Annual Report (10-k)

Date : 03/14/2017 @ 6:04AM
Source : Edgar (US Regulatory)
Stock : Intercloud Systems, Inc. (QB) (ICLD)
Quote : 0.0053  0.0011 (26.19%) @ 9:58AM

Annual Report (10-k)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2016

 

or

 

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

 

For the transition period from _________ to _________  

 

Commission file number: 000-32037

 

InterCloud Systems, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   65-0963722

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

1030 Broad Street

Suite 102

Shrewsbury, NJ 07702

(Address of Principal Executive Offices) (Zip Code)

 

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

 

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

 

Title of Each Class   Name of Each Exchange on Which Registered
Common Stock, $0.0001 par value   OTCQB Venture Market

Warrant to purchase Common Stock

(expiring on November 4, 2018)

   

 

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

None

 

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

 

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

 

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

 

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

 

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

 

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

 

Large accelerated filer   ☐ Accelerated filer   ☐

Non-accelerated filer   ☐

(Do not check if a smaller reporting company)

Smaller reporting company   ☒

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and ask price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $20,591,218 as of June 30, 2016, based on the $0.70 closing price per share of the Company’s common stock on such date.

 

The number of outstanding shares of the registrant’s common stock on March 7, 2017 was 487,892,651. 

 

 

 

 

 

 

FORM 10-K ANNUAL REPORT

FISCAL YEAR ENDED DECEMBER 31, 2016

 

TABLE OF CONTENTS

 

    PAGE
     
PART I    
Item 1. Business. 1
Item 1A. Risk Factors. 8
Item 1B. Unresolved Staff Comments. 27
Item 2. Properties. 27
Item 3. Legal Proceedings. 28
Item 4. Mine Safety Disclosures. 29
     
PART II    
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 30
Item 6. Selected Financial Data 32
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 33
Item 7A. Quantitative and Qualitative Disclosures about Market Risk. 53
Item 8. Financial Statements and Supplementary Data. 53
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 53
Item 9A. Controls and Procedures. 53
Item 9B. Other Information. 54
     
PART III    
Item 10. Directors, Executive Officers and Corporate Governance. 55
Item 11. Executive Compensation. 57
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters. 63
Item 13. Certain Relationships and Related Transactions, and Director Independence. 64
Item 14. Principal Accountant Fees and Services. 64
     
PART IV    
Item 15. Exhibits, Financial Statement Schedules. 65
     
SIGNATURES 66
EXHIBIT INDEX 67
FINANCIAL STATEMENTS F-1

 

 

 

 

FORWARD-LOOKING STATEMENTS

 

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

 

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

 

  our ability to successfully execute our business strategies;

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

  changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural or man-made disasters;
     
  we may incur goodwill and intangible asset impairment charges, which could harm our profitability; and

 

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

 

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

 

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

 

OTHER PERTINENT INFORMATION

 

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

 

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

 

 

 

 

PART I

 

ITEM 1. BUSINESS

 

Overview

 

InterCloud Systems, Inc. is a provider of networking orchestration and automation, for the Internet of things (IOT), software-defined networking (SDN) and network function virtualization (NFV) environments to the telecommunications service provider (carrier) and corporate enterprise markets. Our managed services solutions offer enterprise and service-provider customers the opportunity to adopt an operational expense model by outsourcing cloud deployment and management to our Company rather than the capital expense model that has dominated in recent decades in IT infrastructure management. Our professional services group offers a broad range of solutions to enterprise and service provider customers, including application development teams, analytics, project management, program management, unified communications, network management and field support services on a short and long-term basis. Our applications and infrastructure division offers enterprise and service provider customers specialty contracting services, including engineering, design, installation and maintenance services, that support the build-out and operation of some of the most advanced small cell, Wi-Fi and distributed antenna system (DAS) networks. We believe the migration of these complex networks from proprietary hardware-based solutions to software-defined networks and cloud-based solutions provides our company a significant opportunity as we are one of only a few industry competitors that can span across both the legacy and next-generation networks that are actively being designed and deployed in the marketplace. We also believe we are in a position to assist our customers by offering competitive cloud and SDN solutions from a single source, while also maintaining our customers’ legacy hardware-based solutions.

 

We provide the following categories of offerings to our customers:

 

   Managed Services . Our managed services offering is built around traditional IT managed services and “private cloud in the box” applications services. Our DPoD private cloud platform offers enterprise customers, carriers, and resellers ability to prepackage a “hyper-converged” open source private cloud environment in an opex model rather than the legacy hardware model. Our DPoD private cloud offers orchestration, virtualized compute, virtualized network functions, and virtualized storage. This platform is offered in a multi-year contract, managed services format. We believe DPoD private managed cloud services greatly accelerates our customer’s ability to move production applications seamlessly to a fully-virtualized environment without any vendor lock in from equipment manufacturers as well as lowers cost and decreases their time to market to deliver new applications to their own customers in a secure private environment. Our experience in system integration and solutions-centric services helps our customers quickly to integrate and adopt cloud-based managed services. In addition, our managed-services offerings include network management, 24x7x365 monitoring, security monitoring, storage and backup services.

 

  Applications and Infrastructure. We provide an array of applications and services throughout North America and internationally.  We also offer structured cabling and other field installations. In addition, we design, engineer, install and maintain various types of Wi-Fi and wide-area networks, DAS networks, and small cell distribution networks for incumbent local exchange carriers (ILECs), telecommunications original equipment manufacturers (OEMs), cable broadband multiple system operators (MSOs) and enterprise customers. Our services and applications teams support the deployment of new networks and technologies, as well as expand and maintain existing networks. We also design, install and maintain hardware solutions for the leading OEMs that support voice, data and optical networks.

 

  Professional Services. We provide consulting and professional staffing solutions to the service-provider and enterprise market in support of all facets of IT and next-generation networks, including project management, network implementation, network installation, network upgrades, rebuilds, maintenance and consulting services. We leverage our international recruiting database, which includes more than 70,000 professionals, for the rapid deployment of our professional services. On a weekly basis, we deploy hundreds of telecommunications professionals in support of our worldwide customers. , including SDN training, SDN software development and integration, vertical network function (VNF) validation in a multi-vendor environment, unified communications, interactive voice response (IVR) and SIP-based call centers.

 

  1  

 

 

Our Operating Units

 

Through a series of acquisitions, we have expanded our service offerings and geographic reach over the past four years. Our company is comprised of the following operating units:

 

  Integration Partners-NY Corporation. Integration Partners-NY Corporation (“IPC”), is a full-service voice and data network engineering firm based in New York that serves both corporate enterprises and telecommunications service providers. IPC supports the cloud and managed services aspect of our business and expands our systems integration and applications capabilities.

 

  ADEX Corporation. ADEX Corporation (“ADEX”) is an Atlanta-based provider of engineering and installation services and staffing solutions and other services to the telecommunications industry. ADEX’s managed solutions diversifies our ability to service our customers domestically and internationally throughout the project lifecycle.
     
  AW Solutions, Inc . AW Solutions, Inc. and AW Solutions Puerto Rico, LLC (collectively, “AW Solutions”), are professional, multi-service line, telecommunications infrastructure companies that provide outsourced services to the wireless and wireline industry. AW Solution’s services include network systems design, architectural and engineering services, program management and other technical services. Through Logical Link, an Outside Plant (OSP) engineering company, AW Solutions provides in-field design and drafting of wireline, fiber and DAS deployments. Logical Link also performs construction and installation through subcontractors.

 

  T N S, Inc. T N S, Inc. (“T N S”) is a Chicago-based structured cabling company and DAS installer that supports voice, data, video, security and multimedia systems within commercial office buildings, multi-building campus environments, high-rise buildings, data centers and other structures. T N S extends our geographic reach to the Midwest area and our client reach to end-users, such as multinational corporations, universities, school districts and other large organizations that have significant ongoing next generation network needs.
     
  Rives-Monteiro Engineering LLC and Rives-Monteiro Leasing, LLC. Rives-Monteiro Engineering, LLC (“RM Engineering”) is a cable firm based in Tuscaloosa, Alabama that performs engineering services in the Southeastern United States and internationally, and Rives-Monteiro Leasing, LLC (“RM Leasing”, and together with RM Engineering, “Rives-Monteiro”), is an equipment provider for cable-engineering services firms. RM Engineering provides services to customers located in the United States and Latin America.

 

  Tropical Communications, Inc. Tropical Communications, Inc. (“Tropical”) is a Miami-based provider of structured cabling and DAS systems for commercial and governmental entities in the Southeast.

 

Our Industry

 

Advances in technology architectures have supported the rise of cloud computing, which enables the delivery of a wide variety of cloud-based services. Today, mission-critical applications can be delivered reliably, securely and cost-effectively to our customers over the internet without the need to purchase supporting hardware, software or ongoing maintenance. The lower total cost of ownership, better functionality and flexibility of cloud applications represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting cloud services to rapidly deploy and integrate applications without building out their own expensive infrastructure and to minimize the growth of their own IT departments and create business agility by taking advantage of accelerated time-to-market dynamics.

 

Spending on public cloud services is expected to increase sharply this year and through 2019, according to analysts with International Data Corporation, a leading global market intelligence firm (“IDC”) and Gartner, Inc., a leading IT research and advisory company (“Gartner”). In a report dated January 25, 2016, Gartner analysts projected that the global public cloud services market will increase 16.5 percent last year compared with 2015 - to $204 billion.

 

  2  

 

 

According to the U.S. National Institute of Standards and Technology, or the NIST, cloud computing is on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management and effort and service provider interaction. The NIST has identified five essential characteristics of cloud computing:

 

  on-demand service;

 

  broad network access;

 

  resource pooling;

 

  rapid elasticity; and

 

  measured service

  

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

 

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

 

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

 

Our Competitive Strengths

 

During 2016, we began delivering DPoD, a hyper-converged private/hybrid cloud solution. Our DPoD product offering provides all of the attributes of a public cloud offering, including reduced capital expenditures for our customers and greater elasticity and scalability in a dedicated private cloud environment. DPoD can be deployed within our data centers or on customer premises. In addition to compute and storage resources, DPoD is fully-enabled with SDN and NFV to leverage software-based network appliances. DPoD is a ‘cloud in a box,’ that brings everything together, including a full multi-vendor professional services experience. The DPoD provides the client with a completely secure, private cloud solution that can be leveraged for nearly any business application. 

 

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

 

  Service Provider Relationships . We have established relationships with many leading wireless and wireline telecommunications providers, cable broadband MSOs, OEMs and others. Our current customers include Ericsson Inc., Verizon Communications Inc., Alcatel-Lucent USA Inc., Century Link, Inc., AT&T Inc. and Hotwire Communications.

 

  3  

 

 

  Long-Term Master Service Agreements . We have over 30 master service agreements with service providers and OEMs. Our relationships with our customers and existing master service agreements position us to continue to capture existing and emerging opportunities, both domestically and internationally. We believe the barriers are extremely high for new entrants to obtain master service agreements with service providers and OEMs unless there are established relationships and a proven ability to execute.

 

   Professional Services

 

  Engineering talents . Our geographical reach and vast engineering talents enable our customers to take advantage of our end-to-end solutions and one-stop shopping.

 

  Proven Ability to Recruit, Manage and Retain High-Quality Personnel. Our ability to recruit, manage and retain skilled labor is a critical advantage in an industry in which a shortage of skilled labor is often a key limitation for our customers and competitors alike. We own and operate an actively-maintained database of more than 70,000 telecom and IT personnel. We also employ highly-skilled recruiters and utilize an electronic hiring process that we believe expedites deployment of personnel and reduces costs. We believe this access to a skilled labor pool gives us a competitive edge over our competitors as we continue to expand.
     
  Strong Senior Management Team with Proven Ability to Execute. Our highly-experienced management team has deep industry knowledge and brings an average of over 25 years of individual experience across a broad range of disciplines. We believe our senior management team is a key driver of our success and is well-positioned to execute our strategy.

 

Our Growth Strategy

 

Under the leadership of our senior management team, we intend to build our sales, marketing and operations groups to support our rapid growth while focusing on increasing operating margins. While organic growth will be a main focus in driving our business forward, acquisitions will play a strategic role in augmenting existing product and service lines and cross-selling opportunities. We are pursuing several strategies, including:

 

  Expand Our Cloud-Based Service Offerings . We are building a company that can manage the existing network infrastructures of the largest domestic and international corporations and service providers while also delivering a broad range of enterprise and carrier-grade cloud orchestration platforms and solutions. We believe the ability to provide such services is a critical differentiator as we already have relationships with many potential customers by offering services through our three operating divisions -- applications and infrastructure, professional services, and managed services. Each of our three operating divisions intends to continue to expand by offering additional cloud services, such as cloud management of Wi-Fi and DAS networks, on a virtualized wireless controller running on our cloud rather than installed throughout a corporate network, allowing better controls and cost savings for clients. We recently expanded the service offerings of our professional services group to include services to support the roll-out of NFV, SDN and private cloud solutions and to market such services to both the service provider and enterprise markets.
     
  Grow Revenues and Market Share through Selective Acquisitions. We plan to continue to acquire private companies that enhance our earnings and offer complementary services or expand our geographic reach. We believe such acquisitions will help us to accelerate our revenue growth, leverage our existing strengths, and capture and retain more work in-house as a prime contractor for our clients, thereby contributing to our profitability. We also believe that increased scale will enable us to bid and take on larger contracts. We believe there are many potential acquisition candidates in the high-growth cloud computing space, the fragmented professional services markets, and in the applications and infrastructure arena. 

 

  Aggressively Expand Our Organic Growth Initiatives. Our customers include many leading wireless and wireline telecommunications providers, cable broadband MSOs, OEMs and enterprise customers. As we have expanded the breadth of our service offerings through both organic growth and selective acquisitions, we believe we have opportunities to expand revenues with our existing clients by marketing DPoD private cloud, NFV and SDN service offerings to them, as well as by extending services to existing customers in new geographies.
     
  Expand Our Relationships with New Service Providers. We plan to expand new relationships with cable broadband providers, competitive local exchange carriers (CLECs), integrated communication providers (ICs), competitive access providers (CAPs), network access point providers (NAPs) and integrated communications providers (ICPs). We believe that the business model for the expansion of these relationships, leveraging our core strength and array of service solutions, will support our business model for organic growth.

 

  Increase Operating Margins by Leveraging Operating Efficiencies . We believe that by centralizing administrative functions, consolidating insurance coverage and eliminating redundancies across our newly-acquired businesses, we will be positioned to offer more integrated end-to-end solutions and improve operating margins.

 

  4  

 

 

Our Services

 

We are a provider of networking orchestration and automation solutions for IOT, SDN and NFV and its corresponding professional services. We provide cloud- and managed-service-based platforms, professional services, applications and infrastructure to both the telecommunications industry and corporate enterprises. Our cloud-based and managed services and our engineering, design, construction, installation, maintenance and project staffing services support the build-out, maintenance, upgrade and operation of some of the most advanced fiber optic, Ethernet, copper, wireless and satellite networks. Our breadth of services enables our customers to selectively augment existing services or to outsource entire projects or operational functions. We divide our service offerings into the following categories of services:

 

   Managed Services. We provide integrated cloud-based managed solutions that allow organizations around the globe to migrate and integrate their applications into a public, private or hybrid cloud environment. We combine engineering expertise with white glove service and support to maintain and support these complex global networks. We provide traditional hardware solutions and applications, cloud-based managed solutions and professional staffing services, which work as a seamless extension of a telecommunications service provider or enterprise end user. We provide industry leading vendor-independent, multi-vendor Virtual Network Function validation services. Through third-party VNF validation, service providers know in advance that virtual network functions are working together in a specific, dynamic, environment.
     
 

Applications and Infrastructure. We provide an array of applications and services throughout North America and internationally, including SDN training, SDN software development and integration, VNF validation in a multi-vendor environment, unified communications, interactive voice response (IVR) and SIP-based call centers. We also offer structured cabling and other field installations. In addition, we design, engineer, install and maintain various types of Wi-Fi and wide-area networks, DAS networks, and small cell distribution networks for incumbent local exchange carriers (ILECs), telecommunications original equipment manufacturers (OEMs), cable broadband multiple system operators (MSOs) and enterprise customers. Our services and applications teams support the deployment of new networks and technologies, as well as expand and maintain existing networks. We also design, install and maintain hardware solutions for the leading OEMs that support voice, data and optical networks.

 

Network Function Virtualization. To manage help manage NFV, in 2015 we developed NFVGrid, an NFV orchestration platform, as part of our Network-as-a-Service (NaaS) offering. This software platform helps to manage VNFs, instantiating, monitoring, repairing them and handling billing for the services.

 

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

 

  Silver validation. This first tier of qualification says that a NFV successfully operates in the Cloud/SDN environment, which includes the validation of basic NFV functionality running on fully virtualized SDN-enabled Cloud platform.
  Gold validation. This tier of qualification includes everything in the Silver Validation, plus guaranteed performance testing of scalability (both up and down) to address the demand volatility that CSPs face. Gold validation is done in compliance with OPNFV testing requirements.
  Platinum validation. This is the highest level of validation. It includes everything in the Gold Validation and guarantees that the NFV will remain functional as software and hardware continue to update or change.

 

  Applications. We apply our expertise in networking, converged communications, security, data center solutions and other technologies utilizing our skills in consulting, integration and managed services to create customized solutions for our enterprise customers. We provide applications for managed data, converged services (single and multiple site), voice recognition, session initiation protocol (SIP trunking)Voice Over IP, streaming media and unified communication (UC)) collocation services and others. These applications can be serviced at our customers’ premises or in our cloud solutions.

  

 

Professional Services. We provide consulting and professional staffing solutions to the service-provider and enterprise market in support of all facets of IT and next-generation networks, including project management, network implementation, network installation, network upgrades, rebuilds, maintenance and consulting services. Our global professional services organization offers on-customer-premise and off-premise IT and cloud solutions consulting, design, engineering, integration, implementation and ongoing support of all solutions offered by our company.  We leverage our international recruiting database, which includes more than 70,000 professionals, for the rapid deployment of our professional services. On a weekly basis, we deploy hundreds of telecommunications professionals in support of our worldwide customers. We believe our global footprint is a differentiating factor for national and international-based customers needing a broad range of IT/Cloud technical expertise for management of their legacy and next generation IT networks. 

 

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Customers

 

Our customers include many Fortune 1000 enterprises, wireless and wireline service providers, cable broadband MSOs and telecommunications OEMs. Our current service provider and OEM customers include leading telecommunications companies, such as Ericsson, Inc., Verizon Communications, Sprint Nextel Corporation and AT&T.

 

Our top four customers, Crown Castle, Uline, Ericsson, Inc., and Verizon, accounted for approximately 26% of our total revenues from continuing operations in the year ended December 31, 2016. Our top four customers, Ericsson, Inc., Crown Castle, ULine and NX Utilities, accounted for approximately 33% of our total revenues from continuing operations in the year ended December 31, 2015. No customer accounted for 10% or more of our revenues for the year ended December 31, 2016. Ericsson, Inc. and its affiliates, as an OEM provider for seven different carrier projects, was the only customer to account for 10% or more of our revenues for the year ended December 31, 2015, accounting for approximately 14% of our total revenues.

 

A substantial portion of our revenue is derived from work performed under multi-year master service agreements and multi-year service contracts. We have entered into master service agreements, or MSAs, with numerous service providers and OEMs, and generally have multiple agreements with each of our customers. MSAs are awarded primarily through a competitive bidding process based on the depth of our service offerings, experience and capacity. MSAs generally contain customer-specified service requirements, such as discrete pricing for individual tasks, but do not require our customers to purchase a minimum amount of services. To the extent that such contracts specify exclusivity, there are often a number of exceptions, including the ability of the customer to issue work orders valued above a specified dollar amount to other service providers, perform work with the customer’s own employees and use other service providers. Most of our MSAs may be cancelled by our customers upon minimum notice (typically 60 days), regardless of whether we are then in default. In addition, many of these contracts permit cancellation of particular purchase orders or statements of work without any prior notice. Our managed service offerings are typically sold under multi-year agreements and provide the customers with service level commitments. This is one of the fastest growing portions of our business.

 

  6  

 

 

Suppliers and Vendors

 

We have supply agreements with major technology vendors, such as Ericsson, Avaya, Aruba, Juniper, F5, Microsoft, Ciena, Citrix and Cisco Systems. However, for a majority of the professional services we perform, our customers supply the necessary materials. We expect to continue to further develop our relationships with our technology vendors and to broaden our scope of work with each of our partners. In many cases, our relationships with our partners have extended for over a decade, which we attribute to our commitment to excellence. It is our objective to selectively expand our partnerships moving forward in order to expand our service offerings. 

 

Competition

 

We provide cloud and managed services, professional services, and infrastructure and applications to the enterprise and service provider markets globally. Our markets are highly fragmented and the business is characterized by a large number of participants, including several large companies, as well as a significant number of small, privately-held, local competitors.

 

Our current and potential larger competitors include Amazon.com, Inc., Arrow Electronics, Inc., Black Box Corporation, CenturyLink Technology Solutions (formerly Savvis), Dimension Data, Dycom Industries, Inc., Goodman Networks, Inc., Hewlett Packard Company, Rackspace Hosting, Inc., SoftLayer Technologies, Inc., Tech Mahindra Limited, TeleTech Holdings, Inc. and Volt Information Sciences, Inc. A significant portion of our services revenue is currently derived from MSAs and price is often an important factor in awarding such agreements. Accordingly, our competitors may underbid us if they elect to price their services aggressively to procure such business. Our competitors may also develop the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services, and we may not be able to maintain or enhance our competitive position. The principal competitive factors for our professional services include geographic presence, breadth of service offerings, technical skills, licensing price, quality of service and industry reputation. We believe we compete favorably with our competitors on the basis of these factors.

 

Safety and Risk Management

 

We require our employees to participate in internal training and service programs from time to time relevant to their employment and to complete any training programs required by law. We review accidents and claims from our operations, examine trends and implement changes in procedures to address safety issues. Claims arising in our business generally include workers’ compensation claims, various general liability and damage claims, and claims related to vehicle accidents, including personal injury and property damage. We insure against the risk of loss arising from our operations up to certain deductible limits in substantially all of the states in which we operate. In addition, we retain risk of loss, up to certain limits, under our employee group health plan. We evaluate our insurance requirements on an ongoing basis to help ensure we maintain adequate levels of coverage.

 

We carefully monitor claims and actively participate with our insurers in determining claims estimates and adjustments. The estimated costs of claims are accrued as liabilities, and include estimates for claims incurred but not reported. Due to fluctuations in our loss experience from year to year, insurance accruals have varied and can affect the consistency of our operating margins. If we experience insurance claims in excess of our umbrella coverage limit, our business could be materially and adversely affected.

 

Employees

 

As of December 31, 2016, we had 409 full-time employees and 13 part-time employees, of whom 53 were in administration and corporate management, 8 were accounting personnel, 36 were sales personnel and 325 were technical and project managerial personnel. 

 

In general, the number of our employees varies according to the level of our work in progress. We maintain a core of technical and managerial personnel to supervise all projects and add employees as needed to complete specific projects. Because we also provide project staffing, we are well-positioned to respond to changes in our staffing needs.

 

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Environmental Matters

 

A portion of the work we perform is associated with the underground networks of our customers. As a result, we are potentially subject to material liabilities related to encountering underground objects that may cause the release of hazardous materials or substances. We are subject to federal, state and local environmental laws and regulations, including those regarding the removal and remediation of hazardous substances and waste. These laws and regulations can impose significant fines and criminal sanctions for violations. Costs associated with the discharge of hazardous substances may include clean-up costs and related damages or liabilities. These costs could be significant and could adversely affect our results of operations and cash flows.

 

Regulation

 

Our operations are subject to various federal, state, local and international laws and regulations, including licensing, permitting and inspection requirements applicable to electricians and engineers; building codes; permitting and inspection requirements applicable to construction projects; regulations relating to worker safety and environmental protection; telecommunication regulations affecting our fiber optic licensing business; labor and employment laws; and laws governing advertising.

 

ITEM 1A. RISK FACTORS

 

Investing in our securities involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this report before purchasing our securities. If any of the following risks occur, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that case, the market price of our common stock could decline, and you could lose some or all of your investment.

 

Risks Related to Our Financial Results and Financing Plans

 

We have a history of losses and may continue to incur losses in the future.

 

We have a history of losses and may continue to incur losses in the future, which could negatively impact the trading value of our common stock. We incurred losses from operations of $18.6 million and $25.9 million in the years ended December 31, 2016 and 2015, respectively. In addition, we incurred a net loss attributable to common stockholders of $26.5 million and $65.8 million in the years ended December 31, 2016 and 2015, respectively. We may continue to incur operating and net losses in future periods. These losses may increase and we may never achieve profitability for a variety of reasons, including increased competition, decreased growth in the unified communications industry and other factors described elsewhere in this “Risk Factors” section. If we cannot achieve sustained profitability, our stockholders may lose all or a portion of their investment in our company.

 

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

 

Our total revenues from continuing operations increased to $77.8 million in the year ended December 31, 2016 from $74.1 million in the year ended December 31, 2015, respectively. In order to become profitable and maintain our profitability, we must, among other things, continue to increase our revenues. We may be unable to sustain our revenue levels, particularly if we are unable to develop and market our applications and infrastructure or professional services segments, increase our sales to existing customers or develop new customers. However, even if our revenues grow, they may not be sufficient to exceed increases in our operating expenses or to enable us to achieve or sustain profitability. 

 

Our inability to obtain additional capital may prevent us from completing our acquisition strategy and successfully operating our business; however, additional financings may subject our existing stockholders to substantial dilution.

 

Until we can generate a sufficient amount of revenue, if ever, we expect to finance our anticipated future strategic acquisitions through public or private equity offerings or debt financings. Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available, we may be required to delay, reduce the scope of, or eliminate one or more strategic acquisitions or business plans. In addition, we could be forced to discontinue product development and reduce or forego attractive business opportunities. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience significant dilution. In addition, debt financing, if available, may involve restrictive covenants. We may seek to access the public or private capital markets whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Our access to the financial markets and the pricing and terms we receive in the financial markets could be adversely impacted by various factors, including changes in financial markets and interest rates.

 

Our forecasts regarding the sufficiency of our financial resources to support our current and planned operations are forward-looking statements and involve significant risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed elsewhere in this “Risk Factors” section. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Our future funding requirements will depend on many factors, including, but not limited to, the costs and timing of our future acquisitions.

 

Our substantial indebtedness could adversely affect our business, financial condition and results of operations and our ability to meet our payment obligations.

 

As of December 31, 2016, we had total indebtedness of approximately $47.6 million, consisting of $28.2 million of convertible debentures and notes payable, $19.3 million of related-party indebtedness, and $0.1 million of bank debt. Our substantial indebtedness could have important consequences to our stockholders. For example, it could:

 

  increase our vulnerability to and limit our flexibility in planning for, or reacting to, changes in our business;

 

  place us at a competitive disadvantage compared to our competitors that have less debt;

 

  limit our ability to borrow additional funds, dispose of assets, pay dividends and make certain investments; and

 

  make us more vulnerable to a general economic downturn than a company that is less leveraged.

 

A high level of indebtedness would increase the risk that we may default on our debt obligations. Our ability to meet our debt obligations and to reduce our level of indebtedness will depend on our future performance. General economic conditions and financial, business and other factors affect our operations and our future performance. Many of these factors are beyond our control. We may not be able to generate sufficient cash flows to pay the interest on our debt and future working capital, borrowings or equity financing may not be available to pay or refinance such debt. Factors that will affect our ability to raise cash through an offering of our capital stock or a refinancing of our debt include our ability to access the public equity and debt markets, financial market conditions, the value of our assets and our performance at the time we need capital.

 

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

 

We experienced rapid and significant expansion in the four years ended December 31, 2016 due to a series of strategic acquisitions. We acquired three companies in 2012, one company in 2013, three companies in 2014 and two companies in 2016. We also disposed of one company in 2015, three companies in 2016 and one company in 2017. As a result of our recent acquisitions, our financial results are heavily influenced by the application of the acquisition method of accounting. The acquisition method of accounting requires management to make assumptions regarding the assets purchased and liabilities assumed to determine their fair market value. If our assumptions are incorrect, any resulting change or modification could adversely affect our financial conditions and/or results of operations.

 

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Further, our limited operating history as an integrated company, combined with our short history operating as providers of staffing and cloud-based services, may not provide an adequate basis for investors to evaluate our business, financial condition, results of operations and prospects, and makes accurate financial forecasting difficult for us. Because we operate in the rapidly-evolving IT and telecommunications markets and because our business is rapidly changing due to a series of acquisitions and divestitures, we may have difficulty in engaging in effective business and financial planning. It may also be difficult for us to evaluate trends that may affect our business and whether our expansion may be profitable. Thus, any predictions about our future revenue and expenses may not be as accurate as they would be if we had a longer operating history or operated in a more predictable market.

 

Risks Related to Our Business

 

A failure to successfully execute our strategy of acquiring other businesses to grow our company could adversely affect our business, financial condition, results of operations and prospects.

 

We intend to continue pursuing growth through the acquisition of companies or assets to expand our product offerings, project skill-sets and capabilities, enlarge our geographic markets, add experienced management and increase critical mass to enable us to bid on larger contracts. However, we may be unable to find suitable acquisition candidates or acquisition financing or to complete acquisitions on favorable terms, if at all. Moreover, any completed acquisition may not result in the intended benefits. For example, while the historical financial and operating performance of an acquisition target are among the criteria we evaluate in determining which acquisition targets we will pursue, there can be no assurance that any business or assets we acquire will continue to perform in accordance with past practices or will achieve financial or operating results that are consistent with or exceed past results. Any such failure could adversely affect our business, financial condition or results of operations. In addition, any completed acquisition may not result in the intended benefits for other reasons and our acquisitions will involve a number of other risks, including:

 

  We may have difficulty integrating the acquired companies;

 

  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 not realize the anticipated cost savings or other financial benefits we anticipated;

 

  We may have difficulty applying our expertise in one market to another market;

 

  We may have difficulty retaining or hiring key personnel, customers and suppliers to maintain expanded operations;

 

  Our internal resources may not be adequate to support our operations as we expand, particularly if we are awarded a significant number of contracts in a short time period;

 

  We may have difficulty retaining and obtaining required regulatory approvals, licenses and permits;

 

  We may not be able to obtain additional equity or debt financing on terms acceptable to us or at all, and any such financing could result in dilution to our stockholders, impact our ability to service our debt within the scheduled repayment terms and include covenants or other restrictions that would impede our ability to manage our operations;

 

  We may have failed to, or be unable to, discover liabilities of the acquired companies during the course of performing our due diligence; and

 

  We may be required to record additional goodwill as a result of an acquisition, which will reduce our tangible net worth.

 

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Any of these risks could prevent us from executing our acquisition growth strategy, which could adversely affect our business, financial condition, results of operations and prospects.

 

Our sales are dependent on continued innovations in hardware, software and services offerings by our vendor partners and the competitiveness of their offerings, and our ability to partner with new and emerging technology providers.

 

The technology industry is characterized by rapid innovation and the frequent introduction of new and enhanced hardware, software and services offerings, such as cloud-based solutions, including SaaS, IaaS and PaaS, and the Internet of Things (“IoT”). We have been and will continue to be dependent on innovations in hardware, software and services offerings, as well as the acceptance of those innovations by customers. A decrease in the rate of innovation, or the lack of acceptance of innovations by customers, could have an adverse effect on our business, results of operations or cash flows.

  

In addition, if we are unable to keep up with changes in technology and new hardware, software and services offerings, for example by providing the appropriate training to our account managers, sales technology specialists and engineers to enable them to effectively sell and deliver such new offerings to customers, our business, results of operations or cash flows could be adversely affected.

 

We also are dependent upon our vendor partners for the development and marketing of hardware, software and services to compete effectively with hardware, software and services of vendors whose products and services we do not currently offer or that we are not authorized to offer in one or more customer channels. In addition, our success is dependent on our ability to develop relationships with and sell hardware, software and services from new emerging vendors and vendors that we have not historically represented in the marketplace. To the extent that a vendor’s offering that is highly in demand is not available to us for resale in one or more customer channels, and there is not a competitive offering from another vendor that we are authorized to sell in such customer channels, or we are unable to develop relationships with new technology providers or companies that we have not historically represented, our business, results of operations or cash flows could be adversely impacted.

 

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

 

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

 

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

 

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

 

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

 

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

 

In addition, we may face additional competition from those systems integrators and third-party software providers who develop, acquire or market products competitive with our products. Our strategy of marketing our products directly to customers and indirectly through systems integrators and other technology companies may result in distribution channel conflicts. Our direct sales efforts may compete with those of our indirect channels and, to the extent different systems integrators target the same customers, systems integrators may also come into conflict with each other. Any channel conflicts that develop may have a material adverse effect on our relationships with systems integrators or hurt our ability to attract new systems integrators to market our products.

 

We maintain a strategic relationship with Juniper Networks under which we have undertaken to integrate our respective products and to market the Juniper Networks versions of our products in preference to other versions. Our license revenue may be affected by the success and acceptance of the Juniper Networks products relative to those of Juniper Networks’ competitors. We may experience difficulties in gaining market acceptance of the Juniper Networks version of our products, and difficulties in integrating and coordinating our products and sales efforts with those of Juniper Networks. In addition, customers or prospects that have not adopted the Juniper Networks technology platform may view our alliance with Juniper Networks negatively, and competitive alliances may emerge among other companies that are more attractive to our customers and prospective customers.

 

If we do not accurately estimate the overall costs when we bid on a contract that is awarded to us, we may achieve a lower than anticipated profit or incur a loss on the contract.

 

A significant portion of our revenues from our engineering and professional services offerings are derived from fixed unit price contracts that require us to perform the contract for a fixed unit price irrespective of our actual costs. We bid for these contracts based on our estimates of overall costs, but cost overruns may cause us to incur losses. The costs incurred and any net profit realized on such contracts can vary, sometimes substantially, from the original projections due to a variety of factors, including, but not limited to:

 

  onsite conditions that differ from those assumed in the original bid;

 

  delays in project starts or completion;

 

  fluctuations in the cost of materials to perform under a contract;

 

  contract modifications creating unanticipated costs not covered by change orders;

 

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  availability and skill level of workers in the geographic location of a project;

 

  our suppliers’ or subcontractors’ failure to perform due to various reasons, including bankruptcy;

 

  fraud or theft committed by our employees;

 

  citations or fines issued by any governmental authority;

 

  difficulties in obtaining required governmental permits or approvals or performance bonds;

 

  changes in applicable laws and regulations; and

 

  claims or demands from third parties alleging damages arising from our work or from the project of which our work is a part.

 

These factors may cause actual reduced profitability or losses on projects, which could adversely affect our business, financial condition, results of operations and prospects.

 

Our contracts may require us to perform extra or change order work, which can result in disputes and adversely affect our business, financial condition, results of operations and prospects.

 

Our contracts generally require us to perform extra or change order work as directed by the customer, even if the customer has not agreed in advance on the scope or price of the extra work to be performed. This process may result in disputes over whether the work performed is beyond the scope of the work included in the original project plans and specifications or, if the customer agrees that the work performed qualifies as extra work, the price that the customer is willing to pay for the extra work. Even when the customer agrees to pay for the extra work, we may be required to fund the cost of such work for a lengthy period of time until the change order is approved by the customer and we are paid by the customer.

 

To the extent that actual recoveries with respect to change orders or amounts subject to contract disputes or claims are less than the estimates used in our financial statements, the amount of any shortfall will reduce our future revenues and profits, and this could adversely affect our reported working capital and results of operations. In addition, any delay caused by the extra work may adversely impact the timely scheduling of other project work and our ability to meet specified contract milestone dates.

 

We derive a significant portion of our revenue from a few customers and the loss of one of these customers, or a reduction in their demand for our services, could adversely affect our business, financial condition, results of operations and prospects.

 

Our customer base is highly concentrated. Due to the size and nature of our contracts, one or a few customers have represented a substantial portion of our consolidated revenues and gross profits in any one year or over a period of several consecutive years. No customer accounted for 10% or more of our total revenues for the year ended December 31, 2016. Ericsson Inc. and its affiliates accounted for approximately 14% of our total revenues from continuing operations in the year ended December 31, 2015. Our top four customers, Crown Castle, Uline, Ericsson, Inc., and Verizon, accounted for approximately 26% of our total revenues from continuing operations in the year ended December 31, 2016. Our top four customers, Ericsson, Crown Castle, Uline, and NX Utilities, accounted for approximately 33% of our total revenues from continuing operations in the year ended December 31, 2015. Revenues under our contracts with significant customers may continue to vary from period to period depending on the timing or volume of work that those customers order or perform with their in-house service organizations. A limited number of customers may continue to comprise a substantial portion of our revenue for the foreseeable future. Because we do not maintain any reserves for payment defaults, a default or delay in payment on a significant scale could adversely affect our business, financial condition, results of operations and prospects. We could lose business from a significant customer for a variety of reasons, including:

 

  the consolidation, merger or acquisition of an existing customer, resulting in a change in procurement strategies employed by the surviving entity that could reduce the amount of work we receive;

 

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  our performance on individual contracts or relationships with one or more significant customers could become impaired due to another reason, which may cause us to lose future business with such customers and, as a result, our ability to generate income would be adversely impacted;

 

  the strength of our professional reputation; and

 

  key customers could slow or stop spending on initiatives related to projects we are performing for them due to increased difficulty in the credit markets as a result of economic downturns or other reasons.

 

Since many of our customer contracts allow our customers to terminate the contract without cause, our customers may terminate their contracts with us at will, which could impair our business, financial condition, results of operations and prospects.

 

Our failure to adequately expand our direct sales force will impede our growth.

 

We will need to continue to expand and optimize our sales infrastructure in order to grow our customer base and our business. We plan to continue to expand our direct sales force, both domestically and internationally. Identifying and recruiting qualified personnel and training them requires significant time, expense and attention. Our business may be adversely affected if our efforts to expand and train our direct sales force do not generate a corresponding increase in revenue. If we are unable to hire, develop and retain talented sales personnel or if new direct sales personnel are unable to achieve desired productivity levels in a reasonable period of time, we may not be able to realize the intended benefits of this investment or increase our revenue.

 

Our business is labor intensive and if we are unable to attract and retain key personnel and skilled labor, or if we encounter labor difficulties, our ability to bid for and successfully complete contracts may be negatively impacted.

 

Our ability to attract and retain reliable, qualified personnel is a significant factor that enables us to successfully bid for and profitably complete our work. The increase in demand for consulting technology integration and managed services has increased our need for employees with specialized skills or significant experience in these areas. The future success of our ADEX Division depends, in part, on our ability to attract, hire and retain project managers, estimators, supervisors, foremen, equipment operators, engineers, linemen, laborers and other highly-skilled personnel. Our ability to attract and retain reliable and skilled personnel depends on a number of factors, such as general rates of employment, competitive demands for employees possessing the skills we need and the level of compensation required to hire and retain qualified employees. We may also spend considerable resources training employees who may then be hired by our competitors, forcing us to spend additional funds to attract personnel to fill those positions. Competition for employees is intense, and we could experience difficulty hiring and retaining the personnel necessary to support our business. Our labor expenses may also increase as a result of a shortage in the supply of skilled personnel. If we do not succeed in retaining our current employees and attracting, developing and retaining new highly-skilled employees, our reputation may be harmed and our future earnings may be negatively impacted.

 

If we are unable to attract and retain qualified executive officers and managers, we will be unable to operate efficiently, which could adversely affect our business, financial condition, results of operations and prospects.

 

We depend on the continued efforts and abilities of our executive officers, as well as the senior management of our subsidiaries, to establish and maintain our customer relationships and identify strategic opportunities. The loss of any one of them could negatively affect our ability to execute our business strategy and adversely affect our business, financial condition, results of operations and prospects. Competition for managerial talent with significant industry experience is high and we may lose access to executive officers for a variety of reasons, including more attractive compensation packages offered by our competitors. Although we have entered into employment agreements with certain of our executive officers and certain other key employees, we cannot guarantee that any of them or other key management personnel will remain employed by us for any length of time.

 

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Because we maintain a workforce based upon current and anticipated workloads, we may incur significant costs in adjusting our workforce demands, including addressing understaffing of contracts, if we do not receive future contract awards or if these awards are delayed.

 

Our estimates of future performance depend, in part, upon whether and when we will receive certain new contract awards. Our estimates may be unreliable and can change from time to time. In the case of larger projects, where timing is often uncertain, it is particularly difficult to project whether and when we will receive a contract award. The uncertainty of contract award timing can present difficulties in matching workforce size with contractual needs. If an expected contract award is delayed or not received, we could incur significant costs resulting from retaining more staff than is necessary. Similarly, if we underestimate the workforce necessary for a contract, we may not perform at the level expected by the customer and harm our reputation with the customer. Each of these may negatively impact our business, financial condition, results of operations and prospects.

 

Timing of the award and performance of new contracts could adversely affect our business, financial condition, results of operations and prospects.

 

It is generally very difficult to predict whether and when new contracts will be offered for tender because these contracts frequently involve a lengthy and complex design and bidding process that is affected by a number of factors, such as market conditions, financing arrangements and governmental approvals. Because of these factors, our results of operations and cash flows may fluctuate from quarter to quarter and year to year, and the fluctuation may be substantial. Such delays, if they occur, could adversely affect our operating results for current and future periods until the affected contracts are completed.

 

We derive a significant portion of our revenue from master service agreements that may be cancelled by customers on short notice, or which we may be unable to renew on favorable terms or at all.

 

During the years ended December 31, 2016 and 2015, we derived approximately 23% and 36%, respectively, of our revenues from master service agreements and long-term contracts, none of which require our customers to purchase a minimum amount of services. The majority of these contracts may be cancelled by our customers upon minimal notice (typically 60 days), regardless of whether or not we are in default. In addition, many of these contracts permit cancellation of particular purchase orders or statements of work without any notice.

 

These agreements typically do not require our customers to assign a specific amount of work to us until a purchase order or statement of work is signed. Consequently, projected expenditures by customers are not assured until a definitive purchase order or statement of work is placed with us and the work is completed. Furthermore, our customers generally require competitive bidding of these contracts. As a result, we could be underbid by our competitors or be required to lower the prices charged under a contract being rebid. The loss of work obtained through master service agreements and long-term contracts or the reduced profitability of such work could adversely affect our business or results of operations.

 

Unanticipated delays due to adverse weather conditions, global climate change and difficult work sites and environments may slow completion of our contracts, impair our customer relationships and adversely affect our business, financial condition, results of operations and prospects.

 

Because some of our work is performed outdoors, our business is impacted by extended periods of inclement weather and is subject to unpredictable weather conditions, which could become more frequent or severe if general climatic changes occur. Generally, inclement weather is more likely to occur during the winter season, which falls during our first and fourth fiscal quarters. Additionally, adverse weather conditions can result in project delays or cancellations, potentially causing us to incur additional unanticipated costs, reductions in revenues or the payment of liquidated damages. In addition, some of our contracts require that we assume the risk that actual site conditions vary from those expected. Significant periods of bad weather typically reduce profitability of affected contracts, both in the current period and during the future life of affected contracts, which can negatively affect our results of operations in current and future periods until the affected contracts are completed.

 

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Some of our projects involve challenging engineering, procurement and construction phases that may occur over extended time periods, sometimes up to several years. We may encounter difficulties in engineering, delays in designs or materials provided by the customer or a third party, equipment and material delivery delays, schedule changes, delays from customer failure to timely obtain rights-of-way, weather-related delays, delays by subcontractors in completing their portion of the project and other factors, some of which are beyond our control, but which may impact our ability to complete a project within the original delivery schedule. In some cases, delays and additional costs may be substantial, and we may be required to cancel a project and/or compensate the customer for the delay. We may not be able to recover any of these costs. Any such delays, cancellations, defects, errors or other failures to meet customer expectations could result in damage claims substantially in excess of revenue associated with a project. These factors could also negatively impact our reputation or relationships with our customers, which could adversely affect our ability to secure new contracts.

 

Environmental and other regulatory matters could adversely affect our ability to conduct our business and could require expenditures that could adversely affect our business, financial condition, results of operations and prospects.

 

Our operations are subject to laws and regulations relating to workplace safety and worker health that, among other things, regulate employee exposure to hazardous substances. While immigration laws require us to take certain steps intended to confirm the legal status of our immigrant labor force, we may nonetheless unknowingly employ illegal immigrants. Violations of laws and regulations could subject us to substantial fines and penalties, cleanup costs, third-party property damage or personal injury claims. In addition, these laws and regulations have become, and enforcement practices and compliance standards are becoming, increasingly stringent. Moreover, we cannot predict the nature, scope or effect of legislation or regulatory requirements that could be imposed, or how existing or future laws or regulations will be administered or interpreted, with respect to products or activities to which they have not been previously applied. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies, could require us to make substantial expenditures for, among other things, pollution control systems and other equipment that we do not currently possess, or the acquisition or modification of permits applicable to our activities.

 

If we fail to maintain qualifications required by certain governmental entities, we could be prohibited from bidding on certain contracts.

 

If we do not maintain qualifications required by certain governmental entities, such as low voltage electrical licenses, we could be prohibited from bidding on certain governmental contracts. A cancellation of an unfinished contract or our exclusion from the bidding process could cause our work crews to be idled for a significant period of time until other comparable work becomes available, which could adversely affect our business and results of operations. The cancellation of significant contracts or our disqualification from bidding for new contracts could reduce our revenues and profits and adversely affect our business, financial condition, results of operations and prospects.

 

Fines, judgments and other consequences resulting from our failure to comply with regulations or adverse outcomes in litigation proceedings could adversely affect our business, financial condition, results of operations and prospects.

 

From time to time, we may be involved in lawsuits and regulatory actions, including class action lawsuits that are brought or threatened against us in the ordinary course of business. These actions may seek, among other things, compensation for alleged personal injury, workers’ compensation, violations of the Fair Labor Standards Act and state wage and hour laws, employment discrimination, breach of contract, property damage, punitive damages, civil penalties, consequential damages or other losses, or injunctive or declaratory relief. Any defects or errors, or failures to meet our customers’ expectations could result in large damage claims against us. Claimants may seek large damage awards and, due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. Any failure to properly estimate or manage cost, or delay in the completion of projects, could subject us to penalties.

 

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The ultimate resolution of these matters through settlement, mediation or court judgment could have a material impact on our financial condition, results of operations and cash flows. Regardless of the outcome of any litigation, these proceedings could result in substantial cost and may require us to devote substantial resources to defend ourselves. When appropriate, we establish reserves for litigation and claims that we believe to be adequate in light of current information, legal advice and professional indemnity insurance coverage, and we adjust such reserves from time to time according to developments. If our reserves are inadequate or insurance coverage proves to be inadequate or unavailable, our business, financial condition, results of operations and prospects may suffer.

 

We employ and assign personnel in the workplaces of other businesses, which subjects us to a variety of possible claims that could adversely affect our business, financial condition, results of operations and prospects.

 

We employ and assign personnel in the workplaces of other businesses. The risks of these activities include possible claims relating to:

 

  discrimination and harassment;

 

  wrongful termination or denial of employment;

 

  violations of employment rights related to employment screening or privacy issues;

 

  classification of employees, including independent contractors;

 

  employment of illegal aliens;

 

  violations of wage and hour requirements;

 

  retroactive entitlement to employee benefits; and

 

  errors and omissions by our temporary employees.

 

Claims relating to any of the above could subject us to monetary fines or reputational damage, which could adversely affect our business, financial condition, results of operations and prospects.

 

If we are required to reclassify independent contractors as employees, we may incur additional costs and taxes which could adversely affect our business, financial condition, results of operations and prospects.

 

We use a significant number of independent contractors in our operations for whom we do not pay or withhold any federal, state or provincial employment tax. There are a number of different tests used in determining whether an individual is an employee or an independent contractor and such tests generally take into account multiple factors. There can be no assurance that legislative, judicial or regulatory (including tax) authorities will not introduce proposals or assert interpretations of existing rules and regulations that would change, or at least challenge, the classification of our independent contractors. Although we believe we have properly classified our independent contractors, the U.S. Internal Revenue Service or other U.S. federal or state authorities or similar authorities of a foreign government may determine that we have misclassified our independent contractors for employment tax or other purposes and, as a result, seek additional taxes from us or attempt to impose fines and penalties. If we are required to pay employer taxes or pay backup withholding with respect to prior periods with respect to or on behalf of our independent contractors, our operating costs will increase, which could adversely impact our business, financial condition, results of operations and prospects.

 

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Our dependence on subcontractors and suppliers could increase our costs and impair our ability to complete contracts on a timely basis or at all.

 

We rely on third-party subcontractors to perform some of the work on our contracts. We also rely on third-party suppliers to provide materials needed to perform our obligations under those contracts. We generally do not bid on contracts unless we have the necessary subcontractors and suppliers committed for the anticipated scope of the contract and at prices that we have included in our bid. Therefore, to the extent that we cannot engage subcontractors or suppliers, our ability to bid for contracts may be impaired. In addition, if a subcontractor or third-party supplier is unable to deliver its goods or services according to the negotiated terms for any reason, we may suffer delays and be required to purchase the services from another source at a higher price. We sometimes pay our subcontractors and suppliers before our customers pay us for the related services. If customers fail to pay us and we choose, or are required, to pay our subcontractors for work performed or pay our suppliers for goods received, we could suffer an adverse effect on our business, financial condition, results of operations and prospects.

 

Breaches of data security could adversely impact our business.

 

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

 

Our insurance coverage may be inadequate to cover all significant risk exposures.

 

We will be exposed to liabilities that are unique to the services we provide. While we intend to maintain insurance for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and we may be forced to bear substantial costs resulting from risks and uncertainties of our business. It is also not possible to obtain insurance to protect against all operational risks and liabilities. The failure to obtain adequate insurance coverage on terms favorable to us, or at all, could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Our operations are subject to hazards that may cause personal injury or property damage, thereby subjecting us to liabilities and possible losses, which may not be covered by insurance.

 

Our workers are subject to hazards associated with providing construction and related services on construction sites. For example, some of the work we perform is underground. If the field location maps supplied to us are not accurate, or if objects are present in the soil that are not indicated on the field location maps, our underground work could strike objects in the soil containing pollutants that could result in a rupture and discharge of pollutants. In such a case, we may be liable for fines and damages. These operating hazards can cause personal injury and loss of life, damage to or destruction of property, plant and equipment and environmental damage. Even though we believe that the insurance coverage we maintain is in amounts and against the risks that we believe are consistent with industry practice, this insurance may not be adequate to cover all losses or liabilities that we may incur in our operations. To the extent that we experience a material increase in the frequency or severity of accidents or workers’ compensation claims, or unfavorable developments on existing claims, our business, financial condition, results of operations and prospects could be adversely affected.

 

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The Occupational Safety and Health Act of 1970, as amended, or OSHA, establishes certain employer responsibilities, including the maintenance of a workplace free of recognized hazards likely to cause death or serious injury, compliance with standards promulgated by the Occupational Health and Safety and Health Administration and various recordkeeping, disclosure and procedural requirements. While we have invested, and will continue to invest, substantial resources in occupational health and safety programs, serious accidents or violations of OSHA rules may subject us to substantial penalties, civil litigation or criminal prosecution, which could adversely affect our business, financial condition, results of operations and prospects.

 

Defects in our specialty contracting services may give rise to claims against us, increase our expenses, or harm our reputation.

 

Our specialty contracting services are complex and our final work product may contain defects. We have not historically accrued reserves for potential claims as they have been immaterial. The costs associated with such claims, including any legal proceedings, could adversely affect our business, financial condition, results of operations and prospects.

  

Risks Related to Our Industry

 

Our industry is highly competitive, with a variety of larger companies with greater resources competing with us, and our failure to compete effectively could reduce the number of new contracts awarded to us or adversely affect our market share and harm our financial performance.

 

The contracts on which we bid are generally awarded through a competitive bid process, with awards generally being made to the lowest bidder, but sometimes based on other factors, such as shorter contract schedules or prior experience with the customer. Within our markets, we compete with many national, regional, local and international service providers, including Arrow Electronics, Inc., Black Box Corporation, Dimension Data, plc, Dycom Industries, Inc., Goodman Networks, Inc., MasTec, Inc., TeleTech Holdings, Inc., Tech Mahindra, Ltd., Unisys Corporation, Unitek Global Services, Inc. and Volt Information Sciences, Inc. Price is often the principal factor in determining which service provider is selected by our customers, especially on smaller, less complex projects. As a result, any organization with adequate financial resources and access to technical expertise may become a competitor. Smaller competitors are sometimes able to win bids for these projects based on price alone because of their lower costs and financial return requirements. Additionally, our competitors may develop the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services, and we may not be able to maintain or enhance our competitive position. We also face competition from the in-house service organizations of our customers whose personnel perform some of the services that we provide.

 

Some of our competitors have already achieved greater market penetration than we have in the markets in which we compete, and some have greater financial and other resources than we do. A number of national companies in our industry are larger than we are and, if they so desire, could establish a presence in our markets and compete with us for contracts. As a result of this competition, we may need to accept lower contract margins in order to compete against competitors that have the ability to accept awards at lower prices or have a pre-existing relationship with a customer. If we are unable to compete successfully in our markets, our business, financial condition, results of operations and prospects could be adversely affected.

 

Many of the industries we serve are subject to consolidation and rapid technological and regulatory change, and our inability or failure to adjust to our customers’ changing needs could reduce demand for our services.

 

We derive, and anticipate that we will continue to derive, a substantial portion of our revenue from customers in the telecommunications and utilities industries. The telecommunications and utilities industries are subject to rapid changes in technology and governmental regulation. Changes in technology may reduce the demand for the services we provide. For example, new or developing technologies could displace the wireline systems used for the transmission of voice, video and data, and improvements in existing technology may allow telecommunications providers to significantly improve their networks without physically upgrading them. Alternatively, our customers could perform more tasks themselves, which would cause our business to suffer. Additionally, the telecommunications and utilities industries have been characterized by a high level of consolidation that may result in the loss of one or more of our customers. Our failure to rapidly adopt and master new technologies as they are developed in any of the industries we serve or the consolidation of one or more of our significant customers could adversely affect our business, financial condition, results of operations and prospects.

 

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Further, many of our telecommunications customers are regulated by the Federal Communications Commission, or the FCC, and other international regulators. The FCC and other regulators may interpret the application of their regulations in a manner that is different than the way such regulations are currently interpreted and may impose additional regulations, either of which could reduce demand for our services and adversely affect our business and results of operations.

 

Economic downturns could cause capital expenditures in the industries we serve to decrease, which may adversely affect our business, financial condition, results of operations and prospects.

 

The demand for our services has been, and will likely continue to be, cyclical in nature and vulnerable to general downturns in the United States economy. The United States economy is still recovering from a recession, and growth in United States economic activity has remained slow. It is uncertain when these conditions will significantly improve. The wireless telecommunications industry and the staffing services industry are both particularly cyclical in nature and vulnerable to general downturns in the United States and international economies. Our customers are affected by economic changes that decrease the need for or the profitability of their services. This can result in a decrease in the demand for our services and potentially result in the delay or cancellation of projects by our customers. Slow-downs in real estate, fluctuations in commodity prices and decreased demand by end-customers for services could affect our customers and their capital expenditure plans. As a result, some of our customers may opt to defer or cancel pending projects. A downturn in overall economic conditions also affects the priorities placed on various projects funded by governmental entities and federal, state and local spending levels.

 

In general, economic uncertainty makes it difficult to estimate our customers’ requirements for our services. Our plan for growth depends on expanding our company both in the United States and internationally. If economic factors in any of the regions in which we plan to expand are not favorable to the growth and development of the telecommunications industries in those countries, we may not be able to carry out our growth strategy, which could adversely affect our business, financial condition, results of operations and prospects.

 

Other Risks Relating to Our Company and Results of Operations

 

Our auditors have expressed doubt about our ability to continue as a going concern.

 

The Independent Registered Public Accounting Firms’ Report issued in connection with our audited financial statements for the year ended December 31, 2016 stated that there is “substantial doubt about the Company’s ability to continue as a going concern.” Because we have been issued an opinion by our auditors that substantial doubt exists as to whether we can continue as a going concern, it may be more difficult for us to attract investors. If we are not able to continue our business as a going concern, we have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or part of their investment.

 

Our operating results may fluctuate due to factors that are difficult to forecast and not within our control.

 

Our past operating results may not be accurate indicators of future performance, and you should not rely on such results to predict our future performance. Our operating results have fluctuated significantly in the past, and could fluctuate in the future. Factors that may contribute to fluctuations include:

 

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

 

  our ability to effectively manage our working capital;

 

  our ability to satisfy consumer demands in a timely and cost-effective manner;

 

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  pricing and availability of labor and materials;

 

  our inability to adjust certain fixed costs and expenses for changes in demand;

 

  shifts in geographic concentration of customers, supplies and labor pools; and

 

  seasonal fluctuations in demand and our revenue

 

Actual results could differ from the estimates and assumptions that we use to prepare our financial statements.

 

To prepare financial statements in conformity with GAAP, management is required to make estimates and assumptions as of the date of the financial statements that affect the reported values of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. Areas requiring significant estimates by our management include:

 

  contract costs and profits and application of percentage-of-completion accounting and revenue recognition of contract change order claims;

 

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

 

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

 

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

 

At the time the estimates and assumptions are made, we believe they are accurate based on the information available. However, our actual results could differ from, and could require adjustments to, those estimates.

 

We exercise judgment in determining our provision for taxes in the United States and Puerto Rico that are subject to tax authority audit review that could result in additional tax liability and potential penalties that would negatively affect our net income.

 

The amounts we record in intercompany transactions for services, licenses, funding and other items affects our tax liabilities. Our tax filings are subject to review or audit by the U.S. Internal Revenue Service and state, local and foreign taxing authorities. We exercise judgment in determining our worldwide provision for income and other taxes and, in the ordinary course of our business, there may be transactions and calculations where the ultimate tax determination is uncertain. Examinations of our tax returns could result in significant proposed adjustments and assessment of additional taxes that could adversely affect our tax provision and net income in the period or periods for which that determination is made.

 

The Internal Revenue Service has completed its examination of our 2013 U.S. corporation income tax return. We have agreed to certain adjustments proposed by the IRS and are appealing others. Separately, the IRS has questioned our classification of certain individuals as independent contractors rather than employees. We estimate our potential liability to be $125 but the liability, if any, upon final disposition of these matters is uncertain.

 

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We have identified material weaknesses in our internal control over financial reporting, and our management has concluded that our disclosure controls and procedures are not effective. We cannot assure you that additional material weaknesses or significant deficiencies will not occur in the future. If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to accurately report our financial results or prevent fraud, which may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.

 

We have historically had a small internal accounting and finance staff with limited experience in public reporting. This lack of adequate accounting resources has resulted in the identification of material weaknesses in our internal controls over financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. In connection with the audit of our financial statements for the year ended December 31, 2016, our management team identified material weaknesses relating to (i) our inability to complete our implementation of comprehensive entity level controls, (ii) our lack of a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. GAAP commensurate with our financial reporting requirements, and (iii) our lack of the quantity of resources necessary to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of the transactions we enter into. During 2016, we took steps to help remediate these material weaknesses, including hiring additional accounting staff who have a background and knowledge in the application of U.S. GAAP and performing a comprehensive review of our internal control over financial reporting. We plan to continue to take additional steps to remediate these material weaknesses for the year ending December 31, 2017, to improve our financial reporting systems and implement new policies, procedures and controls. If we do not successfully remediate the material weaknesses described above, or if other material weaknesses or other deficiencies arise in the future, we may be unable to accurately report our financial results on a timely basis, which could cause our reported financial results to be materially misstated and require restatement which could result in the loss of investor confidence, delisting and/or cause the market price of our common stock to decline. 

 

Lawsuits filed against us, if decided in the plaintiffs’ favor, may result in the payment of cash damages that could adversely affect our financial position and liquidity.

 

In July 2013, a complaint was filed against our company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida titled The Farkas Group, Inc., The Atlas Group of Companies, LLC and Michael D. Farkas v. InterCloud Systems, Inc. (Case No. 502013CA01133XXXMB) for breach of contract and unjust enrichment. In the complaint, the plaintiffs allege that we have breached contractual agreements between our company and plaintiffs pertaining to certain indebtedness amounting to approximately $116,000 allegedly owed by us to the plaintiffs and our agreement to convert such indebtedness into shares of our common stock. The plaintiff alleges that they are entitled to receive in the aggregate 2.2 million shares of our company’s common stock or aggregate damages reflecting the trading value at the high price for the common stock. We have asserted as a defense that such indebtedness, together with any right to convert such indebtedness into shares of common stock, was cancelled pursuant to the terms of a Stock Purchase Agreement dated as of July 2, 2009 between our company and the plaintiffs. The Farkas Group was a control person of our company during the period that it was a public “shell” company and facilitated the transfer of control of our company to our former chief executive officer, Gideon Taylor. This matter is presently set on the court’s non-jury trial docket. We intend to continue to vigorously defend this lawsuit.

 

In March 2014, a purported class action suit was filed in the United States District Court for the District of New Jersey against our company, our Chairman of the Board and Chief Executive Officer, Mark Munro, and certain other defendants alleging violations by the defendants (other than Mr. Munro) of Section 10(b) of the Exchange Act and other related provisions in connection with certain alleged courses of conduct that were intended to deceive the plaintiff and the investing public and to cause the members of the purported class to purchase shares of our common stock at artificially inflated prices based on untrue statements of a material fact or omissions to state material facts necessary to make the statements not misleading. The complaint also alleges that Mr. Munro and our company violated Section 20 of the Exchange Act as controlling persons of the other defendants. The complaint seeks unspecified damages, attorney and expert fees, and other unspecified litigation costs. In January 2015, the plaintiff amended the complaint to add certain other third-party defendants.

 

In January and June 2016, derivative actions were filed in the Delaware Chancery Court and the United States Federal District Court for the District of New Jersey against our company, our directors, our executive officers and certain other individuals. These actions arises out of the same conduct at issue in the purported class action discussed above. The complaints seek unspecified damages, amendments to our articles of incorporation and by-laws, disgorgement from the individual defendants and costs and disbursements in the actions.

 

In July 2016, a derivative action was filed in the United States Federal District Court for the District of New Jersey against our company and our directors. This action also arises out of the same conduct at issue in the purported class action discussed above and our subsequent failure to make certain related disclosures or purported false and misleading disclosures in our proxy statements for our annual stockholders’ meetings held in 2013 and 2014. The complaint seeks unspecified damages, amendments to our corporate governance and certain internal procedures, punitive damages and disgorgement from the individual defendants, and costs and disbursements in the actions.

 

We deny the allegations in each complaint and are proceeding to vigorously defend the suits. However, as the outcome of litigation is inherently uncertain, it is possible that the plaintiffs in one or more actions will prevail no matter how vigorously we defend ourselves, which could result in significant compensatory damages on the part of our company and of our executive officers and directors. Any such adverse decision in such actions could have a material adverse effect on our financial position and liquidity and on our business and results of operations. In addition, regardless of outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.

 

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We have received subpoenas in the Securities and Exchange Commission investigation now known as “In the Matter of Certain Stock Promotions,” the consequences of which are unknown .

 

As disclosed in Item 3. Litigation, below, on May 21, 2014 we received a subpoena from the Securities and Exchange Commission, or the SEC, that stated that the staff of the SEC is conducting an investigation now known as “In the Matter of Certain Stock Promotions,” and that the subpoena was issued as part of an investigation as to whether certain investor relations firms and their clients engaged in market manipulation. The SEC’s subpoena and accompanying letter did not indicate whether we are, or are not, under investigation. We have provided testimony to the SEC and produced documents in response to that subpoena and several additional subpoenas from the SEC in connection with that matter, including a subpoena issued on March 1, 2016 requesting information relating to a transaction involving our Series H preferred shares in December 2013. The SEC may in the future require us to produce additional documents or information, or seek testimony from other members of our management team. 

 

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

 

We are unaware of the scope or timing of the SEC’s investigation. As a result, we do not know how the SEC investigation is proceeding, when the investigation will be concluded, or if we will become involved to a greater extent than providing documents and testimony to the SEC. We also are unable to predict what action, if any, might be taken in the future by the SEC or its staff as a result of the matters that are the subject to its investigation or what impact, if any, the cost of continuing to respond to subpoenas might have on our financial position, results of operations, or cash flows. We have not established any provision for losses in respect of this matter. In addition, complying with any such future requests by the SEC for documents or testimony could distract the time and attention of our officers and directors or divert our resources away from ongoing business matters. Furthermore, it is possible that we currently are, or may hereafter become a target of the SEC’s investigation. Any such investigation could result in significant legal expenses, the diversion of management’s attention from our business, damage to our business and reputation, and could subject us to a wide range of remedies, including an SEC enforcement action. There can be no assurance that any final resolution of this and any similar matters will not have a material adverse effect on our financial condition or results of operations. 

 

We are an emerging growth company within the meaning of the Jumpstart Our Businesses Startups Act of 2012 and, as a result, have elected to comply with the reduced disclosure and other reporting requirements available to us as an EGC.

 

Because we qualify as an emerging growth company, or EGC, under the Jumpstart Our Businesses Startups Act of 2012, or JOBS Act, we have elected to comply with the reduced disclosure and other reporting requirements available to us as an EGC in connection with this report, and for a period of up to five years following our November 2013 offering of shares of common stock if we remain an EGC. For example, with respect to this report, we have provided only two fiscal years of audited financial information and selected financial data and have provided scaled-down disclosure on executive compensation, such as not including a “Compensation Discussion and Analysis” in this report. In addition, for as long as we remain an EGC, we are not subject to certain governance requirements, such as holding a “say-on-pay” and “say-on-golden-parachute” advisory votes, and we are not required to obtain an annual attestation report on our internal control over financial reporting from a registered public accounting firm pursuant to Section 404(b) of the Sarbanes-Oxley Act. We may take advantage of these reporting exemptions until we are no longer an EGC. We can be an EGC for a period of up to five years after our November 2013 equity offering, although we will cease to be an EGC earlier than that if our total annual gross revenues equal or exceed $1 billion in a fiscal year, if we issue more than $1 billion in non-convertible debt over a three-year period or if we become a “large accelerated filer” under Rule 12b-2 of the Exchange Act.

 

Accordingly, in this report you are not receiving the same level of disclosure as you would receive in an annual report on Form 10-K of a non-EGC issuer and, following this report, our stockholders will not receive the same level of disclosure that is afforded to stockholders of a non-EGC issuer. It is also possible that investors will find our shares of common stock to be less attractive because we have elected to comply with the reduced disclosure and other reporting requirements available to us as an EGC, which could adversely affect the trading market for our shares of common stock and the prices at which our stockholders may be able to sell shares of our common stock. 

 

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Risks Related to our Common Stock

 

Our common stock price has fluctuated widely in recent years, and the trading price of our common stock is likely to continue to be volatile, which could result in substantial losses to investors and litigation.

 

In addition to changes to market prices based on our results of operations and the factors discussed elsewhere in this “Risk Factors” section, the market price of and trading volume for our common stock may change for a variety of other reasons, not necessarily related to our actual operating performance. The capital markets have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. In addition, the average daily trading volume of the securities of small companies can be very low, which may contribute to future volatility. Factors that could cause the market price of our common stock to fluctuate significantly include: 

 

  the results of operating and financial performance and prospects of other companies in our industry;

 

  strategic actions by us or our competitors, such as acquisitions or restructurings;

 

  announcements of innovations, increased service capabilities, new or terminated customers or new, amended or terminated contracts by our competitors;

 

  the public’s reaction to our press releases, media coverage and other public announcements, and filings with the SEC;

 

  market conditions for providers of services to telecommunications, utilities and managed cloud services customers;

 

  lack of securities analyst coverage or speculation in the press or investment community about us or opportunities in the markets in which we compete;

 

  changes in government policies in the United States and, as our international business increases, in other foreign countries;

 

  changes in earnings estimates or recommendations by securities or research analysts who track our common stock or failure of our actual results of operations to meet those expectations;

 

  dilution caused by the conversion into common stock of convertible debt securities or by the exercise of outstanding warrants;

 

  market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

 

  changes in accounting standards, policies, guidance, interpretations or principles;

 

  any lawsuit involving us, our services or our products;

 

  arrival and departure of key personnel;

 

  sales of common stock by us, our investors or members of our management team; and

 

  changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural or man-made disasters.

 

Any of these factors, as well as broader market and industry factors, may result in large and sudden changes in the trading volume of our common stock and could seriously harm the market price of our common stock, regardless of our operating performance. This may prevent stockholders from being able to sell their shares at or above the price they paid for shares of our common stock, if at all. In addition, following periods of volatility in the market price of a company’s securities, stockholders often institute securities class action litigation against that company. Our involvement in any class action suit or other legal proceeding, including the existing lawsuits filed against us and described elsewhere in this report, could divert our senior management’s attention and could adversely affect our business, financial condition, results of operations and prospects.

 

The sale or availability for sale of substantial amounts of our common stock could adversely affect the market price of our common stock.

 

Sales of substantial amounts of shares of our common stock, or the perception that these sales could occur, could adversely affect the market price of our common stock and could impair our future ability to raise capital through common stock offerings. As of December 31, 2016, we had 114,067,218 shares of common stock issued and 112,840,013 shares outstanding, of which 17,526,863 shares were restricted securities pursuant to Rule 144 promulgated by the SEC. The sale of these shares into the open market may adversely affect the market price of our common stock.

 

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In addition, at December 31, 2016, we also had outstanding $42.2 million aggregate principal amount of convertible notes that were convertible into 66,504,700 shares of common stock on that date. However, we cannot currently determine the total number of shares of our common stock that may be issued upon the conversion or repayment of our convertible notes because the total number of shares and the conversion prices or the prices at which we can issue our common stock to pay down the principal of and interest on our convertible notes depend on a number of factors, including the prices and nature of any equity securities we may issue in the future and the market prices of our common stock in the periods leading up to any particular amortization payment date on which we elect to make amortization payments on our convertible notes in shares of our common stock. See Note 11, Term Loans, and Note 18, Related Parties, to the notes to our consolidated financial statements in this report. For conversions completed between January 1 and March 13, 2017, see Note 21, Subsequent Events, to the notes to our consolidated financial statements in this report. As of December 31, 2016, there were also outstanding warrants to purchase an aggregate of 8,833,712 shares of our common stock at a weighted-average exercise price of $0.58 per share, all of which warrants were exercisable as of such date, and outstanding options to purchase an aggregate of 175,000 shares of common stock at an exercise price of $3.72 per share, of which 166,667 options were exercisable as of such date. The conversion of a significant principal amount of our outstanding convertible debt securities into shares of our common stock, our repayment of a significant amount of principal, interest or other amounts payable under such debt securities in shares of our common stock or the exercise of outstanding warrants at prices below the market price of our common stock could adversely affect the market price of our common stock. The market price of our common stock also may be adversely affected by our issuance of shares of our capital stock or convertible securities in connection with future acquisitions, or in connection with other financing efforts. 

 

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

 

We are authorized to issue 500,000,000 shares of common stock, of which 112,840,013 shares were outstanding on December 31, 2016 and, primarily as a result of the conversion of convertible debt securities since December 31, 2016, 487,892,651 shares were issued and outstanding on March 7, 2017. At March 7, 2017, we had reserved 49,923,696 shares of common stock for issuance upon conversion of certain of our outstanding convertible debt securities and warrants. In addition, at such date, we had outstanding $28,119,795 aggregate principal amount of additional convertible debt securities for which we are not required to reserve a specific number of shares of common stock for conversions but that is convertible into an undeterminable number of shares of common stock based upon a discount to the then-current market price of our common stock. If all of these securities were converted or exercised, the total number of shares of our common stock that we would be required to issue would greatly exceed the number of our remaining authorized but unissued shares of common stock. 

 

As a result of such potential shortfall in the number of our authorized shares of common stock, it is likely that we will have insufficient shares of common stock available to issue in connection with the conversion or exercise of our outstanding options, warrants and convertible debt securities or any future equity finance transaction we may seek to undertake. Accordingly, we may be required to take steps at an annual or special meeting of stockholders to seek approval of an increase in the number of our authorized shares of common stock. However, we cannot assure you that our stockholders would authorize an increase in the number of shares of our common stock. Alternatively, we may be required to reverse split our outstanding shares of common stock to create additional authorized but unissued shares. While our stockholders have approved a reverse split of our common stock on an exchange ratio of up to one-for-four shares on or prior to August 29, 2017 at the discretion of our board of directors, a reverse stock split may adversely affect the market price of our common stock. Our failure to have a sufficient number of authorized shares of common stock for issuance upon future exercise or conversion of our outstanding options, warrants and convertible debt securities could create an event of default under such securities, which could adversely affect our business, financial condition, results of operations and prospects.

 

Our certificate of incorporation and our bylaws, and certain provisions of Delaware corporate law, as well as certain of our contracts, contain provisions that could delay or prevent a change in control even if the change in control would be beneficial to our stockholders.

 

Delaware law, as well as our certificate of incorporation and bylaws, contains anti-takeover provisions that could delay or prevent a change in control of our company, even if the change in control would be beneficial to our stockholders. These provisions could lower the price that future investors might be willing to pay for shares of our common stock. These anti-takeover provisions:

 

  authorize our board of directors to create and issue, without stockholder approval, preferred stock, thereby increasing the number of outstanding shares, which can deter or prevent a takeover attempt;

 

  prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;

 

  establish a three-tiered classified board of directors requiring that not all members of our board be elected at one time;

 

  establish a supermajority requirement to amend our amended and restated bylaws and specified provisions of our amended and restated certificate of incorporation;

 

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

 

  establish limitations on the removal of directors;

 

  empower our board of directors to fill any vacancy on our board of directors, whether such vacancy occurs as a result of an increase in the number of directors or otherwise;

 

  provide that our board of directors is expressly authorized to adopt, amend or repeal our bylaws;

 

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  provide that our directors will be elected by a plurality of the votes cast in the election of directors;

 

  establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by our stockholders at stockholder meetings;

 

  eliminated the ability of our stockholders to call special meetings of stockholders and to act by written consent; and

 

  provide that the Court of Chancery of the State of Delaware will be the exclusive forum for any derivative action, actions asserting a breach of fiduciary duty and certain other actions against us or any directors or executive officers.

 

Section 203 of the Delaware General Corporation Law, the terms of our stock incentive plans, the terms of our change in control agreements with our senior executives and other contractual provisions may also discourage, delay or prevent a change in control of our company. Section 203 generally prohibits a Delaware corporation from engaging in a business combination with an interested stockholder for three years after the date the stockholder became an interested stockholder. Our stock incentive plans include change-in-control provisions that allow us to grant options or stock purchase rights that may become vested immediately upon a change in control. The terms of changes of control agreements with our senior executives and contractual restrictions with third parties may discourage a change in control of our company. Our board of directors also has the power to adopt a stockholder rights plan that could delay or prevent a change in control of our company even if the change in control is generally beneficial to our stockholders. These plans, sometimes called “poison pills,” are oftentimes criticized by institutional investors or their advisors and could affect our rating by such investors or advisors. If our board of directors adopts such a plan, it might have the effect of reducing the price that new investors are willing to pay for shares of our common stock.

 

Together, these charter, statutory and contractual provisions could make the removal of our management and directors more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock. Furthermore, the existence of the foregoing provisions, as well as the significant common stock beneficially owned by our executive officers, key non-executive officer employees, and members of our board of directors, could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.

 

We have never paid cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock.

 

We have never paid cash dividends and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain any earnings to finance our operations and growth. As a result, any short-term return on your investment will depend on the market price of our common stock, and only appreciation of the price of our common stock, which may never occur, will provide a return to stockholders. The decision whether to pay dividends will be made by our board of directors in light of conditions then existing, including, but not limited to, factors such as our financial condition, results of operations, capital requirements, business conditions, and covenants under any applicable contractual arrangements. Investors seeking cash dividends should not invest in our common stock.

 

If equity research analysts do not publish research or reports about our business, or if they issue unfavorable commentary or downgrade our common stock, the market price of our common stock will likely decline.

 

The trading market for our common stock will rely in part on the research and reports that equity research analysts, over whom we have no control, publish about us and our business. We may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the market price for our common stock could decline. In the event we obtain securities or industry analyst coverage, the market price of our common stock could decline if one or more equity analysts downgrade our common stock or if those analysts issue unfavorable commentary, even if it is inaccurate, or cease publishing reports about us or our business.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

None.

 

ITEM 2. PROPERTIES.

 

Our principal executive offices are located in Shrewsbury, New Jersey in segregated offices comprising an aggregate of approximately 3,784 square feet. We are occupying our offices under a 60-month lease that expires in September 2020 and provides for monthly lease payments of $7,568 in the first year and increases of 2% per year thereafter.

 

Set forth below are the locations of the other properties leased by us, the businesses that use the properties, and the size of each such property. All of such properties are used by our company or by one of our subsidiaries principally as office facilities to house their administrative, marketing, and engineering and professional services personnel. We believe our facilities and equipment to be in good condition and reasonably suited and adequate for our current needs.

 

Location   Owned or Leased   User   Size (Sq Ft)  
Tuscaloosa, AL   Leased (1)   Rives-Monteiro Engineering, LLC     5,000  
Miami, FL   Leased (2)   Tropical Communications, Inc.     6,000  
Des Plaines, IL   Leased (3)   T N S, Inc.     1,500  
Upland, CA   Leased (4)   Adex Corporation     2,047  
Naperville, IL   Leased (5)   Adex Corporation     1,085  
Longwood, FL   Leased (6)   AW Solutions     7,750  
Puerto Rico   Leased (7)   AW Solutions     1,575  
Dallas, TX   Leased (8)   InterCloud Systems, Inc.     1,098  
Parsippany, NJ   Leased (9)   Integration Partners – NY Corp.     3,427  
Alpharetta, GA   Leased (10)   Adex Corporation     4,800  
Boca Raton, FL   Leased (11)   AW Solutions     1,282  

 

(1) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,500.
   
(2) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,792.
   
(3) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,133.
   
(4) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $2,252.
   
(5) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,673.
   
(6) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $10,699.
   
(7) This facility is leased pursuant to a month-to-month lease that provides for aggregate monthly rental payments of $1,545.
   
(8) This facility is leased pursuant to a 12 month lease that expires in April 2017 and provides for aggregate monthly rental payments of $2,013.
   
(9) This facility is leased pursuant to a 48 month lease that expires in October 2017 and provides for aggregate monthly rental payments of $4,998.
   
(10) This facility is leased pursuant to a 36 month lease that expires in April 2019 and provides for aggregate monthly rental payments of $4,600.
   
(11) This facility is leased pursuant to a 5 year lease that expires in August 2019 and provides for monthly base rental payments of $2,091 with a 3% annual increase in base rent thereafter plus 1.3% of the operating expenses of the building.

 

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ITEM 3. LEGAL PROCEEDINGS.

 

Pending Litigation

 

Breach of Contract Action. In July 2013, a complaint was filed against our company in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida titled The Farkas Group, Inc., The Atlas Group of Companies, LLC and Michael D. Farkas v. InterCloud Systems, Inc. (Case No. 502013CA01133XXXMB) for breach of contract and unjust enrichment. In the complaint, the plaintiffs allege that we have breached contractual agreements between our company and plaintiffs pertaining to certain indebtedness amounting to approximately $116,000 allegedly owed by us to the plaintiffs and our agreement to convert such indebtedness into shares of our common stock. The plaintiff alleges that they are entitled to receive in the aggregate 2.2 million shares of our company’s common stock or aggregate damages reflecting the trading value at the high price for the common stock. We have asserted as a defense that such indebtedness, together with any right to convert such indebtedness into shares of common stock, was cancelled pursuant to the terms of a Stock Purchase Agreement dated as of July 2, 2009 between our company and the plaintiffs. The Farkas Group was a control person of our company during the period that it was a public “shell” company and facilitated the transfer of control of our company to our former chief executive officer, Gideon Taylor. This matter is presently set on the court’s non-jury trial docket. We intend to continue to vigorously defend this lawsuit.

 

Purported Class Action Suit. In March 2014, a complaint entitled In re InterCloud Systems Sec. Litigation, Case No. 3:14-cv-01982 (D.N.J.) was filed in the United States District Court for the District of New Jersey against our company, our Chairman of the Board and Chief Executive Officer, Mark Munro, The DreamTeamGroup and MissionIR, as purported securities advertisers and investor relations firms, and John Mylant, a purported investor and investment advisor. The complaint was purportedly filed on behalf of a class of certain persons who purchased our common stock between November 5, 2013 and March 17, 2014. The complaint alleged violations by the defendants (other than Mark Munro) of Section 10(b) of the Exchange Act, and other related provisions in connection with certain alleged courses of conduct that were intended to deceive the plaintiff and the investing public and to cause the members of the purported class to purchase shares of our common stock at artificially inflated prices based on untrue statements of a material fact or omissions to state material facts necessary to make the statements not misleading. The complaint also alleged that Mr. Munro and our company violated Section 20 of the Exchange Act as controlling persons of the other defendants. The complaint seeks unspecified damages, attorney and expert fees, and other unspecified litigation costs.

 

On November 3, 2014, the United States District Court for the District of New Jersey issued an order appointing Robbins Geller Rudman & Dowd LLP as lead plaintiffs’ counsel and Cohn Lifland Pearlman Herrmann & Knopf LLP as liaison counsel for the pending actions. The lead plaintiff filed an amended complaint in January 2015 adding additional third-party defendants. We filed a motion to dismiss the amended complaint in late January 2015 and the plaintiffs filed a second amended complaint in early March 2015. We filed a motion to dismiss the second amended complaint on March 13, 2015. Our motion to dismiss was denied by the Court on October 29, 2015. On June 2, 2016, the plaintiffs filed a motion for class certification, to which we filed a reply in opposition on August 2, 2016. The court held oral argument on the class certification motion on January 13, 2017, and on February 16, 2017, the parties entered into a stipulation, which was approved by the court on February 23, 2017, that sets forth a schedule for expert reports, additional briefing on class certification and conclusion of fact discovery on May 12, 2017. The parties are currently engaged in discovery and additional class certification briefing.

 

Derivative Actions. In January 2016, a derivative compliant entitled Michael E. Sloan, derivatively and on behalf of InterCloud Systems, Inc. v. Mark Munro, Mark F. Durfee, Charles K. Miller, Neal Oristano, Daniel J. Sullivan, Roger M. Ponder, Lawrence M. Sands, Frank Jadevia, and Scott Davis, Defendants, and InterCloud Systems, Inc., Nominal Defendant, Case No. 11878 (DE Chancery) was filed in the Delaware Chancery Court. This action arises out of the same conduct at issue in the purported class action lawsuit. In the complaint, nominal plaintiff alleges that the individual defendants breached their fiduciary duty as directors and officers, abused control, grossly mismanaged, and unjustly enriched themselves by having knowingly hired a stock promotion firm that caused analyst reports to be disseminated that falsely stated they were not paid for by such stock promotion firm and our company, and were written on behalf of our company for the purpose of promoting our company and driving up its stock price. Plaintiffs seek unspecified damages, amendments to our articles of incorporation and by-laws, disgorgement from the individual defendants and costs and disbursements in the action. The defendants agreed to accept service on March 21, 2016 and counsel are negotiating a schedule to answer, move to dismiss or otherwise respond to the complaint. The parties are currently engaged in discovery.

  

In June 2016, a derivative compliant entitled Wasseem Hamdan, derivatively and on behalf of InterCloud Systems, Inc. v. Mark Munro, Mark F. Durfee, Charles K. Miller, Neal Oristano, and Roger M. Ponder, Defendants, and InterCloud Systems, Inc., Nominal Defendant, Case No.: 3:16-cv-03706 (D.N.J.) was filed in the New Jersey Federal District Court. This action arises out of the same conduct at issue in the purported class action lawsuit. In the complaint, nominal plaintiff alleges that the individual defendants breached their fiduciary duty as directors and officers, grossly mismanaged, and unjustly enriched themselves during the relevant period (December 2013 to the present) by having knowingly hired a stock promotion firm that caused analyst reports to be disseminated that falsely stated they were not paid for by such stock promotion firm and our company, and were written on behalf of us for the purpose of promoting our company and driving up its stock price. Plaintiffs seek unspecified damages, amendments to our company’s articles of incorporation and by-laws, disgorgement from the individual defendants and costs and disbursements in the action. On February 10, 2017, plaintiffs filed a motion to consolidate this action with the derivative action described below. The court has not yet ruled on the consolidation motion, which is uncontested. It is anticipated that a consolidated amended derivative complaint will be filed.

 

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In July 2016, a derivative compliant entitled John Scrutchens, derivatively and on behalf of InterCloud Systems, Inc. v. Mark E. Munro, Mark F. Durfee, Charles K. Miller, Neal Oristano, and Roger Ponder, Defendants, and InterCloud Systems, Inc., Nominal Defendant, Case No.: 3:16-CV-04207-FLW-DEA (D.N.J.) was filed in the United States Federal District Court for the District of New Jersey. This action arises out of the same conduct at issue in the purported class action lawsuit filed against our company. In the complaint, nominal plaintiff alleges that the individual defendants violated Section 14(a) of the Securities Exchange Act of 1934, as amended, and Rule 14a-9 promulgated thereunder because in exercising reasonable care as directors of our company, the defendants knew or should have known that statements contained in our proxy statements for our annual stockholders’ meetings held in 2013 and 2014 were false and misleading in that such proxy statements (i) omitted material information regarding, among other wrongdoings, the purported wrongdoings of the defendants that generally are at issue in the purported class action lawsuit filed against us and the other derivative actions filed against the defendants, and (ii) included by reference materially false and misleading financial statements. Plaintiffs seek unspecified damages, amendments to our corporate governance and internal procedures to comply with applicable laws and to protect our company and our stockholders from a repeat of the purported wrongdoings of the defendants, punitive damages from the individual defendants, disgorgement from the individual defendants and costs and disbursements in the action. As discussed above, on February 10, 2017, plaintiffs in the derivative action described above filed a motion to consolidate that action with this derivative action. The court has not yet ruled on the consolidation motion, which is uncontested. It is anticipated that a consolidated amended derivative complaint will be filed.

 

We intend to dispute these claims and to defend these litigations vigorously. However, due to the inherent uncertainties of litigation, the ultimate outcome of each of these litigations is uncertain. An unfavorable outcome in either litigation could materially and adversely affect our business, financial condition and results of operations.

 

SEC Subpoenas

 

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

 

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

 

We are unaware of the scope or timing of the SEC’s investigation. As a result, we do not know how the SEC investigation is proceeding, when the investigation will be concluded, or what action, if any, might be taken in the future by the SEC or its staff as a result of the matters that are the subject of its investigation. We are seeking to cooperate with the SEC in its investigation.

 

Other

 

Currently, there is no material litigation pending against our company other than as disclosed in the paragraphs above. From time to time, we may become a party to litigation and subject to claims incident to the ordinary course of our business. Although the results of such litigation and claims in the ordinary course of business cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, results of operations or financial condition. Regardless of outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.

 

As of December 31, 2016, no accruals for loss contingencies have been recorded as the outcomes of these cases are neither probable nor reasonably estimable.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not Applicable.

 

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PART II

 

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

 

Market Information

 

Our common stock trades under the symbol “ICLD”. Through October 5, 2016, our common stock traded on the Nasdaq Capital Market. Since October 6, 2016, our common stock has traded on the OTCQB Venture Market. The following table sets forth, for the periods indicated, the high and low sales price of our common stock as reported on the Nasdaq Capital Market prior to October 6, 2016, and the high and low bid price of our common stock on the OTCQB Venture Market on and after October 6, 2016. The quotations on the OTCQB Venture Market reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not necessarily represent actual transactions. 

 

    High     Low  
Fiscal Year Ended December 31, 2015            
First Quarter   $ 3.00     $ 2.03  
Second Quarter   $ 4.73     $ 1.45  
Third Quarter   $ 2.79     $ 1.65  
Fourth Quarter   $ 1.85     $ 0.94  
                 
Fiscal Year Ended December 31, 2016                
First Quarter   $ 1.17     $ 0.42  
Second Quarter   $ 1.14     $ 0.65  
Third Quarter   $ 0.75     $ 0.09  
Fourth Quarter   $ 0.12     $ 0.03  

 

Holders

 

At February 28, 2017, we had approximately 471 record holders of our common stock. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers or registered clearing agencies.

 

Transfer Agent and Registrar

 

We have appointed Corporate Stock Transfer, 3200 Cherry Creek Dr. South, Denver, CO 80209 to act as the transfer agent of our common stock.

 

Dividend Policy

 

We currently intend to retain future earnings, if any, for use in the operation of our business and to fund future growth. We have never declared or paid cash dividends on our common stock and we do not intend to pay any cash dividends on our common stock for the foreseeable future. The terms of our outstanding convertible debentures prohibit our payment of cash dividends. Any future determination related to our dividend policy will be made at the discretion of our board of directors in light of conditions then-existing, including factors such as our results of operations, financial conditions and requirements, business conditions and covenants under any applicable contractual arrangements.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table summarizes the number of shares of our common stock authorized for issuance under our 2012 Performance Incentive Plan and 2015 Performance Incentive Plan as of December 31, 2016, which were our only equity compensation plans at such date.

 

    (a)     (b)     (c)  
Plan Category   Number of Securities to be Issued Upon Exercise of Outstanding
Options
    Weighted-Average Exercise Price
of
Outstanding
Options
    Number of
Securities
Remaining
Available for
Future Issuance
Under Equity
Compensation
Plans (excluding
securities
reflected in
column(a))
 
Equity compensation plans approved by security holders     175,000     $ 3.72       1,453,565  

 

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Unregistered Sales of Equity Securities

 

In the fourth quarter of 2016, we issued securities in the following transactions, each of which was exempt from the registration requirements of the Securities Act. Except for the shares of our common stock that were issued upon the conversion of our convertible debt securities or the grants of shares of common stock under our 2012 Performance Incentive Plan, all of the below-referenced securities were issued pursuant to the exemption from registration under Section 4(2) of the Securities Act and are deemed to be restricted securities for purposes of the Securities Act. There were no underwriters or placement agents employed in connection with any of these transactions. Use of the exemption provided in Section 4(2) for transactions not involving a public offering is based on the following facts:

 

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

 

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

 

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

 

In October 2016, we issued an aggregate of 3,102,298 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $196. The shares were issued at average fair value of $0.06 per share, per the terms of the agreements.

 

In October 2016, we issued an aggregate of 3,605,440 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $226. The shares were issued at average fair value of $0.06 per share, per the terms of the agreements.

 

In October 2016, we issued an aggregate of 2,253,000 shares of common stock to a related-party lender in satisfaction of notes payable aggregating $156. The shares were issued at average fair value of $0.07 per share, per the terms of the agreements.

 

In November 2016, we issued an aggregate of 6,667,765 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $224. The shares were issued at average fair value of $0.03 per share, per the terms of the agreements.

 

In November 2016, we issued an aggregate of 7,550,872 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $301. The shares were issued at average fair value of $0.04 per share, per the terms of the agreements.

 

In November 2016, we issued an aggregate of 3,989,000 shares of common stock to a related-party lender in satisfaction of notes payable aggregating $182. The shares were issued at average fair value of $0.05 per share, per the terms of the agreements.

 

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In December 2016, we issued an aggregate of 16,496,044 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $268. The shares were issued at average fair value of $0.02 per share, per the terms of the agreements.

 

In December 2016, we issued an aggregate of 5,759,782 shares of common stock to JGB Concord and JGB Waltham in satisfaction of notes payable and accrued interest aggregating $191. The shares were issued at average fair value of $0.03 per share, per the terms of the agreements.

 

In December 2016, we issued an aggregate of 12,723,340 shares of common stock to a related-party lender in satisfaction of notes payable aggregating $439. The shares were issued at average fair value of $0.03 per share, per the terms of the agreements.

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following tables set forth selected consolidated financial data for our company for the years ended December 31, 2016 and 2015 that was derived from our audited consolidated financial statements included elsewhere in this report. The financial data set forth below should be read in conjunction with, and are qualified in their entirety by, reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our historical financial statements and related notes included elsewhere in this report. All dollar amounts are presented in thousands with the exception of share and per share data.

 

    For the years ended  
    December 31,  
    2016     2015  
Statement of Operations Data:            
             
Revenues   $ 78,000     $ 74,108  
Gross profit     19,805       20,244  
Operating expenses     38,429       46,190  
Loss from operations     (18,624 )     (25,946 )
Total other expense     (8,106 )     (25,934 )
Loss from continuing operations before benefit from income taxes     (26,730 )     (51,880 )
Provision for (benefit from) income taxes     207       (1,345 )
Gain (loss) from discontinued operations, net of tax     465       (15,124 )
Net loss attributable to common stockholders     (26,483 )     (65,762 )
Net loss per share, basic   $ (0.63 )   $ (3.05 )
Net loss per share, diluted   $ (0.63 )   $ (3.05 )
Basic weighted average shares outstanding     41,946,410       21,520,885  
Diluted weighted average shares outstanding     41,946,410       21,520,885  

 

    As of December 31,  
    2016     2015  
Balance Sheet Data:            
             
Cash   $ 1,790     $ 7,944  
Accounts receivable, net     13,952       16,616  
Total current assets     18,389       28,553  
Goodwill and intangible assets, net     35,391       40,371  
Total assets     54,569       92,231  
                 
Total current liabilities     57,802       39,951  
Long-term liabilities     12,810       56,480  
Stockholders' (deficit) equity     (16,043 )     (4,200 )

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

This management’s discussion and analysis of financial condition and results of operations contains certain statements that are forward-looking in nature relating to our business, future events or our future financial performance. Prospective investors are cautioned that such statements involve risks and uncertainties and that actual events or results may differ materially from the statements made in such forward-looking statements. In evaluating such statements, prospective investors should specifically consider the various factors identified in this report, including the matters set forth under Item 1A “Risk Factors,” which could cause actual results to differ from those indicated by such forward-looking statements.

 

We are a single-source provider of end-to-end IT and next-generation network solutions to the telecommunications service provider (carrier) and corporate enterprise markets through legacy managed services, cloud managed services and professional services. We believe our market advantages center around our next-generation virtualized network orchestration software platform and services portfolio. . As a next-generation network services provider, we add value by enabling customers to dynamically spool up their growing number of applications on VM’s and with virtualized network functions while helping to contain costs. Customers now demand a partner that can provide end-to-end IT solutions, that offers the customer the ability to move IT expenditures from capital costs to operating costs, and that offers the customer greater elasticity and the ability to rapidly deploy enterprise applications.

Telecommunications providers and enterprise customers continue to seek and outsource solutions in order to reduce their investment in capital equipment, provide flexibility in workforce sizing and expand product offerings without large increases in incremental hiring. As a result, we believe there is significant opportunity to expand both our United States and international telecommunications solutions services and staffing services capabilities. As we continue to expand our presence in the marketplace, we will target those customers going through new network deployments and wireless service upgrades.

   

We expect to continue to increase our gross margins by leveraging our single-source end-to-end network to efficiently provide a full spectrum of end-to-end IT and next-generation network solutions and staffing services to our customers. We believe our solutions and services offerings can alleviate some of the inefficiencies typically present in our industry, which result, in part, from the highly-fragmented nature of the telecommunications industry, limited access to skilled labor and the difficulty industry participants have in managing multiple specialty-service providers to address their needs. As a result, we believe we can provide superior service to our customers and eliminate certain redundancies and costs for them. We believe our ability to address a wide range of end-to-end solutions, network infrastructure and project-staffing service needs of our telecommunications industry clients is a key competitive advantage. Our ability to offer diverse technical capabilities (including design, engineering, construction, deployment, and installation and integration services) allows customers to turn to a single source for those specific specialty services, as well as to entrust us with the execution of entire turn-key solutions.

 

As a result of our recent acquisitions, we have become a multi-faceted company with an international presence. We believe this platform will allow us to leverage our corporate and other fixed costs and capture gross margin benefits. Our platform is highly scalable. We typically hire workers to staff projects on a project-by-project basis and our other operating expenses are primarily fixed. Accordingly, we are generally able to deploy personnel to infrastructure projects in the United States and beyond without incremental increases in operating costs, allowing us to achieve greater margins. We believe this business model enables us to staff our business efficiently to meet changes in demand.

 

Finally, given the worldwide popularity of telecommunications and wireless products and services, we may selectively pursue international expansion, which we believe represents a compelling opportunity for additional long-term growth.

 

Our planned expansion will place increased demands on our operational, managerial, administrative and other resources. Managing our growth effectively will require us to continue to enhance our operations management systems, financial and management controls and information systems and to hire, train and retain skilled telecommunications personnel. The timing and amount of investments in our expansion could affect the comparability of our results of operations in future periods.

 

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Our recent and planned acquisitions have been and will be timed with additions to our management team of skilled professionals with deep industry knowledge and a strong track record of execution. Our senior management team brings an average of over 25 years of individual experience across a broad range of disciplines. We believe our senior management team is a key driver of our success and is well-positioned to execute our strategy.

 

We were incorporated in 1999, but functioned as a development stage company with limited activities through December 2009. Until September 2012, substantially all of our revenue came from our specialty contracting services. In September 2012, we acquired ADEX and TNS and in April 2013, we acquired AW Solutions.

 

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

 

With the acquisitions of IPC and RentVM, we re-evaluated our operating subsidiaries and determined that the IPC and RentVM divisions should be aggregated into one of three reporting segments based on their economic characteristics, products, production methods and distribution methods. The results of operations of IPC and RentVM are categorized within the managed services segment.

  

During 2016 and 2015, we experienced continued operating losses in our managed services segment due to investments we made in our cloud-based products. As a result, during 2016 and 2015, we recorded intangible asset impairment expense of $3.5 million and $0.7 million, respectively, and goodwill impairment expense of $1.1 million and $10.9 million, respectively.

 

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

 

During 2015, we evaluated the results of our former PCS Holdings LLC (“Axim”) subsidiary, which was included in our former cloud services segment, and determined that actual revenues were not meeting our forecasted revenues. As a result, we recorded intangible asset impairment expense of $0.03 million and goodwill impairment expense of $2.0 million. We sold Axim during April 2016. As a result of the sale, the intangible asset and goodwill impairment expenses related to this entity are recorded in loss on discontinued operations for the year ending December 31, 2015. 

 

Our revenue increased from $74.1 million for the year ended December 31, 2015 to $78.0 million for the year ended December 31, 2016. Our net loss attributable to common stockholders decreased from $65.8 million for the year ended December 31, 2015 to $26.5 million for the year ended December 31, 2016. As of December 31, 2016, our stockholders’ deficit was $16.0 million.

 

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A significant portion of our services are performed under master service agreements and other arrangements with customers that extend for periods of one or more years. We are currently party to numerous master service agreements, and typically have multiple agreements with each of our customers. Master service agreements generally contain customer-specified service requirements, such as discreet pricing for individual tasks. To the extent that such contracts specify exclusivity, there are often a number of exceptions, including the ability of the customer to issue work orders valued above a specified dollar amount to other service providers, perform work with the customer’s own employees and use other service providers when jointly placing facilities with another utility. In most cases, a customer may terminate an agreement for convenience with written notice. The remainder of our services are provided pursuant to contracts for specific projects. Long-term contracts relate to specific projects with terms in excess of one year from the contract date. Short-term contracts for specific projects are generally of three to four months in duration.

 

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

 

    Year Ended December 31,  
    2016     2015  
Multi-year master service agreements and long-term contracts     23 %     36 %

 

The percentage of revenue from long-term contracts varies between periods depending on the mix of work performed under our contracts. All revenues derived from master service agreements are from customers that are serviced by our applications and infrastructure and professional services segments. The decline in the percentage of revenues from multi-year master service agreements is due to increases in revenue of our professional services segment, which does not derive revenues from multi-year master service agreements.

 

A significant portion of our revenue typically comes from one large customer within the professional services segment. The following table reflects the percentage of total revenue from our only customer that contributed at least 10% to our total revenue in either of the years ended December 31, 2016 or 2015:

 

    Year ended December 31,  
    2016     2015  
Ericsson, Inc.     *         14 %

 

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

 

Factors Affecting Our Performance

 

Changes in Demand for Data Capacity and Reliability.

 

Advances in technology architectures have supported the rise of cloud computing, which enables the delivery of a wide variety of cloud-based services.in a outsourced managed service environment Today, mission-critical applications can be delivered reliably, securely and cost-effectively to our customers over the internet without the need to purchase supporting hardware, software or ongoing maintenance. The lower total cost of ownership, better functionality and flexibility of cloud solutions represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting outsourced cloud services to rapidly deploy and integrate applications without building out their own expensive infrastructure and to minimize the growth of their own IT departments and create business agility by taking advantage of accelerated time-to-market dynamics.

 

The telecommunications industry has undergone and continues to undergo significant changes due to advances in technology, increased competition as telephone and cable companies converge, the growing consumer demand for enhanced and bundled services and increased governmental broadband stimulus funding. As a result of these factors, the networks of our customers increasingly face demands for more capacity and greater reliability. Telecommunications providers continue to outsource a significant portion of their engineering, construction and maintenance requirements in order to reduce their investment in capital equipment, provide flexibility in workforce sizing, expand product offerings without large increases in incremental hiring and focus on those competencies they consider core to their business success. These factors drive customer demand for our services.

 

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The proliferation of smart phones and other wireless data devices has driven demand for mobile broadband. This demand and other advances in technology have prompted wireless carriers to upgrade their networks. Wireless carriers are actively increasing spending on their networks to respond to the explosion in wireless data traffic, upgrade network technologies to improve performance and efficiency and consolidate disparate technology platforms. These customer initiatives present long-term opportunities for us for the wireless services we provide. Further, the demand for mobile broadband has increased bandwidth requirements on the wired networks of our customers. As the demand for mobile broadband grows, the amount of cellular traffic that must be “backhauled” over customers’ fiber and coaxial networks increases and, as a result, carriers are accelerating the deployment of fiber optic cables to cellular sites. These trends are increasing the demand for the types of services we provide.

 

Our Ability to Recruit, Manage and Retain High-Quality IT and Telecommunications Personnel.

 

The shortage of skilled labor in the telecommunications industry and the difficulties in recruiting and retaining skilled personnel can frequently limit the ability of specialty contractors to bid for and complete certain contracts. In September 2012, we acquired ADEX, an IT and telecommunications staffing firm. Through ADEX, we manage a database of more than 70,000 IT and telecom personnel, which we use to locate and deploy skilled workers for projects. We believe our access to a skilled labor pool gives us a competitive edge over our competitors as we continue to expand.

 

Our Ability to Integrate Our Acquired Businesses and Expand Internationally.

 

We have completed seven material acquisitions and one material divestiture since January 1, 2012 and may consummate additional acquisitions and divestures in the near term. Our success will depend, in part, on our ability to successfully integrate our acquired businesses into our global IT and telecommunications platform. In addition, we believe international expansion represents a compelling opportunity for additional growth over the long-term because of the worldwide need for IT and telecommunications infrastructure. Our AW Solutions operations in Puerto Rico generated approximately $0.9 million of revenue during 2016. Additionally, our ADEX operations in Puerto Rico generated approximately $0.4 million during 2016. We plan to expand our global presence either by expanding our current operations or by acquiring subsidiaries with international platforms.

 

Our Ability to Expand and Diversify Our Customer Base.

 

Our customers for specialty contracting services consist of leading telephone, wireless, cable television and data companies. Ericsson Inc. is our principal telecommunications staffing services customer. Historically, our revenue has been significantly concentrated in a small number of customers. Although we still operate at a net loss, our revenue in recent years has increased as we have acquired additional subsidiaries and diversified our customer base and revenue streams. The percentage of our revenue attributable to our top 10 customers, as well as our only customer that contributed at least 10% of our revenue in at least one of the years specified in the following table, were as follows:

 

    Year ended December 31,  
    2016     2015  
Top 10 customers, aggregate     48 %     55 %
Customer:                
Ericsson, Inc.     *       14 %

 

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

 

Business Unit Transitions.

 

Since January 1, 2012, we have acquired seven material companies and sold one material company. We acquired these businesses to either enhance certain of our existing business units or allow us to gain market share in new lines of business. For example, our acquisition of TNS in September 2012 extended the geographic reach of our structured cabling and digital antenna system services. Our acquisition of AW Solutions in April 2013 broadened our suite of services and added new customers to which we can cross-sell our other services. Our acquisition of IPC in January 2014 improved our systems integration capabilities.

 

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We intend to operate all of the companies we acquire in a decentralized model in which the management of the companies will remain responsible for daily operations while our senior management will utilize their deep industry expertise and strategic contacts to develop and implement growth strategies and leverage top-line and operating synergies among the companies, as well as provide overall general and administrative functions.

 

We expect the companies we acquire to facilitate geographic diversification that should protect against regional cyclicality. We believe our diverse platform of services, capabilities, customers and geographies will enable us to grow as the market continues to evolve.

 

The table below summarizes the revenues for each of our reportable segments in the years ended December 31, 2016 and 2015.

 

    Year ended December 31,  
    2016     2015  
Revenue from:            
Applications and infrastructure   $ 22,173     $ 21,263  
Professional services   $ 36,937     $ 26,655  
Managed services   $ 18,890     $ 26,190  
As a percentage of total revenue:                
Applications and infrastructure     29 %     29 %
Professional services     47 %     36 %
Managed services     24 %     35 %

 

Impact of Recently-Completed Acquisitions

 

We have grown significantly and expanded our service offerings and geographic reach through a series of strategic acquisitions. Since January 1, 2012, we have completed seven material acquisitions and one material divestiture. We expect to regularly review opportunities, and periodically to engage in discussions, regarding possible additional acquisitions and divestitures. Our ability to sustain our growth and maintain our competitive position may be affected by our ability to identify, acquire and successfully integrate companies.

 

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Emerging Growth Company

 

On April 5, 2012, the Jumpstart Our Business Startups Act, or the JOBS Act, was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company,” we may delay adoption of new or revised accounting standards applicable to public companies until the earlier of the date that (i) we are no longer an emerging growth company or (ii) we affirmatively and irrevocably opt out of the extended transition period for complying with such new or revised accounting standards. We have elected not to take advantage of the benefits of this extended transition period. As a result, our financial statements will be comparable to those of companies that comply with such new or revised accounting standards. Upon issuance of new or revised accounting standards that apply to our financial statements, we will disclose the date on which we will adopt the recently-issued accounting guidelines.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based on our historical consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make certain estimates and assumptions that affect the amounts reported therein and accompanying notes. On an ongoing basis, we evaluate these estimates and assumptions, including those related to recognition of revenue for costs, the fair value of reporting units for goodwill impairment analysis, the assessment of impairment of intangibles and other long-lived assets, income taxes, asset lives used in computing depreciation and amortization, allowance for doubtful accounts, stock-based compensation expense, contingent consideration and accruals for contingencies, including legal matters. These estimates and assumptions require the use of judgment as to the likelihood of various future outcomes and as a result, actual results could differ materially from these estimates.

 

We have identified the accounting policies below as critical to the accounting for our business operations and the understanding of our results of operations because they involve making significant judgments and estimates that are used in the preparation of our historical consolidated financial statements. The impact of these policies affects our reported and expected financial results and are discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have discussed the development, selection and application of our critical accounting policies with the Audit Committee of our board of directors, and the Audit Committee has reviewed the disclosure relating to our critical accounting policies in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed below, are also important to understanding our historical consolidated financial statements. The notes to our consolidated financial statements in this report contain additional information related to our accounting policies, including the critical accounting policies described herein, and should be read in conjunction with this discussion.

 

Revenue Recognition.

 

Our revenues are generated from three reportable segments, applications and infrastructure, professional services and managed services. We recognize revenue on arrangements in accordance with ASC Topic 605-10, “ Revenue Recognition ”. We recognize revenue only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.

 

The applications and infrastructure segment is comprised of TNS, Tropical, AW Solutions and RM Engineering. Applications and infrastructure service revenue is derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. The contracts of TNS, Tropical and RM Engineering provide that payment for our services may be based on either (i) direct labor hours at fixed hourly rates or (ii) fixed-price contracts. The services provided under the contracts are generally provided within one month. Occasionally, the services may be provided over a period of up to six months.

 

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AW Solutions, which included 8760 Enterprises from September 14, 2016 through December 31, 2016, generally recognizes revenue using the percentage of completion method. Revenues and fees on these contracts were recognized utilizing the efforts-expended method, which used measures such as task duration and completion. The efforts-expended approach is an input method used in situations where it is more representative of progress on a contract than the cost-to-cost or the labor-hours methods. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. Changes in job performance conditions and final contract settlements may result in revisions to costs and income, which are recognized in the period in which revisions are determined.

 

AW Solutions also generates revenue from service contracts with certain customers. These contracts are accounted for under the proportional performance method. Under this method, revenue is recognized as projects within contracts are completed as of each reporting date. 

 

The revenues of our professional services segment, which is comprised of our ADEX subsidiaries and SDNE, are derived from contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. The contracts provide that payments made for our services may be based on either (i) direct labor hours at fixed hourly rates or (ii) fixed-price contracts. The services provided under these contracts are generally provided within a month. Occasionally, the services may be provided over a period of up to four months. If it is anticipated that the services will span a period exceeding one month, depending on the contract terms, we will provide either progress billing at least once a month or upon completion of the clients’ specifications. The aggregate amount of unbilled work-in-progress recognized as revenues was insignificant at December 31, 2016 and 2015.

 

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

 

Our applications and infrastructure and managed services segments sometimes require customers to provide a deposit prior to beginning work on a project. When this occurs, the deposit is recorded as deferred revenue and is recognized in revenue when the work is complete.

 

The revenues of our managed services segment are derived primarily from the operations of IPC. Our IPC subsidiary is a value-added reseller, the revenues of which are generated from the resale of voice, video and data networking hardware and software contracted services for design, implementation and maintenance services for voice, video and data networking infrastructure. IPC’s customers are higher education organizations, governmental agencies and commercial customers. IPC also provides maintenance and support, resells maintenance and support and provides professional services. For certain maintenance contracts, IPC assumes responsibility for fulfilling the support to customers and recognizes the associated revenue either on a ratable basis over the life of the contract or, if a customer purchases a time and materials maintenance program, as maintenance is provided to the customer. Revenue for the sale of third-party maintenance contracts is recognized net of the related cost of revenue. In a maintenance contract, all services are provided by our third-party providers and as a result, we concluded that we are acting as an agent and recognize revenue on a net basis at the date of sale with revenue being equal to the gross margin on the transaction. As IPC is under no obligation to perform additional services, revenue is recognized at the time of sale as opposed to over the life of the maintenance agreement.

 

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

 

Our former VaultLogix subsidiary, which was sold in February 2016, provided cloud-based on-line data backup services to its customers. Certain customers paid for their services before service began. Revenue for these customers was deferred until the services were performed. As of December 31, 2015, VaultLogix did not have any material customers that paid for their services before service began. For all services, VaultLogix recognized revenue when services were provided, evidence of an arrangement existed, fees were fixed or determinable and collection was reasonably assured.

 

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Allowance for Doubtful Accounts.

 

We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. Management analyzes the collectability of accounts receivable balances each period. This analysis considers the aging of account balances, historical bad debt experience, changes in customer creditworthiness, current economic trends, customer payment activity and other relevant factors. Should any of these factors change, the estimate made by management may also change, which could affect the level of our future provision for doubtful accounts. We recognize an increase in the allowance for doubtful accounts when it is probable that a receivable is not collectable and the loss can be reasonably estimated. Any increase in the allowance account has a corresponding negative effect on our results of operations. We believe that none of our significant customers were experiencing financial difficulties that would materially impact our trade accounts receivable or allowance for doubtful accounts as of December 31, 2016 and 2015.

 

Goodwill and Intangible Assets

 

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

 

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

 

Derivative Financial Instruments

 

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

 

We record the fair value of our financial instruments classified as liabilities at each subsequent measurement date. The changes in fair value of our financial instruments classified as liabilities are recorded as other expense/income. We have historically utilized a Black-Scholes option pricing model to determine the fair value of the derivative liability related to the warrants and the put and effective price of future equity offerings of equity-linked financial instruments. During the quarter ended September 30, 2015, we determined that we should utilize a binomial lattice pricing model to determine the fair value of the derivative liability related to the warrants and the put and effective price of future equity offerings of equity-linked financial instruments. We have evaluated our derivative instruments and determined that the value of those derivative instruments, whether using a binomial lattice pricing model instead of a Black-Scholes pricing model, would be immaterial on our historical consolidated statements of operations for the years ended December 31, 2016 and 2015, respectively. The Monte Carlo simulation is used to determine the fair value of derivatives for instruments with embedded conversion features.

  

Stock-Based Compensation.  

 

Our stock-based award programs are intended to attract, retain and reward employees, officers, directors and consultants, and to align stockholder and employee interests. We granted stock-based awards to individuals in each of 2016 and 2015. Our policy going forward will be to issue awards under our 2015 Employee Incentive Plan and Employee Stock Purchase Plan. 

 

Compensation expense for stock-based awards is based on the fair value of the awards at the measurement date and is included in operating expenses. The fair value of stock option grants is estimated on the date of grant using the Black-Scholes option pricing model based on certain assumptions including: expected volatility based on the historical price of our stock over the expected life of the option, the risk-free rate of return based on the United States treasury yield curve in effect at the time of the grant for the expected term of the option, the expected life based on the period of time the options are expected to be outstanding using historical data to estimate option exercise and employee termination; and dividend yield based on history and expectation of dividend payments. Stock options generally vest ratably over a three-year period and are exercisable over a period of up to ten years. 

 

The fair value of restricted stock is estimated on the date of grant and is generally equal to the closing price of our common stock on that date. The price of our common stock price has varied greatly during the years ended December 31, 2016 and 2015. Some of the factors that influenced the market price of our stock during those periods included: 

 

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

 

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The total amount of stock-based compensation expense ultimately is based on the number of awards that actually vest, as well as the vesting period of all stock-based awards. Accordingly, the amount of compensation expense recognized during any fiscal year may not be representative of future stock-based compensation expense. 

 

The following tables summarize our stock-based compensation for the years ended December 31, 2016 and 2015. 

 

    Year Ended December 31, 2016
Date   Vesting Terms   Shares of Common Stock     Closing Stock Price on Grant Date     Fair Value Per Share     Fair Value of Instrument Granted  
                             
7/5/2016   6 months     200,357     $ 0.68     $ 0.68     $ 136,062  
7/5/2016   Three years     67,500       0.68       0.68       45,839  
7/20/2016   Vest 6/30/2017     412,500       0.58       0.58       238,425  
7/20/2016   Three years     200,000       0.58       0.58       115,600  
7/20/2016   No Vesting     57,142       0.58       0.58       33,028  
7/20/2016   Vest 1/1/2017     100,000       0.58       0.58       57,800  
7/20/2016   6 month Vesting     714,000       0.58       0.58       412,692  
7/27/2016   Vest 12/31/2017     75,000       0.51       0.51       37,875  
7/27/2016   6 month Vesting     64,814       0.51       0.51       32,731  

 

    Year Ended December 31, 2015
Date   Vesting Terms   Shares of Common Stock     Closing Stock Price on Grant Date     Fair Value Per Share     Fair Value of Instrument Granted  
                             
1/27/2015   Three years     90,000     $ 2.53     $ 2.53     $ 227,700  
1/27/2015   6 months     25,000       2.53       2.53       63,250  
1/27/2015   No Vesting     12,000       2.53       2.53       30,360  
2/13/2015   Three years     89,000       2.87       2.87       255,430  
4/10/2015   Three years     849,031       1.98       1.98       1,681,081  
4/10/2015   No Vesting     565,626       1.98       1.98       1,119,939  
6/23/2015   Three years     338,500       2.92       2.92       988,420  
6/23/2015   No Vesting     1,111,796       2.92       2.92       3,246,444  

 

Components of Results of Operations

 

Revenue.

 

    Year ended December 31,  
    2016     2015  
Revenue from:            
Applications and infrastructure   $ 22,173     $ 21,263  
Professional services   $ 36,937     $ 26,655  
Managed services   $ 18,890     $ 26,190  
As a percentage of total revenue:                
Applications and infrastructure     29 %     29 %
Professional services     47 %     36 %
Managed services     24 %     35 %

 

Refer to the discussion below for further detail on changes in revenue by segment.

 

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Cost of Revenues.

 

Cost of revenues includes all direct costs of providing services under our contracts, including costs for direct labor provided by employees, services by independent subcontractors, operation of capital equipment (excluding depreciation and amortization), direct materials, insurance claims and other direct costs.

 

For a majority of the contract services we perform, our customers provide all required materials while we provide the necessary personnel, tools and equipment. Materials supplied by our customers, for which the customer retains financial and performance risk, are not included in our revenue or costs of revenues. We expect cost of revenues to continue to increase if we succeed in continuing to grow our revenue.

 

General and Administrative Costs.

 

General and administrative costs include all of our corporate costs, as well as costs of our subsidiaries’ management personnel and administrative overhead. These costs primarily consist of employee compensation and related expenses, including legal, consulting and professional fees, information technology and development costs, provision for or recoveries of bad debt expense and other costs that are not directly related to performance of our services under customer contracts. Information technology and development costs included in general and administrative expenses are primarily incurred to support and to enhance our operating efficiency. We expect these expenses to continue to generally increase as we expand our operations, but expect that such expenses as a percentage of revenues will decrease if we succeed in increasing revenues.

 

Goodwill and Indefinite Lived Intangible Assets.

 

Goodwill was generated through the acquisitions we have made since 2012. As the total consideration we paid for our completed acquisitions exceeded the value of the net assets acquired, we recorded goodwill for each of our completed acquisitions (see Note 7 of the Notes to our consolidated financial statements included in this report). At the date of acquisition, we performed a valuation to determine the value of the goodwill and intangible assets, along with the allocation of assets and liabilities acquired. The goodwill is attributable to synergies and economies of scale provided to us by the acquired entity.

 

We perform our annual impairment test at the reporting unit level, which is consistent with our operating segments. Our three reportable segments are applications and infrastructure, professional services and managed services. Professional services is comprised of the ADEX entities, applications and infrastructure is comprised of TNS, Tropical, AW Solutions and RM Engineering, the managed services operating segment is comprised of IPC. These reporting units are aggregated to form three operating segments and three reportable segments for financial reporting and for the evaluation of goodwill for impairment. As our business evolves and the acquired entities continue to be integrated, our operating segments may change. This may require us to reassess how goodwill at our reporting units are evaluated for impairment.

 

We perform the impairment testing at least annually (at October 1) or at other times if we believe that it is more likely than not that there may be an impairment to the carrying value of our intangible assets with indefinite lives and goodwill. If it is more likely than not that goodwill impairment exists, the second step of the goodwill impairment test should be performed to measure the amount of impairment loss, if any.

 

During the fourth quarter of 2015, we changed the date of our annual impairment test from December 31 to October 1. The change was made to more closely align the impairment testing date with our long-range planning and forecasting process. We believe the change in our annual impairment testing date did not delay, accelerate, or avoid an impairment charge. We have determined that this change in accounting principle is preferable under the circumstances and does not result in adjustments to our financial statements when applied retrospectively. 

 

We consider the results of an income approach and a market approach in determining the fair value of the reportable units. We evaluated the forecasted revenue using a discounted cash flow model for each of the reporting units. We also noted no unusual cost factors that would impact operations based on the nature of the working capital requirements of the components comprising the reportable units. Current operating results, including any losses, are evaluated by us in the assessment of goodwill and other intangible assets. The estimates and assumptions used in assessing the fair value of the reporting units and the valuation of the underlying assets and liabilities are inherently subject to significant uncertainties. Key assumptions used in the income approach in evaluating goodwill are forecasts for each of the reporting unit revenue growth rates along with forecasted discounted free cash flows for each reporting unit, aggregated into each reporting segment. For the market approach, we used the guideline public company method, under which the fair value of a business is estimated by comparing the subject company to similar companies with publicly-traded ownership interests. From these “guideline” companies, valuation multiples are derived and then applied to the appropriate operating statistics of the subject company to arrive at indications of value.

 

While we use available information to prepare estimates and to perform impairment evaluations, actual results could differ significantly from these estimates or related projections, resulting in impairment related to recorded goodwill balances. Additionally, adverse conditions in the economy and future volatility in the equity and credit markets could impact the valuation of our reporting units. We can provide no assurances that, if such conditions occur, they will not trigger impairments of goodwill and other intangible assets in future periods.

 

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Events that could cause the risk for impairment to increase are the loss of a major customer or group of customers, the loss of key personnel and changes to current legislation that may impact our industry or its customers’ industries.

 

With regard to other long-lived assets and intangible assets with indefinite-lives, we follow a similar impairment assessment. We will assess the quantitative factors to determine if an impairment test of the indefinite-lived intangible asset is necessary. If the quantitative assessment reveals that it is more likely than not that the asset is impaired, a calculation of the asset’s fair value is made. Fair value is calculated using many factors, which include the future discounted cash flows as well as the estimated fair value of the asset in an arm’s-length transaction.

 

We review finite-lived intangible assets for impairment whenever an event occurs or circumstances change that indicates that the carrying amount of such assets may not be fully recoverable. Recoverability is determined based on an estimate of undiscounted future cash flows resulting from the use of an asset and its eventual disposition. An impairment loss is measured by comparing the fair value of the asset to its carrying value. If we determine the fair value of an asset is less than the carrying value, an impairment loss is incurred. Impairment losses, if any, are reflected in operating income or loss in the consolidated statements of operations during the period incurred.

 

We evaluated the recoverability of our long-lived assets in the applications and infrastructure and professional services reporting segments using a two-step impairment process. The first step of the long-lived assets impairment test is to identify potential impairment by comparing the fair value of a segment with its net book value (or carrying amount), including long-lived assets. If the fair value of a segment exceeds its carrying amount, long-lived assets of the segment is considered not to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of the segment exceeds its fair value, the second step of the long-lived assets impairment test is performed to measure the amount of the impairment loss, if any. The second step of the long-lived assets impairment test compares the implied fair value of the segment’s long-lived assets with the carrying amount of that long-lived assets. If the carrying amount of the segment’s long-lived assets exceeds the implied fair value of that long-lived assets, an impairment loss is recognized in an amount equal to that excess. The implied fair value of long-lived assets is determined in the same manner as the amount of long-lived assets recognized in a business combination. That is, the fair value of the segment is allocated to all of the assets and liabilities of that segment (including any unrecognized intangible assets) as if the segment had been acquired in a business combination and the fair value of the segment was the purchase price paid to acquire the segment.

 

In order to determine the fair value of the customer relationships, we utilize an income approach known as excess earnings methodology. Excess earnings are computed as the projected earnings derived from the current customer base net of working capital on tangible and intangible fixed assets. Non-compete agreements are evaluated based on the probability of competition and the revenue that can potentially be generated from the agreements. The fair value of a corporate trade name is determined using the Relief from Royalty Method (“RFRM”), a variation of the “Income Approach”. The RFRM is used to estimate the cost savings that accrue to the owner of an intangible asset who would otherwise have to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate is based on empirical, market-derived royalty rates for guideline intangible assets when available. The royalty rate is applied to the projected revenue over the expected remaining life of the intangible asset to estimate the royalty savings. The net after-tax royalty savings are calculated for each year in the remaining economic life of the intangible asset and discounted to present value. Additionally, as part of the analysis, the operating income of the professional services segment is benchmarked to determine a range of royalty rates that would be reasonable based on a profit-split methodology. The profit-split methodology is based upon assumptions that the total amount of royalties paid for licensable intellectual property should approximate market conditions in order to determine a reasonable royalty rate to estimate the fair value of the corporate trade name. 

 

The first step of the goodwill impairment test is to identify potential impairment by comparing the fair value of a reporting unit with its net book value (or carrying amount), including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of the reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that reporting unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. 

 

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During the first three quarters of 2015, our managed services segment performed below forecasted revenues and did not achieve certain financial targets. We updated the forecast for the managed services segment, of which IPC is a reporting unit, based on the most recent financial results and best estimates of future operations. The updated forecast reflects slower growth in revenues for the managed services segment.

 

We evaluated the recoverability of our long-lived assets in the managed services reporting segment using a two-step impairment process. On October 1, 2015, we performed the two-step definite and indefinite lived intangible asset and goodwill impairment process and determined that the managed services reporting segment failed both tests. As a result, we performed an impairment analysis with respect to the carrying value of the intangible assets and goodwill in the managed services reporting segment. Based on the testing performed at October 1 and December 31, 2015, we recorded a non-cash impairment charge of $11.6 million related to the managed services reporting segment, of which $10.9 million related to goodwill and $0.7 million related to intangible assets.

 

During 2015, we committed to a plan to sell VaultLogix and its subsidiaries, Data Protection Services and US Data, to a third-party. We finalized the transaction in February 2016 and, as a result, we recorded intangible asset impairment expense of $0.4 million and goodwill impairment expense of $11.2 million. As a result of the sale, the operating results of these entities are recorded in loss on discontinued operations for the year ending December 31, 2015.

 

We sold Axim during April 2016. As a result of the sale, the intangible asset and goodwill impairment expenses related to this entity are recorded in loss on discontinued operations for the year ending December 31, 2015. 

 

During 2016, we evaluated the results of our RentVM subsidiary, which is included in our managed services segment. We determined that actual revenues were not meeting our forecasted revenues. As a result, we recorded intangible asset impairment expense of $3.5 million and goodwill impairment expense of $1.1 million. During 2015, we evaluated the results of our former Axim subsidiary, which was included in our former cloud services segment, and determined that actual revenues were not meeting our forecasted revenues. As a result, we recorded intangible asset impairment expense of $0.03 million and goodwill impairment expense of $2.0 million.

 

During the years ended December 31, 2016 and 2015, we also evaluated the results of the reporting units included in our applications and infrastructure and professional services segments and determined that these reporting units were not impaired. 

 

Fair Value of Embedded Derivatives.

 

We used a binomial lattice model as of December 31, 2016 and December 31, 2015 to determine the fair value of the derivative liability related to our outstanding warrants and the put and effective price of future equity offerings of equity-linked financial instruments. Based on our analysis, we derived the fair value of warrants using the common stock price, the exercise price of the warrants, the risk-free interest rate, the historical volatility, and our dividend yield. Prior to December 29, 2015, we did not have sufficient historical data to use our historical volatility; therefore we used a volatility based on the historical volatility of comparable companies. Beginning on December 29, 2015, we began using our historical volatility as we determined that, based on our trading history of two years, there was sufficient data available to begin using our historical volatility. We developed scenarios to take into account estimated probabilities of future outcomes. The fair value of the warrant liabilities is classified as Level 3 within our fair value hierarchy (see Note 9 of the Notes to our consolidated financial statements included in this report).

 

We have convertible debentures outstanding with institutional investors. The convertible debentures held by Forward Investments, JGB Capital and Dominion Capital are convertible at a discount to the average closing stock price on the days prior to the conversion. Between July 7, 2016 and December 31, 2016, these institutional investors converted $5,008 of debentures into 75,681,458 shares of common stock. These debentures are discussed in more detail at Note 11, Term Loans, in our historical financial statements.

  

The aggregate fair value of our derivative liabilities (both current and non-current liabilities) as of December 31, 2016 and 2015 amounted to $3.1 million and $17.5 million, respectively.

 

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Income Taxes.

 

In the years ended December 31, 2016 and 2015, we booked a current provision for state, local and foreign income taxes due of $0.1 million and $0.2 million, respectively. Certain states do not recognize net operating loss carryforwards, and we have operations in some of those states. For the year ended December 31, 2016, we booked a provision for deferred federal and state income taxes of $0.1 million and a total provision for income taxes of $0.2 million. The provision for state and local income taxes in the year ended December 31, 2015 was offset due to a benefit from deferred taxes of $1.5 million in the year ended December 31, 2015. This tax benefit was a result of our acquisition of IPC in 2014 and ADEX and T N S in 2012, which resulted in a deferred tax liability based on the value of the intangible assets acquired. This benefit was offset by the fact that ADEX and T N S were cash-basis taxpayers when they were acquired and were converted to accrual-basis taxpayers upon acquisition, which resulted in an increase in liability. As of December 31, 2016 and 2015, we had federal net operating loss carryforwards (NOLs) of $11.4 million and $65.2 million, respectively, which will be available to reduce future taxable income and expense through 2036. Utilization of the net operating loss and credit carryforwards is subject to an annual limitation due to the ownership percentage change limitations provided by Section 382 of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization. We have adjusted our deferred tax asset to record the expected impact of the limitations. 

 

Credit Risk.

 

We are subject to concentrations of credit risk relating primarily to our cash and equivalents, accounts receivable and other receivables. Cash and equivalents primarily include balances on deposit in banks. We maintain substantially all of our cash and equivalents at financial institutions we believe to be of high credit quality. To date, we have not experienced any loss or lack of access to cash in our operating accounts. 

 

We grant credit under normal payment terms, generally without collateral, to our customers. These customers primarily consist of telephone companies, cable broadband MSOs and electric and gas utilities. With respect to a portion of the services provided to these customers, we have certain statutory lien rights that may, in certain circumstances, enhance our collection efforts. Adverse changes in overall business and economic factors may impact our customers and increase potential credit risks. These risks may be heightened as a result of economic uncertainty and market volatility. In the past, some of our customers have experienced significant financial difficulties and, likewise, some may experience financial difficulties in the future. These difficulties expose us to increased risks related to the collectability of amounts due for services performed. We believe that none of our significant customers were experiencing financial difficulties that would materially impact the collectability of our trade accounts receivable as of December 31, 2016.

 

Contingent Consideration.

 

We recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree or assets of the acquiree in a business combination. The contingent consideration is classified as either a liability or equity in accordance with ASC 480-10 (“ Accounting for certain financial instruments with characteristics of both liabilities and equity” ). If classified as a liability, the liability is remeasured to fair value at each subsequent reporting date until the contingency is resolved. Increases in fair value are recorded as losses on our consolidated statement of operations, while decreases are recorded as gains. If classified as equity, contingent consideration is not remeasured and subsequent settlement is accounted for within equity.

 

Litigation and Contingencies.

 

Litigation and contingencies are reflected in our consolidated financial statements based on management’s assessment of the expected outcome of such litigation or expected resolution of such contingency. An accrual is made when the loss of such contingency is probable and reasonably estimable. If the final outcome of such litigation and contingencies differs significantly from our current expectations, such outcome could result in a charge to earnings.

 

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Results of Operations

 

Management believes that we will continue to incur losses for the immediate future. Therefore, we may need either additional equity or debt financing until we can achieve profitability and positive cash flows from operating activities, if ever. These conditions raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments relating to the recovery of assets or the classification of liabilities that may be necessary should we be unable to continue as a going concern. For the year ended December 31, 2016, we generated gross profits from operations, and we are trying to achieve positive cash flows from operations in future periods

 

The following table shows our results of operations for the years ended December 31, 2016 and 2015. The historical results presented below are not necessarily indicative of the results that may be expected for any future period. All dollar amounts are presented in thousands, except share and per share data.

 

    Year ended  
    December 31,  
    2016     2015  
Statement of Operations Data:            
             
Service revenue   $ 69,625     $ 58,233  
Product revenue     8,375       15,875  
Total revenue     78,000       74,108  
                 
Cost of revenue     58,195       53,864  
Gross profit     19,805       20,244  
                 
Operating expenses:                
Depreciation and amortization     2,113       3,385  
Salaries and wages     18,061       23,056  
General and administrative     13,682       10,410  
Goodwill impairment charges     1,114       10,907  
Intangible assets impairment charges     3,459       675  
Change in fair value of contingent consideration     -       (2,243 )
Total operating expenses     38,429       46,190  
                 
Loss from operations     (18,624 )     (25,946 )
                 
Total other expense     (8,106 )     (25,934 )
Loss from continuing operations before provision for (benefit from) income taxes     (26,730 )     (51,880 )
                 
Provision for (benefit from) income taxes     207       (1,345 )
                 
Net loss from continuing operations     (26,937 )     (50,535 )
                 
Loss from discontinued operations, net of tax     465       (15,124 )
                 
Net loss     (26,472 )     (65,659 )
                 
Net (income) loss attributable to non-controlling interest     11     103
                 
Net loss attributable to InterCloud Systems, Inc. common stockholders   $ (26,483 )   $ (65,762 )

 

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Year ended December 31, 2016 compared to year ended December 31, 2015

 

Revenue.

 

    Year ended December 31,     Change  
    2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 22,173     $ 21,263     $ 910       4 %
Professional services     36,937       26,655       10,282       39 %
Managed services     18,890       26,190       (7,300 )     -28 %
Total   $ 78,000     $ 74,108     $ 3,892       5 %

 

Total revenue for the year ended December 31, 2016 was $78.0 million, which represented an increase of $3.9 million, or 5%, compared to total revenue of $74.1 million for the year ended December 31, 2015. The increase primarily resulted from an increase in professional services revenue of $10.3 million due to increased revenue from our Highwire division, which was sold in February 2017, offset by a decline in managed services revenue of $7.3 million. The decline in managed services revenue was primarily due to two one-time projects in 2015 that were not present in 2016.

 

During 2016, 47% of our revenue was derived from our professional services segment, 29% from our applications and infrastructure segment and 24% from our managed services segment. As a result of the sale of our Highwire division, we expect the percentage of our revenue derived from our professional services segment to decline, and that our revenues in 2017 will be more equally apportioned among our three operating segments. During 2015, 36% of our revenue was derived from our professional services segment, 35% from our managed services segment and 29% from our applications and infrastructure segment. 

 

Cost of revenue and gross margin.

 

    Year ended December 31,     Change  
    2016     2015     Dollars     Percentage  
Applications and infrastructure                        
Cost of revenue   $ 18,541     $ 14,879     $ 3,662       25 %
Gross margin   $ 3,632     $ 6,384     $ (2,752 )     -43 %
Gross profit percentage     16 %     30 %                
                                 
Professional services                                
Cost of revenue   $ 26,463     $ 21,004     $ 5,459       26 %
Gross margin   $ 10,474     $ 5,651     $ 4,823       85 %
Gross profit percentage     28 %     21 %                
                                 
Managed services                                
Cost of revenue   $ 13,191     $ 17,981     $ (4,790 )     -27 %
Gross margin   $ 5,699     $ 8,209     $ (2,510 )     -31 %
Gross profit percentage     30 %     31 %                
                                 
Total                                
Cost of revenue   $ 58,195     $ 53,864     $ 4,331       8 %
Gross margin   $ 19,805     $ 20,244     $ (439 )     -2 %
Gross profit percentage     25 %     27 %                

 

Cost of revenue for the years ended December 31, 2016 and 2015 primarily consisted of direct labor provided by employees, services provided by subcontractors, direct material and other related costs. As discussed above, for a majority of the contract services we perform, our customers provide all necessary materials and we provide the personnel, tools and equipment necessary to perform installation and maintenance services. Cost of revenue increased by $4.3 million, or 8%, for the year ended December 31, 2016, to $58.2 million, as compared to $53.9 million for the year ended December 31, 2015. Costs of revenue as a percentage of revenues were 75% and 73% for the years ended December 31, 2016 and 2015, respectively. 

 

This increase in cost of revenues percentage was primarily due to the lower gross profit margins in our applications and infrastructure segment offset by higher gross profit margins in our professional services segment. Cost of revenues as a percentage of revenues in the managed services segment was 70% and 69% of revenues in the years ended December 31, 2016 and 2015, respectively. Cost of revenues as a percentage of revenues in the professional services business was 72% and 79% of revenues in the years ended December 31, 2016 and 2015, respectively. Cost of revenues as a percentage of revenues in the applications and infrastructure business was 84% and 70% of revenues in the years ended December 31, 2016 and 2015, respectively. Our gross profit percentage declined in our applications and infrastructure segment due to increased costs which were not accompanied by an increase in revenue in 2016 compared to 2015. 

  

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Our gross profit percentage was 25% and 27% for the years ended December 31, 2016 and 2015, respectively. This decrease in gross profit percentage was primarily due to the lower gross profit margins in our application and infrastructure segment offset by higher gross profit margins in our professional services segment. Gross profit as a percentage of revenues in the applications and infrastructure segment was 16% and 30% of revenues in the years ended December 31, 2016 and 2015, respectively, as discussed above. Gross profit as a percentage of revenues in the professional services business was 28% and 21% of revenues in the years ended December 31, 2016 and 2015, respectively. Our gross profit percentage increased in our professional services segment due to the acquisition of SDNE in January 2016, which has higher gross profit percentages than our existing professional services companies. Gross profit as a percentage of revenues in the managed services business was 30% and 31% of revenues in the years ended December 31, 2016 and 2015, respectively. 

 

Selling, General and Administrative.  

 

    Year ended December 31,     Change  
    2016     2015     Dollars     Percentage  
Selling, general and administrative   $ 13,682     $ 10,410     $ 3,272       31 %
Percentage of revenue     18 %     14 %                

 

Selling, general and administrative costs include all of our corporate costs, as well as the costs of our subsidiaries’ management personnel and administrative overhead. These costs consist of office rental, legal, consulting and professional fees, travel costs and other costs that are not directly related to the performance of our services under customer contracts. Selling, general and administrative expenses increased $3.3 million, or 31%, to $13.7 million in the year ended December 31, 2016, as compared to $10.4 million in the year ended December 31, 2015. As a percentage of revenue, selling, general and administrative expenses was 18% and 14% as of December 31, 2016 and 2015, respectively. The increase in selling, general and administrative expense was primarily due to an increase of $1.9 million relating to extraordinary accounting and legal expenses, which are expected to decline to historical levels in 2017. 

 

Salaries and Wages.

 

    As of December 31,     Change  
    2016     2015     Dollar     Percentage  
Salaries and wages   $ 18,061     $ 23,056     $ (4,995 )     -22 %
Percentage of revenue     23 %     31 %                

 

For the year ended December 31, 2016, salaries and wages decreased $5.0 million to $18.1 million as compared to approximately $23.1 million for the year ended December 31, 2015. The decrease primarily resulted from a decrease in equity compensation expense of $5.3 million. Equity compensation expense decreased to $3.3 million in 2016 compared to $8.6 million in 2015. Salaries and wages were 23% of revenue in the year ended December 31, 2016, as compared to 31% in the year ended December 31, 2015. In the future, salaries and wages are not expected to increase or decrease proportionally to our increase or decrease in revenue.

 

Interest Expense.

 

    As of December 31,     Change  
    2016     2015     Dollar     Percentage  
Interest expense   $ 13,784     $ 9,397     $ 4,387       47 %

 

Interest expense for the years ended December 31, 2016 and 2015 was $13.8 million and $9.4 million, respectively. The expense incurred in the 2016 period primarily related to interest expense of $1.7 million related to the related-party loans, $5.0 related to term loans, $7.0 million of amortization of debt discounts, $0.4 million related to amortization of loan costs related to the 12% debentures and loans and $0.1 million related to other loans. This compared to the 2015 period where interest expense consisted of $0.7 million related to the related-party loans, $2.6 million related to term loans, $5.6 million of amortization of debt discounts and $0.1 million related to other loans.  

 

Net Loss Attributable to our Common Stockholders.

 

Net loss attributable to our common stockholders was $26.5 million for year ended December 31, 2016, as compared to net loss attributable to common stockholders of $65.8 million for the year ended December 31, 2015.

 

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Liquidity, Capital Resources and Cash Flows

 

Working Capital.

 

We believe that our available cash balance as of the date of this filing will not be sufficient to fund our anticipated level of operations for at least the next 12 months. The Independent Registered Public Accounting Firm’s Report issued in connection with our audited financial statements for the year ended December 31, 2016 stated that there is “substantial doubt about the Company’s ability to continue as a going concern”. Management believes that our ability to continue our operations depends on our ability to sustain and grow revenue and results of operations as well as our ability to access capital markets when necessary to accomplish our strategic objectives. Management believes that we will continue to incur losses for the immediate future. For the year ended December 31, 2016, we generated gross profits from operations, but we incurred negative cash flow from operations. We expect to finance our cash needs from the results of operations and, depending on results of operations, we may need additional equity or debt financing until we can achieve profitability and positive cash flows from operating activities, if ever. 

 

At December 31, 2016, we had a working capital deficit of approximately $39.4 million, as compared to a working capital deficit of approximately $11.4 million at December 31, 2015. The decrease of $28.0 million in our working capital from December 31, 2015 to December 31, 2016 was primarily the result of an increase in the current portion of term loans. 

 

On or prior to March 31, 2018, we have obligations relating to the payment of indebtedness on term loans and notes to related parties of $25.7 million and $10.9 million, respectively.

 

We anticipate meeting our cash obligations on our indebtedness that is payable on or prior to March 31, 2018 from the results of operations and, depending on results of operations, we may need additional equity or debt financing. Additionally, during February 2017, we sold the Highwire division of our ADEX subsidiary for a $4 million cash payment plus a working capital adjustment, which is expected to be paid to us in August 2017, of approximately $0.9 million. $2.5 million of the net proceeds from the sale of our Highwire division was applied to the repayment of our indebtedness to JGB (Cayman) Concord Ltd. 

 

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Our future capital requirements for our operations will depend on many factors, including the profitability of our businesses, the number and cash requirements of other acquisition candidates that we pursue, and the costs of our operations. Our management has taken several actions to ensure that we will have sufficient liquidity to meet our obligations through March 31, 2018, including the reduction of certain general and administrative expenses, consulting expenses and other professional services fees, and the sale of certain of our operating subsidiaries. Additionally, if our actual revenues are less than forecasted, we anticipate implementing headcount reductions to a level that more appropriately matches then-current revenue and expense levels. We also are evaluating other measures to further improve our liquidity, including, the sale of equity or debt securities and entering into joint ventures with third parties. Lastly, we may elect to reduce certain related-party and third-party debt by converting such debt into preferred or common shares. We are currently in discussions with a third party on a credit facility to enhance our liquidity position. Our management believes that these actions will enable us to meet our liquidity requirements through December 31, 2017. There is no assurance that we will be successful in any capital-raising efforts that we may undertake to fund operations during 2017.

 

We plan to generate positive cash flow from our subsidiaries. However, to execute our business plan, service our existing indebtedness and implement our business strategy, we will need to obtain additional financing from time to time and may choose to raise additional funds through public or private equity or debt financings, a bank line of credit, borrowings from affiliates or other arrangements. We cannot be sure that any additional funding, if needed, will be available on terms favorable to us or at all. Furthermore, any additional capital raised through the sale of equity or equity-linked securities may dilute our current stockholders’ ownership in us and could also result in a decrease in the market price of our common stock. The terms of those securities issued by us in future capital transactions may be more favorable to new investors and may include the issuance of warrants or other derivative securities, which may have a further dilutive effect. We also may be required to recognize non-cash expenses in connection with certain securities we issue, such as convertible notes and warrants, which may adversely impact our financial condition. Furthermore, any debt financing, if available, may subject us to restrictive covenants and significant interest costs. There can be no assurance that we will be able to raise additional capital, when needed, to continue operations in their current form.

  

We had capital expenditures of $0.1 million and $0.2 million in the years ended December 31, 2016 and 2015, respectively. We expect our capital expenditures for next 12 months will be consistent with our prior spending. These capital expenditures will be primarily utilized for equipment needed to generate revenue and for office equipment. We expect to fund such capital expenditures out of our working capital.

 

As of December 31, 2016, we had cash of $1.9 million, which was exclusively denominated in U.S. dollars and consisted of bank deposits. 

 

Summary of Cash Flows.

 

The following summary of our cash flows for the years ended December 31, 2016 and 2015 has been derived from our historical consolidated financial statements, which are included elsewhere in this report:

 

    Year ended December 31,  
(dollars amounts in thousands)   2016     2015  
             
Net cash used in operations     (11,029 )   $ (1,829 )
Net cash provided by (used in) investing activities     20,998       (1,484 )
Net cash provided by (used in) financing activities     (16,123 )     5,787  

 

Net cash used in operating activities. We have historically experienced cash deficits from operations as we continued to expand our business and sought to establish economies of scale. Our largest uses of cash for operating activities are for general and administrative expenses. Our primary source of cash flow from operating activities is cash receipts from customers. Our cash flow from operations will continue to be affected principally by the extent to which we grow our revenues and increase or decrease our headcount.

 

Net cash used in operating activities for the year ended December 31, 2016 was $11.0 million, which included $3.4 million in stock compensation for services, charges of $6.9 million related to amortization of debt discount and deferred issuance costs, gain of $17.5 million on the fair value of derivative liabilities, losses of $9.6 million on the extinguishment of debt, gains of $0.4 million on the conversion of debt, goodwill and intangible asset impairment charges of $4.6 million, and changes in accounts receivable, inventory, other assets, deferred revenue, accounts payable and accrued expenses of $5.4 million. Non-cash charges related to depreciation and amortization totaled $2.1 million. Net cash used in operating activities for the year ended December 31, 2015 of $1.8 million, which included $8.6 million in stock compensation for services, charges of $5.1 million related to amortization of debt discount and deferred issuance costs, losses of $9.4 million on the fair value of derivative liabilities, losses of $3.7 million on the extinguishment of debt, losses of $1.1 million on the conversion of debt, goodwill and intangible asset impairment charges of $11.6 million, deferred income taxes of $1.2 million, and changes in accounts receivable, inventory, other assets, accounts payable and accrued expenses of $5.5 million. Non-cash charges related to depreciation and amortization totaled $3.4 million. 

 

Net cash provided by/used in investing activities. Net cash provided by investing activities for the year ended December 31, 2016 was $21.0 million, which consisted of capital expenditures of $0.1 million, cash paid for acquisitions of $0.1 million, issuance of notes receivable of $0.9 million, and cash provided by investing activities of discontinued operations of $21.9 million. Net cash used in investing activities for the year ended December 31, 2015 was $1.5 million, which consisted of capital expenditures of $0.2 million and loans issued to an equity method investee of $0.9 million. We also incurred a net $0.4 million in cash used in investing activities relating to capital expenditures related to the VaultLogix discontinued operations as of December 31, 2015.

 

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Net provided by/used in financing activities. Net cash used in financing activities for the year ended December 31, 2016 was $16.1 million, which resulted from proceeds from third-party borrowings of $2 million, repayments of third-party borrowings of $16.1 million, and restricted cash applied to long term loans of $2 million. Net cash provided by financing activities for the year ended December 31, 2015 was $5.8 million, which resulted from net proceeds from and repayments of third-party borrowings of $6.0 million and repayments of bank notes of $0.2.

 

Indebtedness.

 

At December 31, 2016 and 2015, term loans consisted of the following:

 

    December 31,  
    2016     2015  
Former owners of RM Leasing, unsecured, non-interest bearing, due on demand   $ 2     $ 3  
                 
Promissory note with company under common ownership by former owner of Tropical, 9.75% interest, monthly payments of interest only of $1, unsecured and personally guaranteed by officer, matured in November 2016     106       106  
                 
Term loan, White Oak Global Advisors, LLC, originally maturing in February 2019 and paid during February of 2016, interest of 12% with 2% paid-in-kind interest, net of debt discount of $366     -       10,938  
                 
8% convertible promissory note, London Bay - VL Holding Company, LLC, unsecured, maturing October 2017     7,408       7,408  
                 
8% convertible promissory note, WV VL Holding Corp., unsecured, maturing October 2017     7,003       7,003  
                 
8% convertible promissory note, Tim Hannibal, unsecured, maturing October 2017     1,215       1,215  
                 
Promissory note, 12% interest, unsecured, Dominion Capital, matured in May 2016, net of debt discount of $9     -       748  
                 
12% senior convertible note, unsecured, Dominion Capital, matured in January 2017, net of debt discount of $29 and $507, respectively     1,170       1,599  
                 
12% senior convertible note, unsecured, Dominion Capital, matured in November 2016, net of debt discount of $173     -       352  
                 
12% senior convertible note tranche 1, unsecured, Dominion Capital, matured in January 2016, net of debt discount of $15     -       235  
                 
12% senior convertible note tranche 2, unsecured, Dominion Capital, matured in February 2016, net of debt discount of $80     -       253  
                 
12% senior convertible note tranche 3, unsecured, Dominion Capital, matured in March 2016, net of debt discount of $55     -       445  
                 
12% convertible note, Richard Smithline, unsecured, matured in January 2017, net of debt discount of $2 and $107, respectively     360       419  
                 
Senior secured convertible debenture, JGB (Cayman) Waltham Ltd., bearing interest of 4.67%, maturing in May 2019, net of debt discount of $3,136 and $4,179, respectively     1,900       3,321  
                 
Senior secured convertible note, JGB (Cayman) Concord Ltd., bearing interest at 4.67%, maturing in May 2019, net of debt discount of $1,668     2,080       -  
                 
Senior secured note, JGB (Cayman) Waltham Ltd., bearing interest at 4.67%, maturing in May 2019, net of debt discount of $234     358       -  
                 
12% senior convertible note, unsecured, Dominion Capital, maturing in November 2017, net of debt discount of $65     475       -  
                 
Receivables Purchase Agreement with Dominion Capital, net of debt discount of $44     430       -  
                 
Promissory note issued to Trinity Hall, 3% interest, unsecured, maturing in January 2018     500       -  
      23,007       34,045  
Less: Current portion of term loans     (21,147 )     (3,787 )
                 
Long-term portion term loans, net of debt discount   $ 1,860     $ 30,258  

 

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

 

At December 31, 2016 and 2015, we had outstanding the following notes payable to related parties:

 

    December 31,  
    2016     2015  
Promissory note issued to CamaPlan FBO Mark Munro IRA, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $38 and $72, respectively   $ 658     $ 525  
Promissory note issued to 1112 Third Avenue Corp, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $36 and $68, respectively     339       307  
Promissory note issued to Mark Munro, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $62 and $116, respectively (partially reclassified to term loans during 2016 - refer to the reclassification paragraphs later within this footnote and Note 11, Term Loans)     575       1,221  
Promissory note issued to Pascack Road, LLC, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $152 and $286, respectively     2,398       2,364  
Promissory notes issued to Forward Investments, LLC, between 2% and 10% interest, matured on July 1, 2016, unsecured, net of debt discount of $0 and $749, respectively     4,235       5,727  
Promissory notes issued to Forward Investments, LLC, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $861 and $1,528, respectively     3,513       2,844  
Promissory notes issued to Forward Investments, LLC, 6.5% interest, matured on July 1, 2016, unsecured, net of debt discount of $0 and $147, respectively     390       243  
Former owner of IPC, unsecured, 8% interest, matured on May 30, 2016, due on demand     5,755       5,755  
Former owner of IPC, unsecured, 15% interest, due on demand     75       75  
Former owner of Nottingham, unsecured, 8% interest, matured on May 30, 2016     225       225  
      18,163       19,286  
Less: current portion of debt     (9,531 )     (11,103 )
Long-term portion of notes payable, related parties   $ 8,632     $ 8,183  

 

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

 

As of December 31, 2016, the outstanding balances of term loans and notes payable to related parties were $23.0 million and $18.2 million, respectively, net of debt discounts of $5.2 million and $1.1 million, respectively. 

 

The total outstanding principal balance per the note agreements due to our debt holders was $47.5 million at December 31, 2016. We are currently in discussions with certain of our creditors to restructure some of these term loan agreements to reduce the principal balance and extend maturity dates. However, there can be no assurance that we will be successful in reducing the principal balance or extending the maturity dates of any of our outstanding notes.

 

Accounts Receivable 

 

We had accounts receivable at December 31, 2016 and 2015 of $14.0 million and $16.6 million, respectively. Our day’s sales outstanding calculated on an annual basis at December 31, 2016 and 2015 was 66 days and 82 days, respectively. 

 

Capital expenditures  

 

We had capital expenditures of $0.1 million and $0.2 million for the years ended December 31, 2016 and 2015, respectively. We expect our capital expenditures for next 12 months will be consistent with our prior spending. These capital expenditures will be primarily utilized for equipment needed to generate revenue and for office equipment. We expect to fund such capital expenditures out of our working capital.

 

Loans Receivable   

 

We have loaned $0.3 million to a third-party software developing company utilizing software defined networking strategies. We have accounted for this as a loan receivable in the balance sheet.  

 

Off-balance sheet arrangements  

 

During the years ended December 31, 2016 and 2015, other than operating leases, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. 

 

Contingencies

 

Other than the purported class action lawsuit disclosed herein under the caption “Business - Legal Proceedings,” we only are involved in claims and legal proceedings arising from the ordinary course of our business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and the amount can be reasonably estimated. If these estimates and assumptions change or prove to be incorrect, it could have a material impact on our financial statements.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

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

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Our consolidated balance sheets as of December 31, 2016 and 2015, and the related consolidated statements of operations and stockholders’ deficit and cash flows for each of the two years in the years ended December 31, 2016 and 2015, together with the related notes and the report of our independent registered public accounting firm, are set forth on pages F-1 to F-82 of this report.

 

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

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Management’s Report on Internal Control over Financial Reporting

 

Evaluation of Disclosure Controls and Procedures.

 

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

As of the end of the period covered by this Annual Report on Form 10-K, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation and the material weaknesses described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective such that the information relating to our company required to be disclosed in our Securities and Exchange Commission reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure as a result of material weaknesses in our disclosure controls and procedures. The material weaknesses relate to our inability to timely file our reports and other information with the SEC as required under Section 13 of the Exchange Act, together with material weaknesses in our internal control over financial reporting. Our management also has identified material weaknesses in our internal controls over financial reporting relating to (i) our inability to complete our implementation of comprehensive entity level controls, (ii) our lack of a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. GAAP commensurate with our financial reporting requirements, and (iii) our lack of the quantity of resources necessary to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of the transactions into which we enter. Our management believes that these weaknesses are due in part to the small size of our staff, which makes it challenging to maintain adequate disclosure controls. To remediate the material weaknesses in disclosure controls and procedures, after our liquidity position improves, we plan to hire additional experienced accounting and other personnel to assist with filings and financial record keeping and to take additional steps to improve our financial reporting systems and implement new policies, procedures and controls.

 

Management’s Report on Internal Control over Financial Reporting.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:

 

  pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

 

  provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

  provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013). Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of these controls. Based on this assessment, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that as of December 31, 2016, our internal control over financial reporting was not effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles as a result of the material weaknesses identified in our disclosure controls and procedures. 

 

Our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2016 we had material weaknesses due to (i) our inability to complete our implementation of comprehensive entity level controls, (ii) our lacking a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. generally accepted accounting principles, or GAAP, commensurate with our financial reporting requirements, and (iii) the lack of the quantity of resources to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of transactions entered into by our company. The monitoring of our accounting and reporting functions were not operating effectively. These facts, coupled with the lack of personnel, limits our ability to prepare and timely issue our required filings with the SEC. 

 

Remediation of Internal Control Deficiencies  

 

It is reasonably possible that, if not remediated, one or more of the material weaknesses described above could result in a material misstatement in our reported financial statements that might result in a material misstatement in a future annual or interim period. 

 

As disclosed in Item 9A. Controls and Procedures of our Annual Report on Form 10-K for the year ended December 31, 2015, management identified material weaknesses in our internal control over financial reporting as of December 31, 2015, including the material weaknesses described above and a deficiency related to a lack of assessment of our internal control environment. As a result, numerous adjustments to our financial statements were identified leading to a restatement of our Form 10-Q for the quarter ended September 30, 2015 and a delay in filing our Form 10-K for the year ended December 31, 2015. Throughout 2015, our management designed and implemented a plan to remediate the deficiencies in our control environment. 

 

Specifically in 2015, our management took the following actions to improve our internal control over financial reporting and remediate the material weaknesses described above: 

 

  We hired a third-party consulting firm to assess, document, and test our internal control environment.

 

  We implemented various entity-level controls which allowed us to consider whether control activities were sufficient to address identified risks.

 

  We evaluated our information technology controls related to our processes and systems which support our financial reporting environment.

  

  We performed an evaluation of our remediation efforts and continued to perform ongoing evaluations to determine the effectiveness of our internal controls over financial reporting.

 

  We performed timely assessments of our progress and evaluations of prior year material weaknesses and our current fiscal year internal control deficiencies.

 

We believe that we are in the process of addressing the deficiencies that affected our internal control over financial reporting and we are developing specific action plans for each of the above material weaknesses. Because the remedial actions require hiring of additional personnel, upgrading certain of our information technology systems and relying extensively on manual review and approval, the successful operation of these controls for at least several quarters may be required before management may be able to conclude that the material weaknesses have been remediated. We intend to continue to evaluate and strengthen our internal control over financial reporting. These efforts require significant time and resources. During 2016, we were unable to continue to improve our internal controls to the level necessary to remove our material weaknesses. Management does not believe it will be able to hire an adequate number of additional accounting personnel until our liquidity position improves. If we are unable to establish adequate internal control over financial reporting, we may encounter difficulties in the audit or review of our financial statements by our independent registered public accounting firm, which in turn may have a material adverse effect on our ability to prepare financial statements in accordance with GAAP and to comply with our SEC reporting obligations. 

 

Changes in Internal Controls over Financial Reporting  

 

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

 

ITEM 9B. OTHER INFORMATION

 

None.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Executive Officers and Directors

 

The following sets forth information about our executive officers and directors as of February 28, 2017.

 

  Name   Position   Age
         
Mark Munro   Chairman of the Board, Chief Executive Officer   54
Mark F. Durfee   Director   60
Charles K. Miller   Director   56
Roger Ponder   Director   64
Neal L. Oristano   Director   61
Timothy A. Larkin   Chief Financial Officer   54

 

The following is information about the experience and attributes of the members of our board of directors and senior executive officers as of the date of this report.  The experience and attributes of our directors discussed below provide the reasons that these individu