of our initial public
offering, (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible
debt securities, or (iv) the date on which we are deemed a "large accelerated filer" (with at least $700 million in public
float) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”).
As an "emerging
growth company", we may take advantage of specified reduced disclosure and other requirements that are otherwise applicable
generally to public companies. These provisions include:
• only two years
of audited financial statements in addition to any required unaudited interim financial statements with correspondingly reduced
“Management’s Discussion and Analysis” disclosure;
• reduced disclosure
about our executive compensation arrangements;
• no requirement
that we hold non-binding advisory votes on executive compensation or golden parachute arrangements; and
• exemption from
the auditor attestation requirement in the assessment of our internal control over financial reporting.
We have taken advantage
of some of these reduced burdens, and thus the information we provide stockholders may be different from what you might receive
from other public companies in which you hold shares.
In addition, Section
107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided
in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging
growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies.
However, we are choosing to “opt out” of such extended transition period, and as a result, we will comply with new
or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.
Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised
accounting standards is irrevocable.
Notwithstanding the
above, we are also currently a “smaller reporting company”, meaning that we are not an investment company, an asset-backed
issuer, or a majority-owned subsidiary of a parent company that is not a smaller reporting company and have a public float of less
than $75 million and annual revenues of less than $50 million during the most recently completed fiscal year. In the event that
we are still considered a “smaller reporting company”, at such time as we cease being an “emerging growth company”,
the disclosure we will be required to provide in our SEC filings will increase, but will still be less than it would be if we were
not considered either an “emerging growth company” or a “smaller reporting company”. Specifically,
similar to “emerging growth companies”, “smaller reporting companies” are able to provide simplified executive
compensation disclosures in their filings; are exempt from the provisions of Section 404(b) of the Sarbanes-Oxley Act (“SOX”)
requiring that independent registered public accounting firms provide an attestation report on the effectiveness of internal control
over financial reporting; and have certain other decreased disclosure obligations in their SEC filings, including, among other
things, only being k]=required to provide two years of audited financial statements in annual reports.
Item 1A. Risk Factors.
RISKS RELATING TO OUR DRONE BUSINESS AND OUR INDUSTRY
We have an extremely limited operating
history.
With respect to the
manufacturing and sale of drones, we are currently a start-up company without any current material sales of our drone products.
There is no historical basis to make judgments on the capabilities associated with our enterprise, management and/or employee’s
ability to produce a commercial drone product leading to a profitable company beyond what we have acquired through our purchase
of Howco which is in the business of spare parts and replacement parts.
We will need to raise additional
capital.
Given the limited revenues
from sales of our drone products to date, we expect that Drone USA will need to obtain additional operating capital either through
equity offerings, debt offerings or a combination thereof, in the future. In addition, if, in the future, we are not capable
of generating sufficient revenues from operations and its capital resources are insufficient to meet future requirements, we may
have to raise funds to allow us to continue to commercialize, market and sell our products. We presently have no committed
sources of funding and we have not entered into any agreements or arrangements with respect to our fundraising efforts. We
cannot be certain that funding will be available on acceptable terms or at all. To the extent that we raise additional funds
by issuing equity securities, our stockholders may experience significant dilution. Any debt financing, if available, may
involve restrictive covenants that may impact our ability to conduct business. If we are unable to raise additional capital
if required or on acceptable terms, we may have to significantly scale back, delay or discontinue the development and/or commercialization
of our drone products, restrict our operations or obtain funds by entering into agreements on unattractive terms.
Our financial status raises doubt
about our ability to continue as a going concern.
Our cash and cash equivalents were $152,492 at September 30, 2017. For the year ended September 30, 2017,
we have incurred net losses of approximately $ $7,826,933 and used cash in operations of approximately $478,769. Our working capital
deficit, stockholders' deficit and accumulated deficit was $10,360,702, $6,410,086, and $13,856,425, respectively, at September
30, 2017, respectively. Furthermore, on April 13, 2017, we received a default notice on our payment obligations under the senior
secured credit facility agreement with TCA, defaulted on our note payable – Seller in September 2017 and as of September
30, 2017, we are subject to two lawsuits and have received several demands for payment of past due amounts for services from several
consultants and service providers. These matters raise substantial doubt about our ability to continue as a going concern for a
period of twelve months from the issuance date of our consolidated financial statements included elsewhere in this Form 10-K. Our
ability to continue as a going concern is dependent upon management’s ability to further implement its business plan and
raise additional capital as needed from the sales of stock or debt. We plan to implement cost-cutting measures, raise equity through
a private placement, restructure or repay our secured obligations and structure payment plans, if necessary, with vendors and service
providers who are owed money. The accompanying consolidated financial statements elsewhere in this Form 10-K do not include any
adjustments that might be required should we be unable to continue as a going concern. We continue to incur significant operating
losses, and management expects that significant on-going operating expenditures will be necessary to successfully implement our
business plan and develop and market our products. Implementation of our plans and our ability to continue as a going concern will
depend upon our ability to market our drone technology, continue with sales of equipment spare and replacement parts to the U.S.
Government and commercial customers and raise additional capital.
Management believes
that we have access to capital resources through possible public or private equity offerings, exchange offers, debt financings,
corporate collaborations or other means. In addition, we continue to explore opportunities to strategically monetize our technology
and our services, although there can be no assurance that we will be successful with such plans. We have historically been able
to raise capital through equity and debt offerings, although no assurance can be provided that we will continue to be successful
in the future. If we are unable to raise sufficient capital through 2018 or otherwise, we may be required to severely curtail,
or even to cease, our operations.
Most of our management has limited
experience in the drone industry
With the exception
of our CTO, our management has limited experience in aerospace, aviation and unmanned aerial systems manufacturing sectors. While
our management has considerable general management experience, some have specialized knowledge and abilities in the unmanned aerial
industry, but none of the managers have experience managing a business that manufacturers and markets aircrafts. The management
will rely on contracted individuals with the specified skills, qualifications and knowledge related to aircraft manufacturing and
marketing, without impacting the overall budget for compensation.
Potential product liabilities may
harm our operating results.
As a manufacturer of
a UAV products, and with aircrafts and aviation sector companies being scrutinized heavily, we may be subject to FAA mandates and/or
regulations, which could result in potential law suits. Defects in our product may lead to life, health and property risks. Currently,
the unmanned aerial systems industry lacks a formative insurance market. It is possible that our operations could be adversely
affected by the costs and disruptions of responding to such liabilities even if insurance against liabilities is available.
If our proposed marketing efforts
are unsuccessful we may not earn enough revenue to become profitable
.
Our success will depend
on investment in marketing resources and the successful implementation of our marketing plan. Our marketing plan may include
attendance at trade shows and making private demonstrations, advertising and promotional materials and advertising campaigns in
print and/or broadcast media. We cannot give any assurance that our marketing efforts will be successful. If they are
not, revenue may not be sufficient to cover our fixed costs and we may not become profitable.
We may be unable to respond to rapid
technology changes and innovative products.
In a constantly changing
and innovative technology market with frequent new product introductions, enhancement and modifications, we may be forced to implement
and develop new technologies into our products for anticipation of changing customer requirements that may significantly impact
costs in order to retain or enhance our competitive position in existing and new markets.
There is intense competition in our
market.
The aerospace and aviation
markets are very saturated and intensely competitive. By entering this sector, our management is aware that failure to compete
with direct market leading companies and new entrants will affect overall business and the product. Therefore, the faster innovative
applications and technologies are implemented to the developed product, the better the pricing and commercial business strategies
management will be able to offer to businesses purchasing drones. Competitive factors in this market are all related to product
performance, price, customer service, training platforms, reputation, sales and marketing effectiveness.
Future acquisitions may be unsuccessful
and may negatively affect operations and financial condition
.
The integration of
businesses, personnel, product lines and technologies can be difficult, time consuming and subject to significant risks. Any difficulties
could disrupt our ongoing business, distract our management and employees, increase our expenses and decrease our revenue.
We may be unable to protect our intellectual
property.
Our ability to protect
our proprietary technology and operate without infringing the rights of others will allow our UAV business to compete successfully
and achieve future revenue growth. If we are unable to protect our proprietary technology or infringe upon the rights of others,
it could negatively impact our operating results.
We will be reliant on information
systems, electronic communication systems, and internal and external data and applications.
Business operations
and manufacturing are dependent on computer hardware, software and communication systems. Information systems are vulnerable and
are subject to failures that could create internal or external events that will affect our business and operations. Management
is mindful of these risks since we have developed a strategy by adopting third party information technology and system practices.
Any breach of security could disrupt our overall UAV business and result in various effects in operations and efficiency. UAVs
could encounter increased overhead costs, loss of important information and data, which may also hinder our reputation.
If we lose our key personnel or are
unable to hire additional personnel, we will have trouble growing our business
.
We depend to a large
extent on the abilities of our key management. The loss of any key employee or our inability to attract or retain other qualified
employees could seriously impair our results of operations and financial condition.
Our future success
depends on our ability to attract, retain and motivate highly skilled technical, marketing, management, accounting and administrative
personnel. We plan to hire additional personnel in all areas of our business as we grow. Competition for qualified personnel
is intense. As a result, we may be unable to attract and retain qualified personnel. We may also be unable to retain
the employees that we currently employ or to attract additional technical personnel. The failure to retain and attract the
necessary personnel could seriously harm our business, financial condition and results of operations.
Because our executive officers collectively
own a majority of our outstanding shares, they can elect our directors without regard to other stockholders’ votes.
Our CEO, Michael Bannon,
has majority voting control through his ownership of 250 shares of Series A preferred stock. As a result, he may elect all
of our directors, who in turn elect all executive officers, without regard to the votes of other stockholders. The voting
control of Mr. Bannon gives him the ability to authorize change-in-control transactions, amendments to our certificate of incorporation
and other matters that may not be in the best interests of our minority stockholders. In this regard, Mr. Bannon has absolute
control over our management and affairs.
We face a higher risk of failure
because we cannot accurately forecast our future revenues and operating results.
The rapidly changing
nature of the markets in which we compete makes it difficult to accurately forecast our revenues and operating results. Furthermore,
we expect our revenues and operating results to fluctuate in the future due to a number of factors, including the following:
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the timing of sales of our UAV products;
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unexpected delays in introducing new UAV
products;
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increased expenses, whether related to
sales and marketing, or administration;
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costs related to anticipated acquisitions
of businesses.
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Our UAV products may suffer defects.
Products may suffer
defects that may lead to substantial product liability, damage or warranty claims. Given our complex platforms and systems within
our product, errors and defects may be related to flight and/or communications. Such an event could result in significant expenses
arising from product liability and warranty claims, and reduce sales, which could have a material adverse effect on business, financial
condition and results of operations.
Our products are subject to FAA regulations.
Compliance with the
new FAA regulations by businesses interested in using UAVs may negatively affect commercial usage of our UAVs, which will adversely
affect our operations and overall sales.
Since we intend to pursue acquisitions,
investments or other strategic relationships or alliances, this will consume significant resources, may be unsuccessful and could
dilute holders of our common stock.
Acquisitions, investments
and other strategic relationships and alliances, if pursued, may involve significant cash expenditures, debt incurrence, operating
losses, and expenses that could have a material adverse effect on our financial condition and operating results. Acquisitions involve
numerous other risks, including:
• Diversion of
management time and attention from daily operations;
• Difficulties
integrating acquired businesses, technologies and personnel into our business;
• Inability to
obtain required regulatory approvals and/or required financing on favorable terms;
• Entry into new
markets in which we have little previous experience;
• Prior approval
of any acquisition by TCA;
• Potential loss
of our key employees, key contractual relationships or key customers of acquired companies; and
• Assumption of
the liabilities and exposure to unforeseen liabilities of acquired companies.
If these types of transactions
are pursued, it may be difficult for us to complete these transactions quickly and to integrate these acquired operations efficiently
into its current business operations. Any acquisitions, investments or other strategic relationships and alliances by us may ultimately
harm our business and financial condition. In addition, future acquisitions may not be as successful as originally anticipated
and may result in impairment charges.
We may be required to record a significant
charge to earnings as we are required to reassess our goodwill or other intangible assets arising from acquisitions.
We are required under
U.S. GAAP to review our intangible assets, including goodwill for impairment when events or changes in circumstances indicate the
carrying value may not be recoverable. Goodwill is required to be tested for impairment annually or more frequently if facts and
circumstances warrant a review. Factors that may be considered a change in circumstances indicating that the carrying value of
our amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization and slower
or declining growth rates in our industry. We may be required to record a significant charge to earnings in our financial statements
during the period in which any impairment of our goodwill or amortizable intangible assets is determined.
Our products may be subject to export
regulations; government agencies may require terms that are disadvantageous to our business.
Our business model
contemplates working with law enforcement and possibly military agencies. Because we may sell our products to these customers,
we may need to register with the U.S. Department of State under its International Trafficking in Arms Regulations (ITAR). If we
choose to sell our products overseas, we may be required to obtain a license form the State Department or face substantial fines
or, in an extreme case, a shutdown of our business. Additionally, government agencies typically require provisions in their contracts
that allow them to terminate agreements or change purchasing terms in their discretion without notice. Such contractual provisions,
if exercised by our customers in the future, could have a material adverse effect on our cash flow and business performance.
Risks Related to Consolidated Operations
Since we have recently acquired Howco,
it is difficult for potential investors to evaluate our future consolidated business.
We completed the Howco
acquisition on September 9, 2016. Therefore, our limited combined operating history makes it difficult for potential investors
to evaluate our business or prospective operations and your purchase of our securities. Therefore, we are subject to the risks
inherent in the financing, expenditures, complications and delays inherent in a newly combined business. These risks are described
below under the risk factor titled
“Any future acquisitions that we may make could disrupt our business, cause dilution
to our stockholders and harm our business, financial condition or operating results.”
In addition, while the former Howco
shareholders have indemnified us from any undisclosed liabilities, there may not be adequate resources to cover such indemnity.
Furthermore, there are risks that Howco's vendors, suppliers and customers may not renew their relationships for which there is
no indemnification. Accordingly, our business and success face risks from uncertainties faced by developing companies in a competitive
environment. There can be no assurance that our efforts will be successful or that we will ultimately be able to attain profitability.
Failure to manage or protect growth
may be detrimental to our business because our infrastructure may not be adequate for expansion
The Howco acquisition
requires a substantial expansion of our systems, workforce and facilities. We may fail to adequately manage our anticipated future
growth. The substantial growth in our operations as a result of the Howco and planned acquisitions is expected to place a significant
strain on our administrative, financial and operational resources, and increase demands on our management and on our operational
and administrative systems, controls and other resources. Howco’s growth strategy includes broadening its service and product
offerings, implementing an aggressive marketing plan and employing leading technologies. There can be no assurance that our systems,
procedures and controls will be adequate to support our operations as they expand. We cannot assure you that our existing personnel,
systems, procedures or controls will be adequate to support our operations in the future or that we will be able to successfully
implement appropriate measures consistent with our growth strategy. As part of this growth, we may have to implement new operational
and financial systems, procedures and controls to expand, train and manage our employee base, and maintain close coordination among
our staff. We cannot guarantee that we will be able to do so, or that if we are able to do so, we will be able to effectively integrate
them into our existing staff and systems.
To the extent we acquire
other businesses, we will also need to integrate and assimilate new operations, technologies and personnel. The integration of
new personnel will continue to result in some disruption to ongoing operations. The ability to effectively manage growth in a rapidly
evolving market requires effective planning and management processes. We will need to continue to improve operational, financial
and managerial controls, reporting systems and procedures, and will need to continue to expand, train and manage our work force.
There can be no assurance that we would be able to accomplish such an expansion on a timely basis. If we are unable to affect any
required expansion and is unable to perform its contracts on a timely and satisfactory basis, its reputation and eligibility to
secure additional contracts in the future could be damaged. The failure to perform could also result in a contract terminations
and significant liability. Any such result would adversely affect our business and financial condition.
We will need to increase the size
of our organization, and we may experience difficulties in managing growth, which would hurt our financial performance.
In addition to employees
hired from Howco and any other companies which we may acquire, we will need to expand our employee infrastructure for managerial,
operational, financial and other resources at the parent company level. Future growth will impose significant added responsibilities
on members of management, including the need to identify, recruit, maintain and integrate additional employees. Our future financial
performance and our ability to commercialize our product candidates and to compete effectively will depend, in part, on our ability
to manage any future growth effectively.
In order to manage
our future growth, we will need to continue to improve our management, operational and financial controls and our reporting systems
and procedures. All of these measures will require significant expenditures and will demand the attention of management. If we
do not continue to enhance our management personnel and our operational and financial systems and controls in response to growth
in our business, we could experience operating inefficiencies that could impair our competitive position and could increase our
costs more than we had planned. If we are unable to manage growth effectively, our business, financial condition and operating
results could be adversely affected.
Our business depends on experienced
and skilled personnel, and if we are unable to attract and integrate skilled personnel, it will be more difficult for us to manage
our business and complete contracts.
The success of our
business depends on the skill of our personnel. Accordingly, it is critical that we maintain, and continue to build, a highly experienced
management team and specialized workforce, including sales professionals. Competition for personnel, particularly those with expertise
in government consulting and a security clearance is high, and identifying candidates with the appropriate qualifications can be
costly and difficult. We may not be able to hire the necessary personnel to implement our business strategy given our anticipated
hiring needs, or we may need to provide higher compensation or more training to our personnel than we currently anticipate. In
addition, our ability to recruit, hire and indirectly deploy former employees of the U.S. Government is subject to complex laws
and regulations, which may serve as an impediment to our ability to attract such former employees.
Our business is labor
intensive and our success depends on our ability to attract, retain, train and motivate highly skilled employees, including employees
who may become part of our organization in connection with our acquisitions. The increase in demand for consulting, technology
integration and managed services has further increased the need for employees with specialized skills or significant experience
in these areas. Our ability to expand our operations will be highly dependent on our ability to attract a sufficient number of
highly skilled employees and to retain our employees and the employees of companies that we have acquired. We may not be successful
in attracting and retaining enough employees to achieve our desired expansion or staffing plans. Furthermore, the industry turnover
rates for these types of employees are high and we may not be successful in retaining, training or motivating our employees. Any
inability to attract, retain, train and motivate employees could impair our ability to adequately manage and complete existing
projects and to accept new client engagements. Such inability may also force us to increase our hiring of independent contractors,
which may increase our costs and reduce our profitability on client engagements. We must also devote substantial managerial and
financial resources to monitoring and managing our workforce. Our future success will depend on our ability to manage the levels
and related costs of our workforce.
In the event we are
unable to attract, hire and retain the requisite personnel and subcontractors, we may experience delays in completing contracts
in accordance with project schedules and budgets, which may have an adverse effect on our financial results, harm our reputation
and cause us to curtail our pursuit of new contracts. Further, any increase in demand for personnel may result in higher costs,
causing us to exceed the budget on a contract, which in turn may have an adverse effect on our business, financial condition and
operating results and harm our relationships with our customers.
We expect to expand our business,
in part, through future acquisitions, but we may not be able to complete the pending acquisition or identify or complete suitable
acquisitions, which could harm our financial performance.
Acquisitions are a
significant part of our growth strategy.l,m We continually review, evaluate and consider potential investments and acquisitions.
In such evaluations, we are required to make difficult judgments regarding the value of business opportunities and the risks and
cost of potential liabilities. We plan to use acquisitions of companies or technologies to expand our project skill-sets and capabilities,
expand our geographic markets, add experienced management and increase our product and service offerings. Although we have identified
several acquisition considerations, we may be unable to implement our growth strategy if we cannot reach agreement with acquisition
targets on acceptable terms or arrange required financing for acquisitions on acceptable terms. In addition, the time and effort
involved in attempting to identify acquisition candidates and consummate acquisitions may divert members of our management from
the operations of our company.
Any future acquisitions that we may
make could disrupt our business, cause dilution to our stockholders and harm our business, financial condition or operating results.
If we are successful
in consummating acquisitions, those acquisitions could subject us to a number of risks, including, but not limited to:
•the purchase price we pay
and/or unanticipated costs could significantly deplete our cash reserves or result in dilution to our existing stockholders;
•we may find that the acquired
company or technologies do not improve market position as planned;
•we may have difficulty
integrating the operations and personnel of the acquired company, as the combined operations will place significant demands on
the Company’s management, technical, financial and other resources;
•key personnel and customers
of the acquired company may terminate their relationships with the acquired company as a result of the acquisition;
•we may experience additional
financial and accounting challenges and complexities in areas such as tax planning and financial reporting;
•we may assume or be held
liable for risks and liabilities (including environmental-related costs) as a result of our acquisitions, some of which we may
not be able to discover during our due diligence or adequately adjust for in our acquisition arrangements;
•our ongoing business and
management’s attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically
or culturally diverse enterprises;
•we may incur
one-time write-offs or restructuring charges in connection with the acquisition;
•we may acquire goodwill
and other intangible assets that are subject to amortization or impairment tests, which could result in future charges to earnings;
and
•we may not be able to realize the
cost savings or other financial benefits we anticipated.
We cannot assure you
that we will successfully integrate Howco or profitably manage any other acquired business. In addition, we cannot assure you that,
following any acquisition, our continued business will achieve sales levels, profitability, efficiencies or synergies that justify
acquisition or that the acquisition will result in increased earnings for us in any future period. These factors could have a material
adverse effect on our business, financial condition and operating results.
Insurance and contractual protections
may not always cover lost revenue, increased expenses or liquidated damages payments, which could adversely affect our financial
results.
Although we maintain
insurance and intend to obtain warranties from suppliers, obligate subcontractors to meet certain performance levels and attempt,
where feasible, to pass risks we cannot control to our customers, the proceeds of such insurance, warranties, performance guarantees
or risk sharing arrangements may not be adequate to cover lost revenue, increased expenses or liquidated damages payments that
may be required in the future.
If we are unable to comply with certain
financial and operating restrictions in our credit facilities, we may be limited in our business activities and access to credit
or may default under our credit facilities
Pursuant to our existing
Credit Agreement with TCA, all of our assets, including the assets of Howco, are secured with our senior lender. Provisions in
the Credit Agreement and debt instruments impose restrictions or require prior approval on our and certain of our subsidiaries’
ability to, among other things:
●
incur additional debt;
●
pay cash dividends and make distributions;
●
make certain investments and acquisitions;
●
guarantee the indebtedness of others or our subsidiaries;
●
redeem or repurchase capital stock;
●
create liens or encumbrances;
●
enter into transactions with affiliates;
●
engage in new lines of business;
●
sell, lease or transfer certain parts of our business or property;
●
restrictions on incurring obligations for capital expenditures;
●
issue additional capital stock of the Company or any subsidiary of the Company;
●
acquire new companies and merge or consolidate.
These agreements also
contain other customary covenants, including covenants that require us to meet specified financial ratios and financial tests.
We may not be able to comply with these covenants in the future. Our failure to comply with these covenants may result in the declaration
of an event of default and cause us to be unable to borrow under our credit facilities and debt instruments. In addition to preventing
additional borrowings under these agreements, an event of default, if not cured or waived, may result in the acceleration of the
maturity of indebtedness outstanding under these agreements, which would require us to pay all amounts outstanding. If the maturity
of our indebtedness is accelerated, we may not have sufficient funds available for repayment or we may not have the ability to
borrow or obtain sufficient funds to replace the accelerated indebtedness on terms acceptable to us or at all. Our failure to repay
our bank indebtedness would result in the bank foreclosing on all or a portion of our assets and force us to curtail our operations.
Our obligations to our senior secured
lender, TCA, are secured by a security interest in substantially all of our assets, so if we default on those obligations, TCA
could foreclose on, liquidate and/or take possession of our assets. If that were to happen, we could be forced to curtail, or even
to cease, our operations.
Under the Credit Facility,
effective September13, 2016, with TCA Global Credit Master Fund, L.P. (“TCA”), we borrowed $3.5 million to acquire
Howco and pay certain creditors. The initial loan was due 18 months from the date of the loan and bears interest of 18% per annum
and a default interest rate of 25% per annum. As of September 30, 2017, we had approximately $3,669,417 in outstanding principal
and interest owed to TCA. Under the terms of the Credit Facility, all amounts due under it are secured by our assets, including
the assets of Howco. As a result of being in default of our payment obligations under the Credit Facility, TCA could foreclose
on its security interest and liquidate or take possession of some or all of these assets, which would harm our business, financial
condition and results of operations and could require us to curtail, or even to cease, operations.
TCA has certain rights upon an event
of default under its Credit Facility that could harm our business, financial condition and results of operations and could require
us to curtail or cease our operations.
In light of being in
default under our payment obligations to TCA, it has certain rights under the Credit Facility to protect its financial position,
including an increase in the interest rate on any amounts in default under the terms of the Credit Facility, the right to accelerate
the payment of any outstanding loans made pursuant to the Credit Facility and the right to foreclose on our assets, among other
rights. The Credit Facility includes in its definition of an event of default, among other occurrences, the failure to pay any
principal or interest when due, our termination, winding up, liquidation or dissolution, a change of control, a material adverse
change in our financial condition and the filing of any lien not bonded, vacated or dismissed within 60 days of its filing. The
exercise of any of these rights upon an event of default could substantially harm our financial condition and force us to curtail,
or even to cease, our operations.
We may be subject to damages resulting
from claims that the Company or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.
Upon completion of
any acquisitions by the Company, we may be subject to claims that our acquired companies and their employees may have inadvertently
or otherwise used or disclosed trade secrets or other proprietary information of former employers or competitors. Litigation may
be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result
in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying money claims,
we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper
or prevent our ability to commercialize certain products, which could severely harm our business.
The loss of our Chief Executive Offer
or other key personnel may adversely affect our operations.
The Company’s
success depends to a significant extent upon the operation, experience, and continued services of certain of its officers, including
our CEO, as well as other key personnel. While our CEO and the executive officers of Howco are all employed under employment contracts,
there is no assurance we will be able to retain their services. The loss of our CEO or several of the other key personnel could
have an adverse effect on the Company. If a CEO or other executive officers were to leave we would face substantial difficulty
in hiring a qualified successor and could experience a loss in productivity while any successor obtains the necessary training
and experience. In addition, our CEO, CFO and other key personnel do not have prior experience in SEC reporting obligations. Furthermore,
we do not maintain “key person” life insurance on the lives of any executive officer and their death or incapacity
would have a material adverse effect on us. The competition for qualified personnel is intense, and the loss of services of certain
key personnel could adversely affect our business.
Internal system or service failures
could disrupt our business and impair our ability to effectively provide our services and products to our customers, which could
damage our reputation and adversely affect our revenues and profitability.
Any system or service
disruptions, including those caused by ongoing projects to improve our information technology systems and the delivery of services,
if not anticipated and appropriately mitigated, could have a material adverse effect on our business including, among other things,
an adverse effect on our ability to bill our customers for work performed on our contracts, collect the amounts that have been
billed and produce accurate financial statements in a timely manner. We are also subject to systems failures, including network,
software or hardware failures, whether caused by us, third-party service providers, cyber security threats, natural disasters,
power shortages, terrorist attacks or other events, which could cause loss of data and interruptions or delays in our business,
cause us to incur remediation costs, subject us to claims and damage our reputation. In addition, the failure or disruption of
our communications or utilities could cause us to interrupt or suspend our operations or otherwise adversely affect our business.
Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of
any system or operational failure or disruption and, as a result, our future results could be adversely affected.
Our financial performance could be
adversely affected by decreases in spending on technology products and services by our public sector customers.
Our sales to our public
sector customers are impacted by government spending policies, budget priorities and revenue levels. Although our sales to the
federal government are diversified across multiple agencies and departments, they collectively accounted for approximately 95%
of Howco's net sales. An adverse change in government spending policies (including budget cuts at the federal level resulting from
sequestration), budget priorities or revenue levels could cause our public sector customers to reduce their purchases or to terminate
or not renew their contracts with us, which could adversely affect our business, results of operations or cash flows.
Our business could be adversely affected
by the loss of certain vendor partner relationships and the availability of their products.
We purchase products
for resale from vendor partners, which include OEMs and wholesale distributors. We are authorized by vendor partners to sell all
or some of their products via direct marketing activities. Our authorization with each vendor partner is subject to specific terms
and conditions regarding such things as sales channel restrictions, product return privileges, price protection policies and purchase
discounts. In the event we were to lose one of our significant vendor partners, our business could be adversely affected.
We expect to enter into joint ventures,
teaming and other arrangements, and these activities involve risks and uncertainties.
We expect to enter
into joint ventures, teaming and other arrangements. These activities involve risks and uncertainties, including the risk of the
joint venture or applicable entity failing to satisfy its obligations, which may result in certain liabilities to us for guarantees
and other commitments, the challenges in achieving strategic objectives and expected benefits of the business arrangement, the
risk of conflicts arising between us and our partners and the difficulty of managing and resolving such conflicts, and the difficulty
of managing or otherwise monitoring such business arrangements.
Our business and operations expose
us to numerous legal and regulatory requirements and any violation of these requirements could harm our business.
We are subject to numerous
federal, state and foreign legal requirements on matters as diverse as data privacy and protection, employment and labor relations,
immigration, taxation, anticorruption, import/export controls, trade restrictions, internal and disclosure control obligations,
securities regulation and anti-competition. Compliance with diverse and changing legal requirements is costly, time-consuming and
requires significant resources. We are also focused on expanding our business in certain identified growth areas, such as health
information technology, energy and environment, which are highly regulated and may expose us to increased compliance risk. Violations
of one or more of these diverse legal requirements in the conduct of our business could result in significant fines and other damages,
criminal sanctions against us or our officers, prohibitions on doing business and damage to our reputation. Violations of these
regulations or contractual obligations related to regulatory compliance in connection with the performance of customer contracts
could also result in liability for significant monetary damages, fines and/or criminal prosecution, unfavorable publicity and other
reputational damage, restrictions on our ability to compete for certain work and allegations by our customers that we have not
performed our contractual obligations.
If we do not adequately protect our
intellectual property rights, we may experience a loss of revenue and our operations may be materially harmed.
We have not registered
any patents or copyrights for any of the intellectual property we have acquired or developed. We rely upon confidentiality agreements
signed by our employees, consultants and third parties to protect our intellectual property. We cannot assure you that we can adequately
protect our intellectual property or successfully prosecute potential infringement of our intellectual property rights. Also, we
cannot assure you that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that
we will be able to successfully resolve these types of conflicts to our satisfaction. Our failure to protect our intellectual property
rights may result in a loss of revenue and could materially adversely affect our operations and financial condition.
Risks Relating to Howco’s Business
and Industry
We depend on the U.S. Government
for a substantial portion of our business and changes in government defense spending could have adverse consequences on our financial
position, results of operations and business.
Approximately 98% of
our U.S. revenues from Howco's operations have been from and will continue to be from sales and services rendered directly or indirectly
to the U.S. Government. Our revenues from the U.S. Government largely result from contracts awarded to us under various U.S. Government
programs, primarily defense-related programs with the Department of Defense (DoD), as well as a broad range of programs with the
Department of Homeland Security, the intelligence community and other departments and agencies. Cost cutting including through
consolidation and elimination of duplicative organizations and insurance has become a major initiative for DoD. The funding of
our programs is subject to the overall U.S. Government budget and appropriation decisions and processes which are driven by numerous
factors, including geo-political events and macroeconomic conditions. The overall level of U.S. defense spending increased in recent
years for numerous reasons, including increases in funding of operations in Iraq and Afghanistan. However, with the winding down
of both wars, defense spending levels are becoming increasingly difficult to predict and are expected to be affected by numerous
factors. Such factors include priorities of the Administration and the Congress, and the overall health of the U.S. and world economies
and the state of governmental finances.
The Budget Control
Act of 2011 enacted 10-year discretionary spending caps which are expected to generate over $1 trillion in savings for the U.S.
Government, a substantial portion of which comes from DoD baseline spending reductions. In addition, the Budget Control Act of
2011 provides for additional automatic spending cuts (referred to as “sequestration”) totaling $1.2 trillion over nine
years. These reduction targets will further reduce DoD and other federal agency budgets. Although the Office of Management and
Budget has provided guidance to agencies on implementing sequestration cuts, there remains much uncertainty about how exactly sequestration
cuts will be implemented and the impact those cuts will have on contractors supporting the government. Given the potential impasse
over raising the debt ceiling, we are not able to predict them impact of budget cuts, including sequestration, on our company or
our financial results. However, we expect that budgetary constraints and concerns related to the national debt will continue to
place downward pressure on DoD spending levels and that implementation of the automatic spending cuts without change will reduce,
delay or cancel funding for certain of our contracts - particularly those with unobligated balances - and programs and could adversely
impact our operations, financial results and growth prospects.
Significant reduction
in defense spending could have long-term consequences for our size and structure. In addition, reduction in government priorities
and requirements could impact the funding, or the timing of funding, of our programs, which could negatively impact our results
of operations and financial condition. In addition, we are involved in U.S. Government programs, which are classified by the U.S.
Government and our ability to discuss these programs, including any risks and disputes and claims associated with and our performance
under such programs, could be limited due to applicable security restrictions.
The U.S. Government Systems spare
parts business is intensely competitive and we may not be able to win government bids when competing against much larger companies,
which could reduce our revenues and profitability.
Large spare parts contracts
awarded by the U.S. Government are few in number and are awarded through a formal competitive bidding process, including indefinite
delivery/indefinite quantity ("IDIQ"), GSA Schedule and other multi-award contracts. Bids are awarded on the basis of
price, compliance with technical bidding specifications, technical expertise and, in some cases, demonstrated management ability
to perform the contract. There can be no assurance that the Company will win and/or fulfill additional contracts. Moreover, the
award of these contracts is subject to protest procedures and there can be no assurance that the Company will prevail in any ensuing
legal protest. Howco’s failure to secure a significant dollar volume of U.S. Government contracts in the future would adversely
affect us.
The U.S. Government
spare parts business is intensely competitive and subject to rapid change. Many of the existing and potential competitors have
greater financial, operating and technological resources than Howco. The competitive environment may require us to make changes
in our pricing, services or marketing. The competitive bidding process involves substantial costs and a number of risks, including
significant cost and managerial time to prepare bids and proposals for contracts that may not be awarded to us, or that may be
awarded, but for which we do not receive meaningful revenues. Accordingly, our success depends on our ability to develop services
and products that address changing needs and to provide people and technology needed to deliver these services and products. To
remain competitive, we must consistently provide superior service, technology and performance on a cost-effective basis to our
customers. Our response to competition could cause us to expend significant financial and other resources, disrupt our operations,
strain relationships with partners, any of which could harm our business and/or financial condition.
Our financial performance is dependent
on our ability to perform on our U.S. Government contracts, which are subject to termination for convenience, which could harm
our financial performance.
Our financial performance
is dependent on our performance under our U.S. Government contracts. Government customers have the right to cancel any contract
for its convenience. An unanticipated termination of, or reduced purchases under, one of the Company’s major contracts whether
due to lack of funding, for convenience or otherwise, or the occurrence of delays, cost overruns and product failures could adversely
impact our results of operations and financial condition. If one of our contracts were terminated for convenience, we would generally
be entitled to payments for our allowable costs and would receive some allowance for profit on the work performed. If one of our
contracts were terminated for default, we would generally be entitled to payments for our work that has been accepted by the government.
A termination arising out of our default could expose us to liability and have a negative impact on our ability to obtain future
contracts and orders. Furthermore, on contracts for which we are a subcontractor and not the prime contractor, the U.S. Government
could terminate the prime contract for convenience or otherwise, irrespective of our performance as a subcontractor.
Our failure to comply with a variety
of complex procurement rules and regulations could result in our being liable for penalties, including termination of our U.S.
Government contracts, disqualification from bidding on future U.S. Government contracts and suspension or debarment from U.S. Government
contracting that could adversely affect our financial condition
.
We must comply with
laws and regulations relating to the formation, administration and performance of U.S. Government contracts, which affect how we
do business with our customers and may impose added costs on our business. U.S. Government contracts generally are subject to the
Federal Acquisition Regulation (FAR), which sets forth policies, procedures and requirements for the acquisition of goods and services
by the U.S. Government, department-specific regulations that implement or supplement DFAR, such as the DOD’s Defense Federal
Acquisition Regulation Supplement (DFARS) and other applicable laws and regulations. We are also subject to the Truth in Negotiations
Act, which requires certification and disclosure of cost and pricing data in connection with certain contract negotiations; the
Procurement Integrity Act, which regulates access to competitor bid and proposal information and government source selection information,
and our ability to provide compensation to certain former government officials; the Civil False Claims Act, which provides for
substantial civil penalties for violations, including for submission of a false or fraudulent claim to the U.S. Government for
payment or approval; the Civil False Claims Act, which provides for substantial civil penalties for violations, including for submission
of a false or fraudulent claim to the U.S. Government for payment or approval; and the U.S. Government Cost Accounting Standards,
which impose accounting requirements that govern our right to reimbursement under certain cost-based U.S. Government contracts.
These regulations impose a broad range of requirements, many of which are unique to government contracting, including various procurement,
import and export, security, contract pricing and cost, contract termination and adjustment, and audit requirements. A contractor’s
failure to comply with these regulations and requirements could result in reductions to the value of contracts, contract modifications
or termination, and the assessment of penalties and fines and lead to suspension or debarment, for cause, from government contracting
or subcontracting for a period of time. In addition, government contractors are also subject to routine audits and investigations
by U.S. Government agencies such as the Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA). These
agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations
and standards. The DCAA also reviews the adequacy of and a contractor’s compliance with its internal control systems and
policies, including the contractor’s purchasing, property, estimating, compensation and management information systems. During
the term of any suspension or debarment by any U.S. Government agency, contractors can be prohibited from competing for or being
awarded contracts by U.S. Government agencies. The termination of any of the Company’s significant Government contracts or
the imposition of fines, damages, suspensions or debarment would adversely affect the Company’s business and financial condition.
The U.S. Government may adopt new
contract rules and regulations or revise its procurement practices in a manner adverse to us at any time.
Our industry has experienced,
and we expect it will continue to experience, significant changes to business practices as a result of an increased focus on affordability,
efficiencies, and recovery of costs, among other items. U.S. Government agencies may face restrictions or pressure regarding the
type and amount of services that they may obtain from private contractors. Legislation, regulations and initiatives dealing with
procurement reform, mitigation of potential conflicts of interest and environmental responsibility or sustainability, as well as
any resulting shifts in the buying practices of U.S. Government agencies, such as increased usage of fixed price contracts, multiple
award contracts and small business set-aside contracts, could have adverse effects on government contractors, including us. Any
of these changes could impair our ability to obtain new contracts or renew our existing contracts when those contracts are recompeted.
Any new contracting requirements or procurement methods could be costly or administratively difficult for us to implement and could
adversely affect our future revenues, profitability and prospects.
We may incur cost overruns as a result
of fixed priced government contracts which would have a negative impact on our operations.
A number of Howco’s
current U.S. Government contracts are multi-award, multi-year IDIQ task order based contracts, which generally provide for fixed
price schedules for products and services, have no pre-set delivery schedules, have very low minimum purchase requirements, are
typically competed among multiple awardees and force us to carry the burden of any cost overruns. Due to their nature, fixed-priced
contracts inherently have more risk than cost reimbursable contracts. If we are unable to control costs or if our initials cost
estimates are incorrect, we can lose money on these contracts. In addition, some of our contracts have provisions relating to cost
controls and audit rights, and if we fail to meet the terms specified in those contracts, we may not realize their full benefits.
Lower earnings caused by cost overruns and cost controls would have a negative impact on our results of operations. The U.S. Government
has the right to enter into contracts with other suppliers, which may be competitive with the Company’s IDIQ contracts. The
Company also performs fixed priced contracts under which the Company agrees to provide specific quantities of products and services
over time for a fixed price. Since the price competition to win both IDIQ and fixed price contracts is intense and the costs of
future contract performance cannot be predicted with certainty, there can be no assurance as to the profits, if any, that the Company
will realize over the term of such contracts.
Misconduct of employees, subcontractors,
agents and business partners could cause us to lose existing contracts or customers and adversely affect our ability to obtain
new contracts and customers and could have a significant adverse impact on our business and reputation.
Misconduct could include
fraud or other improper activities such as falsifying time or other records and violations of laws, including the Anti-Kickback
Act. Other examples could include the failure to comply with our policies and procedures or with federal, state or local government
procurement regulations, regulations regarding the use and safeguarding of classified or other protected information, legislation
regarding the pricing of labor and other costs in government contracts, laws and regulations relating to environmental, health
or safety matters, bribery of foreign government officials, import-export control, lobbying or similar activities, and any other
applicable laws or regulations. Any data loss or information security lapses resulting in the compromise of personal information
or the improper use or disclosure of sensitive or classified information could result in claims, remediation costs, regulatory
sanctions against us, loss of current and future contracts and serious harm to our reputation. Although we have implemented policies,
procedures and controls to prevent and detect these activities, these precautions may not prevent all misconduct, and as a result,
we could face unknown risks or losses. Our failure to comply with applicable laws or regulations or misconduct by any of our employees,
subcontractors, agents or business partners could damage our reputation and subject us to fines and penalties, restitution or other
damages, loss of security clearance, loss of current and future customer contracts and suspension or debarment from contracting
with federal, state or local government agencies, any of which would adversely affect our business, reputation and our future results.
We may fail to obtain and maintain
necessary security clearances, which may adversely affect our ability to perform on certain U.S. government contracts and depress
our potential revenues.
Many U.S. government
programs require contractors to have security clearances. Depending on the level of required clearance, security clearances can
be difficult and time-consuming to obtain. If we or our employees are unable to obtain or retain necessary security clearances,
we may not be able to win new business, and our existing clients could terminate their contracts with us or decide not to renew
them. To the extent we are not able to obtain and maintain facility security clearances or engage employees with the required security
clearances for a particular contract, we may not be able to bid on or win new contracts, or effectively rebid on expiring contracts,
as well as lose existing contracts, which may adversely affect our operating results and inhibit the execution of our growth strategy.
Our future revenues and growth prospects
could be adversely affected by our dependence on other contractors.
If other contractors
with whom we have contractual relationships either as a prime contractor or subcontractor eliminate or reduce their work with us,
or if the U.S. Government terminates or reduces these other contractors’ programs, does not award them new contracts or refuses
to pay under a contract our financial and business condition may be adversely affected. Companies that do not have access to U.S.
Government contracts may perform services as our subcontractor and that exposure could enhance such companies’ prospect of
securing a future position as a prime U.S. Government contractor which could increase competition for future contracts and impair
our ability to perform on contracts.
We may have disputes
with our subcontractors arising from, among other things, the quality and timeliness of work performed by the subcontractor, customer
concerns about the subcontractor, our failure to extend existing task orders or issue new task orders under a subcontract, our
hiring of a subcontractor’s personnel or the subcontractor’s failure to comply with applicable law. Current uncertain
economic conditions heighten the risk of financial stress of our subcontractors, which could adversely impact their ability to
meet their contractual requirements to us. If any of our subcontractors fail to timely meet their contractual obligations or have
regulatory compliance or other problems, our ability to fulfill our obligations as a prime contractor or higher tier subcontractor
may be jeopardized. Significant losses could arise in future periods and subcontractor performance deficiencies could result in
our termination for default. A termination for default could eliminate a revenue source, expose us to liability and have an adverse
effect on our ability to compete for future contracts and task orders, especially if the customer is an agency of the U.S. Government.
Our international business exposes
us to geo-political and economic factors, regulatory requirements and other risks associated with doing business in foreign countries.
.
We intend to engage
in additional foreign operations which pose complex management, foreign currency, legal, tax and economic risks, which we may not
adequately address. These risks differ from and potentially may be greater than those associated with our domestic business.
Our international business
is sensitive to changes in the priorities and budgets of international customers and geo-political uncertainties, which may be
driven by changes in threat environments and potentially volatile worldwide economic conditions, various regional and local economic
and political factors, risks and uncertainties, as well as U.S. foreign policy. Our international sales are subject to U.S. laws,
regulations and policies, including the International Traffic in Arms Regulations (ITAR) and the Foreign Corrupt Practices Act
(see below) and other export laws and regulations. Due to the nature of our products, we must first obtain licenses and authorizations
from various U.S. Government agencies before we are permitted to sell our products outside of the U.S. We can give no assurance
that we will continue to be successful in obtaining the necessary licenses or authorizations or that certain sales will not be
prevented or delayed. Any significant impairment of our ability to sell products outside of the U.S. could negatively impact our
results of operations and financial condition.
Our international sales
are also subject to local government laws, regulations and procurement policies and practices which may differ from U.S. Government
regulations, including regulations relating to import-export control, investments, exchange controls and repatriation of earnings,
as well as to varying currency, geo-political and economic risks. Our international contracts may include industrial cooperation
agreements requiring specific in-country purchases, manufacturing agreements or financial support obligations, known as offset
obligations, and provide for penalties if we fail to meet such requirements. Our international contracts may also be subject to
termination at the customer’s convenience or for default based on performance, and may be subject to funding risks. We also
are exposed to risks associated with using foreign representatives and consultants for international sales and operations and teaming
with international subcontractors, partners and suppliers in connection with international programs. As a result of these factors,
we could experience award and funding delays on international programs and could incur losses on such programs, which could negatively
impact our results of operations and financial condition.
We are also subject
to a number of other risks including:
● the absence in some
jurisdictions of effective laws to protect our intellectual property rights;
● multiple and possibly
overlapping and conflicting tax laws;
● restrictions on movement
of cash;
● the burdens of complying
with a variety of national and local laws;
● political instability;
● currency fluctuations;
● longer payment cycles;
● restrictions on the
import and export of certain technologies;
●
price controls or restrictions on exchange of foreign currencies; and
●
trade barriers.
Our international operations are
subject to special U.S. government laws and regulations, such as the Foreign Corrupt Practices Act, and regulations and procurement
policies and practices, including regulations to import-export control, which may expose us to liability or impair our ability
to compete in international markets.
Our international operations
are subject to the U.S. Foreign Corrupt Practices Act, or the FCPA, and other laws that prohibit improper payments or offers of
payments to foreign governments and their officials and political parties by U.S. and other business entities for the purpose of
obtaining or retaining business. We have operations and deal with governmental customers in countries known to experience corruption,
including certain countries in the Middle East and in the future, the Far East. Our activities in these countries create the risk
of unauthorized payments or offers of payments by one of our employees, consultants or contractors that could be in violation of
various laws including the FCPA, even though these parties are not always subject to our control. We are also subject to import-export
control regulations restricting the use and dissemination of information classified for national security purposes and the export
of certain products, services, and technical data, including requirements regarding any applicable licensing of our employees involved
in such work.
As a U.S. defense contractor we are
vulnerable to security threats and other disruptions that could negatively impact our business.
As a U.S. defense contractor,
we face certain security threats, including threats to our information technology infrastructure, attempts to gain access to our
proprietary or classified information, and threats to physical security. These types of events could disrupt our operations, require
significant management attention and resources, and could negatively impact our reputation among our customers and the public,
which could have a negative impact on our financial condition, results of operations and liquidity. We are continuously exposed
to cyber-attacks and other security threats, including physical break-ins. Any electronic or physical break-in or other security
breach or compromise may jeopardize security of information stored or transmitted through our information technology systems and
networks. This could lead to disruptions in mission-critical systems, unauthorized release of confidential or otherwise protected
information and corruption of data. Although we have implemented policies, procedures and controls to protect against, detect and
mitigate these threats, we face advanced and persistent attacks on our information systems and attempts by others to gain unauthorized
access to our information technology systems are becoming more sophisticated. These attempts include covertly introducing malware
to our computers and networks and impersonating authorized users, among others, and may be perpetrated by well-funded organized
crime or state sponsored efforts. We seek to detect and investigate all security incidents and to prevent their occurrence or recurrence.
We continue to invest in and improve our threat protection, detection and mitigation policies, procedures and controls. In addition,
we work with other companies in the industry and government participants on increased awareness and enhanced protections against
cyber security threats. However, because of the evolving nature and sophistication of these security threats, which can be difficult
to detect, there can be no assurance that our policies, procedures and controls have or will detect or prevent any of these threats
and we cannot predict the full impact of any such past or future incident. Although we work cooperatively with our customers and
other business partners to seek to minimize the impacts of cyber and other security threats, we must rely on the safeguards put
in place by those entities. Any remedial costs or other liabilities related to cyber or other security threats may not be fully
insured or indemnified by other means. Occurrence of any of these security threats could expose us to claims, contract terminations
and damages and could adversely affect our reputation, ability to work on sensitive U.S. Government contracts, business operations
and financial results.
Difficult conditions in the global
capital markets and the economy generally may materially adversely affect our business and results of operations.
Our results of operations
are materially affected by conditions in the global capital markets and the economy generally, both in the U.S. and elsewhere around
the world. Weak economic conditions sustained uncertainty about global economic conditions, concerns about future U.S. budgetary
cuts, or a prolonged or further tightening of credit markets could cause our customers and potential customers to postpone or reduce
spending on technology products or services or put downward pressure on prices, which could have an adverse effect on our business,
results of operations or cash flows. In the event of extreme prolonged adverse market events, such as a global credit crisis, we
could incur significant losses.
Risks Related to Our Common Stock
We are eligible to be treated as
an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, and we cannot be certain
if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.
We are an “emerging
growth company”, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. For as long as we continue
to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to
other public companies that are not emerging growth companies, including (1) not being required to comply with the auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which we refer to as the Sarbanes-Oxley Act, (2) reduced disclosure
obligations regarding executive compensation in this Form 10-K and our periodic reports and proxy statements and (3) exemptions
from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute
payments not previously approved. In addition, as an emerging growth company, we are only required to provide two years of audited
financial statements and two years of selected financial data in this Form 10. We could be an emerging growth company for up to
five years, although circumstances could cause us to lose that status earlier, including if the market value of our common stock
held by non-affiliates exceeds $700.0 million as of any June 30 before that time or if we have total annual gross revenue of $1.0
billion or more during any fiscal year before that time, in which cases we would no longer be an emerging growth company as of
the following December 31 or, if we issue more than $1.0 billion in non-convertible debt during any three-year period before that
time, we would cease to be an emerging growth company immediately. Even after we no longer qualify as an emerging growth company,
we may still qualify as a “smaller reporting company” which would allow us to take advantage of many of the same exemptions
from disclosure requirements, including not being required to comply with the auditor attestation requirements of Section 404 of
the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements.
We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors
find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock
price may be more volatile.
Our independent registered
public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting
until the later of our second annual report or the first annual report required to be filed with the Commission following the date
we are no longer an “emerging growth company” as defined in the JOBS “Act. We cannot assure you that there will
not be material weaknesses or significant deficiencies in our internal controls in the future.
Under the JOBS Act,
emerging growth companies can also delay adopting new or revised accounting standards until such time as those standards apply
to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards
and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging
growth companies.
Our directors and executive officers
beneficially own a significant number of shares of our common stock. Their interests may conflict with our outside stockholders,
who may be unable to influence management and exercise control over our business
.
As of the date of this
Form 10-K, our executive officers and directors beneficially own approximately 88% of our shares of common stock. As a result,
our executive officers and directors may be able to: elect or defeat the election of our directors, amend or prevent amendment
to our certificates of incorporation or bylaws, effect or prevent a merger, sale of assets or other corporate transaction, and
control the outcome of any other matter submitted to the shareholders for vote. Accordingly, our outside stockholders may be unable
to influence management and exercise control over our business.
We do not intend to pay cash dividends
to our stockholders, so you will not receive any return on your investment in our Company prior to selling your interest in the
Company.
We have never paid
any dividends to our common stockholders as a public company. We currently intend to retain any future earnings for funding growth
and, therefore, do not expect to pay any cash dividends in the foreseeable future. If we determine that we will pay cash dividends
to the holders of our common stock, we cannot assure that such cash dividends will be paid on a timely basis. The success of your
investment in the Company will likely depend entirely upon any future appreciation. As a result, you will not receive any return
on your investment prior to selling your shares in our Company and, for the other reasons discussed in this “Risk Factors”
section, you may not receive any return on your investment even when you sell your shares in our Company.
Anti-Takeover, Limited Liability
and Indemnification Provisions
Some provisions of our certificate
of incorporation and by-laws may deter takeover attempts, which may inhibit a takeover that stockholders consider favorable and
limit the opportunity of our stockholders to sell their shares at a favorable price.
Under our certificate
of incorporation, our Board of Directors may issue additional shares of common or preferred stock. Our Board of Directors has the
ability to authorize “blank check” preferred stock without future shareholder approval. This makes it possible for
our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any
attempt to acquire us by means of a merger, tender offer, proxy contest or otherwise, including a transaction in which our stockholders
would receive a premium over the market price for their shares and/or any other transaction that might otherwise be deemed to be
in their best interests, and thereby protects the continuity of our management and limits an investor’s opportunity to profit
by their investment in the Company. Specifically, if in the due exercise of its fiduciary obligations, the Board of Directors were
to determine that a takeover proposal was not in our best interest, shares could be issued by our Board of Directors without stockholder
approval in one or more transactions that might prevent or render more difficult or costly the completion of the takeover by:
●
diluting the voting or other rights of the proposed acquirer or insurgent stockholder group,
● putting a substantial
voting bloc in institutional or other hands that might undertake to support the incumbent Board of Directors, or
●
effecting an acquisition that might complicate or preclude the takeover.
Delaware's Anti-Takeover Law may
discourage acquirers and eliminate a potentially beneficial sale for our stockholders.
We are subject to the
provisions of the Delaware Shareholder Protection Act concerning corporate takeovers. This section prevents many Delaware corporations
from engaging in a business combination with any interested stockholder, under specified circumstances. For these purposes, a business
combination includes a merger or sale of more than 5% of our assets, and an interested stockholder includes a stockholder who owns
10% or more of our outstanding voting stock, as well as affiliates and associates of these persons. Under these provisions, this
type of business combination is prohibited for three years following the date that the stockholder became an interested stockholder
unless:
● the transaction in which
the stockholder became an interested stockholder is approved by the Board of directors prior to the date the interested stockholder
attained that status;
● on consummation of the
transaction that resulted in the stockholder’s becoming an interested stockholder, the interested stockholder owned at least
90% of the voting stock of the corporation outstanding at the time the transaction was commenced, excluding those shares owned
by persons who are directors and also officers; or
● on or subsequent to that
date, the business combination is approved by the Board of Directors and authorized at an annual or special meeting of stockholders
by the affirmative vote of at least a majority of the outstanding voting stock that is not owned by the interested stockholder.
This statute could
prohibit or delay mergers or other takeover or change in control attempts and, accordingly, may discourage attempts to acquire
us.
Our indemnification of our officers
and directors may cause us to use corporate resources to the detriment of our stockholders.
Our certificate of
incorporation eliminates the personal liability of our directors for monetary damages arising from a breach of their fiduciary
duty as directors to the fullest extent permitted by Delaware law. This limitation does not affect the availability of equitable
remedies, such as injunctive relief or rescission. Our certificate of incorporation requires us to indemnify our directors and
officers to the fullest extent permitted by Delaware law, including in circumstances in which indemnification is otherwise discretionary
under Delaware law.
Under Delaware law,
we may indemnify our directors or officers or other persons who were, are or are threatened to be made a named defendant or respondent
in a proceeding because the person is or was our director, officer, employee or agent, if we determine that the person:
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conducted himself or herself in good faith,
reasonably believed, in the case of conduct in his or her official capacity as our director or officer, that his or her conduct
was in our best interests, and, in all other cases, that his or her conduct was at least not opposed to our best interests; and
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in the case of any criminal proceeding,
had no reasonable cause to believe that his or her conduct was unlawful.
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These persons may be
indemnified against expenses, including attorneys’ fees, judgments, fines, including excise taxes, and amounts paid in settlement,
actually and reasonably incurred, by the person in connection with the proceeding. If the person is found liable to the corporation,
no indemnification will be made unless the court in which the action was brought determines that the person is fairly and reasonably
entitled to indemnity in an amount that the court will establish.
Insofar as indemnification
for liabilities under the Securities Act may be permitted to directors, officers or persons controlling us under the above provisions,
we have been informed that, in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable.
Our bylaws designate the Court of
Chancery of the State of Delaware as the exclusive forum for certain litigation that may be initiated by our stockholders, which
could limit our stockholders' ability to obtain a favorable judicial forum for disputes with us.
Under the provisions
of our amended and restated bylaws (“bylaws”), unless we consent in writing to the selection of an alternative forum,
the Court of Chancery of the State of Delaware will be the sole and exclusive forum for: (i) any derivative action or proceeding
brought on behalf of us; (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers
or other employees or agents to us or our stockholders; (iii) any action asserting a claim against us arising pursuant to
any provision of the Delaware General Corporation Law or our amended certificate of incorporation or bylaws; or (iv) any action
asserting a claim against us governed by the internal affairs doctrine. By becoming a stockholder in our company, you will be deemed
to have notice of and have consented to the provisions of our bylaws related to choice of forum. The choice of forum provision
in our bylaws may limit our stockholders' ability to obtain a favorable judicial forum for disputes with us.
The obligations associated with being
a public company require significant resources and management attention, which may divert from our business operations.
We are subject to the
reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and The Sarbanes-Oxley
Act of 2002, or the Sarbanes-Oxley Act. The Exchange Act requires that we file annual, quarterly and current reports with respect
to our business and financial condition, proxy statement, and other information. The Sarbanes-Oxley Act requires, among other things,
that we establish and maintain effective internal controls and procedures for financial reporting. Our Chief Executive Officer
and Chief Financial Officer will need to certify that our disclosure controls and procedures are effective in ensuring that material
information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the SEC’s rules and forms. We may need to hire additional financial reporting,
internal controls and other financial personnel in order to develop and implement appropriate internal controls and reporting procedures.
As a result, we will incur significant legal, accounting and other expenses. Furthermore, the need to establish the corporate infrastructure
demanded of a public company may divert management’s attention from implementing our growth strategy, which could prevent
us from improving our business, results of operations and financial condition. We have made, and will continue to make, changes
to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations as a public
company. However, the measures we take may not be sufficient to satisfy our obligations as a public company. In addition, we cannot
predict or estimate the amount of additional costs we may incur in order to comply with these requirements. We anticipate that
these costs will materially increase our selling, general and administrative expenses.
Section 404 of the
Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting.
In connection with the implementation of the necessary procedures and practices related to internal control over financial reporting,
we may identify deficiencies. If we are unable to comply with the internal controls requirements of the Sarbanes-Oxley Act of 2002,
then we may not be able to obtain the independent account and certifications required by that act, which may preclude us from keeping
our filings with the SEC current, and interfere with the ability of investors to trade our securities and our shares to continue
to be quoted on the OTCQB or our ability to list our shares on any national securities exchange.
If we fail to establish and maintain
an effective system of internal controls, we may not be able to report our financial results accurately or prevent fraud. Any inability
to report and file our financial results accurately and timely could harm our reputation and adversely impact the trading price
of our common stock.
Effective internal
controls are necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial
reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment
existed, and our business and reputation with investors may be harmed. With each prospective acquisition we may make we will conduct
whatever due diligence is necessary or prudent to assure us that the acquisition target can comply with the internal controls requirements
of the Sarbanes-Oxley Act. Notwithstanding our diligence, certain internal controls deficiencies may not be detected. As a result,
any internal control deficiencies may adversely affect our financial condition, results of operations and access to capital. We
have not performed an in-depth analysis to determine if historical undiscovered failures of internal controls exist, and may in
the future discover areas of our internal controls that need improvement.
Public company compliance may make
it more difficult to attract and retain officers and directors.
The Sarbanes-Oxley
Act and rules implemented by the SEC have required changes in corporate governance practices of public companies. As a public company,
these rules and regulations increase our compliance costs and make certain activities more time consuming and costly. As a public
company, these rules and regulations may make it more difficult and expensive for us to maintain our director and officer liability
insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the
same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our
board of directors or as executive officers, and to maintain insurance at reasonable rates, or at all.
Our stock price may be volatile.
The market price of
our common stock is likely to be highly volatile and could fluctuate widely in price in response to various factors, many of which
are beyond our control, including the following:
●
our ability to execute our business plan and complete prospective acquisitions;
●
changes in our industry;
●
competitive pricing pressures;
●
our ability to obtain working capital financing;
●
additions or departures of key personnel;
● limited “public
float” in the hands of a small number of persons whose sales or lack of sales could result in positive or negative pricing
pressure on the market price for our common stock;
●
sales of our common stock (particularly following effectiveness of this Form 10);
●
operating results that fall below expectations;
●
regulatory developments;
●
economic and other external factors;
●
period-to-period fluctuations in our financial results;
●
our inability to develop or acquire new or needed technologies;
● the public’s response
to press releases or other public announcements by us or third parties, including filings with the SEC;
● changes in financial
estimates or ratings by any securities analysts who follow our common stock, our failure to meet these estimates or failure of
those analysts to initiate or maintain coverage of our common stock;
●
the development and sustainability of an active trading market for our common stock; and
●
any future sales of our common stock by our officers, directors and significant stockholders.
In addition, the securities
markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance
of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.
Our shares of common stock are thinly
traded, the price may not reflect our value, and there can be no assurance that there will be an active market for our shares of
common stock either now or in the future.
Our shares of common
stock are thinly traded, our common stock is available to be traded and is held by a small number of holders, and the price may
not reflect our actual or perceived value. There can be no assurance that there will be an active market for our shares of common
stock either now or in the future. The market liquidity will be dependent on the perception of our operating business, among other
things. We will take certain steps including utilizing investor awareness campaigns and firms, press releases, road shows and conferences
to increase awareness of our business. Any steps that we might take to bring us to the awareness of investors may require that
we compensate consultants with cash and/or stock. There can be no assurance that there will be any awareness generated or the results
of any efforts will result in any impact on our trading volume. Consequently, investors may not be able to liquidate their investment
or liquidate it at a price that reflects the value of the business, and trading may be at an inflated price relative to the performance
of the Company due to, among other things, the availability of sellers of our shares.
If an active market
should develop, the price may be highly volatile. Because there is currently a low price for our shares of common stock, many brokerage
firms or clearing firms are not willing to effect transactions in the securities or accept our shares for deposit in an account.
Many lending institutions will not permit the use of low priced shares of common stock as collateral for any loans. Furthermore,
our securities are currently traded on the OTCQB where it is more difficult (1) to obtain accurate quotations, (2) to obtain coverage
for significant news events because major wire services generally do not publish press releases about these companies, and (3)
to obtain needed capital.
Our common stock may be deemed a
“penny stock,” which would make it more difficult for our investors to sell their shares.
Our common stock is
currently subject to the “penny stock” rules adopted under Section 15(g) of the Exchange Act. The penny stock rules
generally apply to companies whose common stock is not listed on The Nasdaq Stock Market or another national securities exchange
and trades at less than $4.00 per share, other than companies that have had average revenues of at least $6,000,000 for the last
three years or that have tangible net worth of at least $5,000,000 ($2,000,000 if the company has been operating for three or more
years). These rules require, among other things, that brokers who trade penny stock to persons other than “established customers”
complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning
trading in the security, including a risk disclosure document and quote information under certain circumstances. Many brokers have
decided not to trade penny stocks because of the requirements of the penny stock rules and, as a result, the number of broker-dealers
willing to act as market makers in these securities is limited. If we remain subject to the penny stock rules for any significant
period, it could have an adverse effect on the market, if any, for our securities. If our securities are subject to the penny stock
rules, investors will find it more difficult to dispose of our securities.
Offers or availability for sale of
a substantial number of shares of our common stock may cause the price of our common stock to decline.
If our stockholders
sell substantial amounts of our common stock in the public market upon the expiration of any statutory holding period under Rule
144, or shares issued upon the exercise of outstanding options or warrants, it could create a circumstance commonly referred to
as an “overhang” and, in anticipation of which, the market price of our common stock could fall. The existence of an
overhang, whether or not sales have occurred or are occurring, also could make more difficult our ability to raise additional financing
through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.
Sales of substantial
amounts of our common stock in the public market, or the perception that these sales could occur, could adversely affect the price
of our common stock and impair our ability to raise capital through the sale of shares.
Because we became public by means
of a reverse merger, we may not be able to attract the attention of major brokerage firms.
There may be risks
associated with us having become public through a “reverse merger.” Securities analysts of major brokerage firms may
not provide coverage of us since there is no incentive to brokerage firms to recommend the purchase of our common stock. No assurance
can be given that brokerage firms will, in the future, want to conduct any offerings on our behalf.
Any substantial sale of stock by
existing shareholders could depress the market value of our stock, thereby devaluing the market price and causing investors to
risk losing all or part of their investment.
Stockholders, including
our directors and officers hold a large number of our outstanding shares. We can make no prediction as to the effect, if any, that
sales of shares, or the availability of shares for future sale, will have on the prevailing market price of our shares of common
stock. Sales of substantial amounts of shares in the public market, or the perception that such sales could occur, could depress
prevailing market prices for the shares. Such sales may also make it more difficult for us to sell equity securities or equity-related
securities in the future at a time and price which it deems appropriate.
Our issuance of preferred stock in
the future may adversely affect the rights of our common stockholders
.
Our certificate of
incorporation permits us to issue up to 5,000,000 shares of preferred stock with such rights and preferences as the Board of Directors
may designate. As a result, our Board of Directors may authorize a series of preferred stock that would grant to preferred
stockholders’ preferential rights to our assets upon liquidation; the right to receive dividends before dividends become
payable to our common stockholders; the right to redemption of the preferred stock prior to the redemption of our common stock;
and super-voting rights to our preferred stockholders. To the extent that we designate and issue such a class or series of
preferred stock, the rights of our common stockholders may be impaired.
Risks Related to Our IP
Our Success May Depend on Our Ability
to Obtain and Protect the Proprietary Information on Which We Base Our UAV Products.
As we acquire companies
with intellectual property ("IP") that is important to the development of our UAV products, we will need to:
●
obtain valid and enforceable patents;
●
protect trade secrets; and
●
operate without infringing upon the proprietary rights of others.
We will be able to
protect our proprietary technology from unauthorized use by third parties only to the extent that such proprietary rights are covered
by valid and enforceable patents or are effectively maintained as trade secrets. Any non-confidential disclosure to or misappropriation
by third parties of our confidential or proprietary information could enable competitors to quickly duplicate or surpass our technological
achievements, thus eroding our competitive position in our market.
The patent application
process, also known as patent prosecution, is expensive and time-consuming, and we and our current or future licensors and licensees
may not be able to prepare, file and prosecute all necessary or desirable patent applications at a reasonable cost or in a timely
manner. It is also possible that we or our current licensors, or any future licensors or licensees, will fail to identify patentable
aspects of inventions made in the course of development and commercialization activities before it is too late to obtain patent
protection on them. Therefore, these and any of our patents and applications may not be prosecuted and enforced in a manner consistent
with the best interests of our business. It is possible that defects of form in the preparation or filing of our patents or patent
applications may exist, or may arise in the future, for example with respect to proper priority claims or inventorship. If we or
our current licensors or licensees, or any future licensors or licensees, fail to establish, maintain or protect such patents and
other intellectual property rights, such rights may be reduced or eliminated. If our current licensors or licensees, or any future
licensors or licensees, are not fully cooperative or disagree with us as to the prosecution, maintenance or enforcement of any
patent rights, such patent rights could be compromised. If there are material defects in the form or preparation of our patents
or patent applications, such patents or applications may be invalid and unenforceable. Any of these outcomes could impair our ability
to prevent competition from third parties, which may harm our business.
The patent applications
that we may own or license may fail to result in issued patents in the United States or in other countries. Even if patents do
issue on such patent applications, third parties may challenge the validity, enforceability or scope thereof, which may result
in such patents being narrowed, invalidated or held unenforceable. For example, U.S. patents can be challenged by any person before
the new USPTO Patent Trial and Appeals Board at any time within the one year period following that person’s receipt of an
allegation of infringement of the patents. Patents granted by the European Patent Office may be similarly opposed by any person
within nine months from the publication of the grant. Similar proceedings are available in other jurisdictions, and in the United
States, Europe and other jurisdictions third parties can raise questions of validity with a patent office even before a patent
has granted. Furthermore, even if they are unchallenged, our patents and patent applications may not adequately protect our intellectual
property or prevent others from designing around our claims. If the breadth or strength of protection provided by the patents and
patent applications we hold or pursue with respect to our product candidates is successfully challenged, then our ability to commercialize
such product candidates could be negatively affected, and we may face unexpected competition that could harm our business. Further,
if we encounter delays in our clinical trials, the period of time during which we or our collaborators could market our product
candidates under patent protection would be reduced.
The degree of future
protection of our proprietary rights is uncertain. Patent protection may be unavailable or severely limited in some cases and may
not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:
● we might not have been
the first to invent or the first to file the inventions covered by each of our pending patent applications and issued patents;
● others may be able to
make, use, sell, offer to sell or import products that are similar to our products or product candidates but that are not covered
by the claims of our patents; others may independently develop similar or alternative technologies or duplicate any of our technologies;
●
the proprietary rights of others may have an adverse effect on our business;
● any proprietary rights
we do obtain may not encompass commercially viable products, may not provide us with any competitive advantages or may be challenged
by third parties;
●
any patents we obtain or our in-licensed issued patents may not be valid or enforceable; or
● we may not develop additional
technologies or products that are patentable or suitable to maintain as trade secrets.
If we or our current
licensors or licensees, or any future licensors or licensees, fail to prosecute, maintain and enforce patent protection for our
product candidates, our ability to develop and commercialize our product candidates could be harmed and we might not be able to
prevent competitors from making, using and selling competing products. This failure to properly protect the intellectual property
rights relating to our product candidates could harm our business, financial condition and operating results. Moreover, our competitors
may independently develop equivalent knowledge, methods and know-how.
Even where laws provide
protection, costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights,
and the outcome of such litigation would be uncertain. If we or one of our collaborators were to initiate legal proceedings against
a third party to enforce a patent covering the product candidate, the defendant could assert an affirmative defense or counterclaim
that our patent is not infringed, invalid and/or unenforceable. In patent litigation in the United States, defendant defenses and
counterclaims alleging non-infringement, invalidity and/or unenforceability are commonplace. Grounds for a validity challenge could
be an alleged failure to meet any of several statutory requirements, including lack of novelty, anticipation or obviousness, and
lack of written description, definiteness or enablement. Patents may be unenforceable if someone connected with prosecution of
the patent withheld material information from the USPTO, or made a misleading statement, during prosecution. The outcomes of proceedings
involving assertions of invalidity and unenforceability are unpredictable. It is possible that prior art of which we and the patent
examiner were unaware during prosecution exists, which would render our patents invalid. Moreover, it is also possible that prior
art may exist that we are aware of, but that we do not believe are relevant to our current or future patents, that could nevertheless
be determined to render our patents invalid. If a defendant were to prevail on a legal assertion of invalidity and/or unenforceability
of our patents covering one of our product candidates, we would lose at least part, and perhaps all, of the patent protection on
such product candidate. Such a loss of patent protection would harm our business. Moreover, our competitors could counterclaim
in any suit to enforce our patents that we infringe their intellectual property. Furthermore, some of our competitors have substantially
greater intellectual property portfolios, and resources, than we do.
Our ability to stop
third parties from using our technology or making, using, selling, offering to sell or importing our products is dependent upon
the extent to which we have rights under valid and enforceable patents that cover these activities. If any patent we currently
or in the future may own or license is deemed not infringed, invalid or unenforceable, it could impact our commercial success.
We cannot predict the breadth of claims that may be issued from any patent applications we currently or may in the future own or
license from third parties.
To the extent that
consultants or key employees apply technological information independently developed by them or by others to our product candidates,
disputes may arise as to who has the proprietary rights to such information and product candidates, and certain of such disputes
may not be resolved in our favor. Consultants and key employees that work with our confidential and proprietary technologies are
required to assign all intellectual property rights in their inventions and discoveries created during the scope of their work
to our company. However, these consultants or key employees may terminate their relationship with us, and we cannot preclude them
indefinitely from dealing with our competitors.
If we are unable to prevent disclosure
of our trade secrets or other confidential information to third parties, our competitive position may be impaired.
We also may rely on
trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. Our
ability to stop third parties from obtaining the information or know-how necessary to make, use, sell, offer to sell or import
our products or practice our technology is dependent in part upon the extent to which we prevent disclosure of the trade secrets
that cover these activities. Trade secret rights can be lost through disclosure to third parties. Although we use reasonable efforts
to protect our trade secrets, our employees, consultants, contractors, outside scientific collaborators and other advisors may
unintentionally or willfully disclose our trade secrets to third parties, resulting in loss of trade secret protection. Moreover,
our competitors may independently develop equivalent knowledge, methods and know-how, which would not constitute a violation of
our trade secret rights. Enforcing a claim that a third party is engaged in the unlawful use of our trade secrets is expensive,
difficult and time consuming, and the outcome is unpredictable. In addition, recognition of rights in trade secrets and a willingness
to enforce trade secrets differs in certain jurisdictions.
If we are sued for infringing intellectual
property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation could harm
our business.
Our commercial success
depends significantly on our ability to operate without infringing, violating or misappropriating the patents and other proprietary
rights of third parties. Our own technologies we acquire or develop may infringe, violate or misappropriate the patents or other
proprietary rights of third parties, or we may be subject to third-party claims of such infringement. Numerous U.S. and foreign
issued patents and pending patent applications owned by third parties, exist in the fields in which we are developing our product
candidates. Because some patent applications may be maintained in secrecy until the patents are issued, because publication of
patent applications is often delayed, and because publications in the scientific literature often lag behind actual discoveries,
we cannot be certain that we were the first to invent the technology or that others have not filed patent applications for technology
covered by our pending applications. We may not be aware of patents that have already issued that a third party might assert are
infringed by our product candidates. It is also possible that patents of which we are aware, but which we do not believe are relevant
to our product candidates, could nevertheless be found to be infringed by our product candidates. Moreover, we may face patent
infringement claims from non-practicing entities that have no relevant product revenue and against whom our own patent portfolio
may thus have no deterrent effect. In the future, we may agree to indemnify our manufacturing partners against certain intellectual
property claims brought by third parties.
Intellectual property
litigation involves many risks and uncertainties, and there is no assurance that we will prevail in any lawsuit brought against
us. Third parties making claims against us for infringement, violation or misappropriation of their intellectual property rights
may seek and obtain injunctive or other equitable relief, which could effectively block our ability to further develop and commercialize
our product candidates. Further, if a patent infringement suit were brought against us, we could be forced to stop or delay research,
development, manufacturing or sales of the product or product candidate that is the subject of the suit. Defense of these claims,
regardless of their merit, would cause us to incur substantial expenses and, would be a substantial diversion of resources from
our business. In the event of a successful claim of any such infringement, violation or misappropriation, we may need to obtain
licenses from such third parties and we and our partners may be prevented from pursuing product development or commercialization
and/or may be required to pay damages. We cannot be certain that any licenses required under such patents or proprietary rights
would be made available to us, or that any offer to license would be made available to us on commercially reasonable terms. If
we cannot obtain such licenses, we and our collaborators may be restricted or prevented from manufacturing and selling products
employing our technology. These adverse results, if they occur, could adversely affect our business, results of operations and
prospects, and the value of our shares.
We may become involved in lawsuits
to protect or enforce our patents or other intellectual property, which could be expensive, time consuming and unsuccessful.
The defense and prosecution
of contractual or intellectual property lawsuits, USPTO interference or derivation proceedings, European Patent Office oppositions
and related legal and administrative proceedings in the United States, Europe and other countries, involve complex legal and factual
questions. As a result, such proceedings may be costly and time-consuming to pursue and their outcome is uncertain.
Litigation may be necessary to:
● protect and
enforce our patents and any future patents issuing on our patent applications;
● enforce or
clarify the terms of the licenses we have granted or may be granted in the future;
● protect and enforce trade
secrets, know-how and other proprietary rights that we own or have licensed, or may license in the future; or
● determine the enforceability,
scope and validity of the proprietary rights of third parties and defend against alleged patent infringement.
Competitors may infringe
our intellectual property. As a result, we may be required to file infringement claims to stop third-party infringement or unauthorized
use. This can be expensive, particularly for a company of our size, and time-consuming. In addition, in an infringement proceeding,
a court may decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the
technology at issue on the grounds that our patent claims do not cover its technology or that the factors necessary to grant an
injunction against an infringer are not satisfied. An adverse determination of any litigation or other proceedings could put one
or more of our patents at risk of being invalidated, interpreted narrowly, or amended such that they do not cover our product candidates.
Moreover, such adverse determinations could put our patent applications at risk of not issuing, or issuing with limited and potentially
inadequate scope to cover our product candidates or to prevent others from marketing similar products.
Interference, derivation
or other proceedings brought at the USPTO, may be necessary to determine the priority or patentability of inventions with respect
to our patent applications or those of our licensors or potential collaborators. Litigation or USPTO proceedings brought by us
may fail or may be invoked against us by third parties. Even if we are successful, domestic or foreign litigation or USPTO or foreign
patent office proceedings may result in substantial costs and distraction to our management. We may not be able, alone or with
our licensors or potential collaborators, to prevent misappropriation of our proprietary rights, particularly in countries where
the laws may not protect such rights as fully as in the United States.
Furthermore, because
of the substantial amount of discovery required in connection with intellectual property litigation or other proceedings, there
is a risk that some of our confidential information could be compromised by disclosure during this type of litigation or other
proceedings. In addition, during the course of this kind of litigation or proceedings, there could be public announcements of the
results of hearings, motions or other interim proceedings or developments or public access to related documents. If investors perceive
these results to be negative, the market price for our common stock could be significantly harmed.
Some of our competitors
may be able to sustain the costs of patent-related disputes, including patent litigation, more effectively than we can because
they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any
litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations.
We may not be able to enforce our
intellectual property rights throughout the world.
Filing, prosecuting
and defending patents on our product candidates in all countries throughout the world would be prohibitively expensive. The requirements
for patentability may differ in certain countries, particularly in developing countries. Moreover, our ability to protect and enforce
our intellectual property rights may be adversely affected by unforeseen changes in foreign intellectual property laws. Additionally,
laws of some countries outside of the United States do not afford intellectual property protection to the same extent as the laws
of the United States. Many companies have encountered significant problems in protecting and defending intellectual property rights
in certain foreign jurisdictions. The legal systems of some countries, particularly developing countries, do not favor the enforcement
of patents and other intellectual property rights. This could make it difficult for us to stop the infringement of our patents
or the misappropriation of our other intellectual property rights. For example, many foreign countries have compulsory licensing
laws under which a patent owner must grant licenses to third parties. Consequently, we may not be able to prevent third parties
from practicing our inventions in all countries outside the United States. Competitors may use our technologies in jurisdictions
where we have not obtained patent protection to develop their own products and, further, may export otherwise infringing products
to territories where we have patent protection, if our ability to enforce our patents to stop infringing activities is inadequate.
These products may compete with our products, and our patents or other intellectual property rights may not be effective or sufficient
to prevent them from competing.
Proceedings to enforce
our patent rights in foreign jurisdictions, whether or not successful, could result in substantial costs and divert our efforts
and resources from other aspects of our business. Furthermore, while we intend to protect our intellectual property rights in major
markets for our products, we cannot ensure that we will be able to initiate or maintain similar efforts in all jurisdictions in
which we may wish to market our products. Accordingly, our efforts to protect our intellectual property rights in such countries
may be inadequate.