Riot Blockchain, Inc. and Subsidiaries
During the nine months ended September 30, 2017, 20,000 options were issuedNotes to a director under the Plan, exercisable at $4.02 per share with a grant date fair value of $3.04 per share. The options expire ten years from the date of grant and vest monthly in arrears, over a 24 month period.Condensed Consolidated Financial Statements
(Unaudited)
During the nine months ended September 30, 2017, 34,000 options outstanding under the Plan were exercised generating $98,260 in cash proceeds. The 34,000 options exercised had a total intrinsic value when exercised of $53,180. During the nine months ended September 30, 2016, no options were exercised.
During the nine months ended September 30, 2016, 77,000 options were issued to non-employee directors under the Plan, exercisable at an average of $2.89 per share. The options expire ten years from the date of grant and vest 50% upon on the date of grant, and 25% on each of July 1, 2016 and October 1, 2016. During the nine months ended September 30, 2016, 150,000 options were issued to officers and employees under the Plan, exercisable at an average of $2.89 per share. The options expire ten years from the date of grant and vest 50% upon each of the nine month and the one year anniversary of the grant date.
During the nine months ended September 30, 2017, a total of 495,414 options granted under the Plan were forfeited as part of the equity rights terminations (see Note 6). Of the total, 438,414 options were vested, exercisable at an average exercise price of $25.59 and 57,000 were unvested, exercisable at an average exercise price of $2.92. During the nine months ended September 30, 2016, a total of 25,445 options that were granted under the Plan were forfeited as a result of option holders’ terminations from the Company, of which 21,825 were vested and 3,620 were unvested. The vested options were exercisable at an average of $39.81 per share and the unvested options were exercisable at an average of $15.13 per share.
The total fair value of stock options granted to employees and directors that vested and became exercisable during the nine months ended September 30, 2017 and 2016, was approximately $110,000 and $363,000, respectively. Based upon the Company’s experience, approximately 80% of the outstanding September 30, 2017 nonvested stock options, or approximately 24,000 options, are expected to vest in the future, under their terms.
A summary of the activity of nonvested options under the Plan to acquire common shares granted to employees, officers, directors and consultants during the nine months ended September 30, 2017 is presented below:
| Nonvested Shares | | Nonvested Shares Underlying Options | | | Weighted Average Exercise Price | | | Weighted Average Grant Date Fair Value | |
| | | | | | | | | | |
| Nonvested at January 1, 2017 | | | 97,738 | | | $ | 3.51 | | | $ | 2.58 | |
| Granted | | | 20,000 | | | | 4.02 | | | | 3.04 | |
| Vested | | | (30,905 | ) | | | 4.92 | | | | 3.57 | |
| Forfeited | | | (57,000 | ) | | | 2.92 | | | | 2.16 | |
| | | | | | | | | | | | | |
| Nonvested at September 30, 2017 | | | 29,833 | | | $ | 3.54 | | | $ | 2.67 | |
At September 30, 2017, based upon employee and director options granted under the Plan to that point, there was approximately $54,000 of additional unrecognized compensation cost related to stock options that will be recorded over a weighted average future period of approximately one year.
Other common stock purchase options and warrants:
As of September 30, 2017, in addition to the Plan options discussed above, the Company had outstanding 3,157,929 warrants in connection with offerings that were not issued under the Plan.
In March 2017, the Company completed a total of $7.0 million in private placements of securities and in connection with those offerings, granted investors in the offerings, warrants which are classified as equity, exercisable six-months after issuance, to purchase a total of 2,800,000 shares of common stock, with 900,000 warrants at an exercise price of $3.50 per share and 1,900,000 warrants at an exercise price of $3.56 per share, all expiring in March 2020. See Note 6.
During the nine month period ended September 30, 2016, 95,000 options were granted outside of the Plan. During the nine months ended September 30, 2017, these 95,000 options were forfeited. Operating expenses for the nine months ended September 30, 2017 and 2016, included $87,620 and $6,820, respectively, related to stock-based compensation.
Following is a summary of outstanding options and warrants that were issued outside of the Plan for the nine months ended September 30, 2017:
| | | Shares Underlying Options / Warrants | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (Years) | | | Aggregate Intrinsic Value | |
| | | | | | | | | | | | | |
| Outstanding at January 1, 2017 | | | 527,003 | | | $ | 13.36 | | | | | | | |
| Granted | | | 2,800,000 | | | | 3.54 | | | | | | | |
| Exercised | | | - | | | | - | | | | | | | |
| Forfeited | | | (169,074 | ) | | | 18.62 | | | | | | | |
| | | | | | | | | | | | | | | |
| Outstanding at September 30, 2017 | | | 3,157,929 | | | $ | 4.37 | | | | 2.3 | | | $ | 4,534,000 | |
| | | | | | | | | | | | | | | | | |
| Exercisable at September 30, 2017 | | | 3,157,929 | | | $ | 4.37 | | | | 2.3 | | | $ | 4,534,000 | |
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on September 30, 2017 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders been able to, and in fact had, exercised their options on September 30, 2017.
During the nine months ended September 30, 2017 and 2016, no warrants were exercised. At September 30, 2017 the 3,157,959 total outstanding warrants are non-compensatory rights, exercisable at an average of $4.37 per common share, expiring through March 2020, granted in connection with offerings. No rights are outstanding that have been granted under compensatory arrangements.
During the nine months ended September 30, 2017, a total of 169,074 options and warrants that were granted outside of the Plan were forfeited. Of the total forfeited, 71,574 warrants expired under their terms and 60,000 options lapsed (15,000 vested and 45,000 unvested) due to the holders’ terminations from the Company. The 60,000 options which lapsed were exercisable at an average of $3.78 per share. The remaining 37,500, which were forfeited resulted from negotiated payments made to each holder to waive their rights to the outstanding options. See Note 6.
Note 8. Animal Health License Agreements:
Effective May 1, 2004, Washington University in St. Louis ("WU") and the Company entered into an Exclusive License Agreement ("WU License Agreement"), which granted the Company exclusive license and right to sublicense WU's technology (as defined under the WU License Agreement) for veterinary products worldwide, except where such products are prohibited under U.S. laws for export. The term of the WU License Agreement continues until the expiration of the last of WU's patents (as defined in the WU License Agreement) expire. The Company agreed to pay minimum annual royalties of $20,000 during the term of the WU License Agreement and such amounts are creditable against future royalties. Royalties payable to WU under the WU License Agreement for covered product sales by the Company carry a mid-single digit royalty rate and for sublicense fees received by the Company carry a low double-digit royalty rate. The WU License Agreement contains customary terms for confidentiality, prosecution and infringement provisions for licensed patents, publication rights, indemnification and insurance coverage. The WU License Agreement is cancelable by the Company with ninety days advance notice at any time and by WU with sixty days advance notice if the Company materially breaches the WU License Agreement and fails to cure such breach.
In July 2012, the Company entered into an Exclusive License Agreement (the "License Agreement") with Ceva Santé Animale S.A. ("Licensee"), pursuant to which the Company granted the Licensee an exclusive royalty-bearing license, until December 31, 2028, to the Company's intellectual property and other assets, including patent rights and know-how, relating to recombinant single chain reproductive hormone technology for use in non-human mammals (the "Company's Animal Health Assets"). The License Agreement is subject to termination by the Licensee (a) for convenience on 180 days prior written notice, (b) in the Licensee's discretion in the event of a sale or other disposal of the Company's animal health assets, (c) in the Licensee's discretion upon a change in control of the Company, (d) for a material breach of the License Agreement by the Company, or (e) in the Licensee's discretion, if the Company becomes insolvent. The License Agreement is also terminable by the Company if there is a material breach of the License Agreement by the Licensee, or if the Licensee challenges the Company's ownership of designated intellectual property. The License Agreement includes a sublicense of the technology licensed to the Company by WU. Under the terms of the WU License Agreement, a portion of license fees and royalties the Company receives from sublicensing agreements will be paid to WU. The obligation for such license fees due to WU is included in accrued expenses at September 30, 2017.
Under the License Agreement, the Licensee obtained a worldwide exclusive license to develop, seek regulatory approval for and offer to sell, market, distribute, import and export luteinizing hormone ("LH") and/or follicle-stimulating hormone ("FSH") products for bovine (cattle), equine and swine in the field of the assistance and facilitation of reproduction in bovine, equine and swine animals.
Under the License Agreement, as of September 30, 2017, the following future milestone payments are provided, assuming future milestones are successfully achieved:
milestone payments, totaling up to a potential of $1.1 million in the aggregate, based on the satisfactory conclusion of milestones as defined in the License Agreement;
potential for milestone payments of up to an additional $2 million for development and receipt of regulatory approval for additional licensed products; and
royalties, at low double digit rates, based on sales of licensed products.
Revenue recognition related to the License Agreement and WU License Agreement is based primarily on the Company's consideration of ASC 808-10-45, "Accounting for Collaborative Arrangements." For financial reporting purposes, the license fees and milestone payments received from the License Agreement, net of the amounts due to third parties, including WU, have been recorded as deferred revenue and are amortized over the term of the License Agreement. License fees and milestone revenue currently totaling a net of approximately $1,556,000 commenced being amortized into income upon the July 2012 date of milestone achievement. As of September 30, 2017, deferred revenue of $96,698 has been classified as a current liability and $992,792 has been classified as a long-term liability. The current liability represents the next twelve months' portion of the amortizable milestone revenue. During each of the nine months ended September 30, 2017 and 2016, $72,524 was recorded as the amortized license fee revenue arising from the License Agreement.
A tabular summary of the revenue categories and cumulative amounts of revenue recognition associated with the License Agreement follows:
| Category | | Totals | |
| License fees and milestone amounts paid / achieved | | $ | 1,920,000 | |
| Third party obligations recorded, including WU | | | (363,700 | ) |
| Deferred revenue balance | | | 1,556,300 | |
| Revenue amortization to September 30, 2017 | | | (466,810 | ) |
| Net deferred revenue balance at September 30, 2017 | | $ | 1,089,490 | |
Commencement of license fees revenue recognition | Upon signing or receipt | |
Commencement of milestone revenue recognition | Upon milestone achievement over then remaining life | |
Original amortization period | 197 months | |
Note 9. Acquisition and Discontinued Operations:8. Stockholders’ equity:
Series B – Preferred Stock
Acquisition:
On September 12, 2016, the Company completed the strategic acquisition of BDI, a privately-held entity. Pursuant to a purchase agreement (the "Purchase Agreement"), through a wholly-owned subsidiary ("Venaxis Sub"), the Company acquired all of the outstanding shares of Series 1 Preferred Stock of BDI from the selling shareholders (the "Seller"), representing more than 98% of the outstanding voting stock of BDI, and BDI thereupon become a majority owned subsidiary of the Company.
Under the terms of the Purchase Agreement, the consideration consisted of an aggregate of 627,010 shares of the Company's common stock (the "Shares") which Shares were distributed in accordance with the liquidation preferences set forth in BDI's Fifth Amended and Restated Certificate of Incorporation, as amended. The Shares were valued at approximately $2,577,000 (based upon the closing value of our common stock on the acquisition date) and the issuance represented approximately 14% of the Company’s then outstanding common stock at the closing. The Purchase Agreement contained customary representations and warranties of the parties, including BDI, and the Sellers have customary indemnification obligations to the Company relating to BDI, which are subject to certain limitations described further in the Purchase Agreement. The issuance of the Shares was effected as a private placement of securities. The Company also entered into a registration rights agreement with the Sellers.
The total consideration transferred consisted of the 627,010 shares of the Company's common stock with a value of $2,577,000.
Under the acquisition method of accounting, the total estimated purchase consideration was allocated to the acquired tangible and intangible assets and assumed liabilities based on their estimated fair values as of the acquisition date. Following was the allocation of the purchase consideration:
| Cash and cash equivalents | | $ | 17,000 | |
| Accounts receivable | | | 21,000 | |
| Inventory | | | 379,000 | |
| Prepaid and other assets | | | 51,000 | |
| Equipment | | | 1,000 | |
| Identifiable intangible assets: | | | | |
| Trademarks (5 year estimated useful life) | | | 99,000 | |
| Customer base (6 year estimated useful life) | | | 37,000 | |
| Developed technology (4 year estimated useful life) | | | 1,864,000 | |
| Total identifiable intangible assets | | | 2,000,000 | |
| Goodwill | | | 430,000 | |
| Accounts payable | | | (118,000 | ) |
| Accrued and other liabilities | | | (175,000 | ) |
| Non-controlling interest | | | (29,000 | ) |
| Purchase price | | $ | 2,577,000 | |
Intangible assets acquired consisted of the following as of December 31, 2016:
| Trademarks | | $ | 99,000 | |
| Customer base | | | 37,000 | |
| Developed technology | | | 1,864,000 | |
| Total | | | 2,000,000 | |
| Less accumulated amortization | | | (148,264 | ) |
| Balance at December 31, 2016 | | $ | 1,851,736 | |
As of November 30, 2016, the Company paid approximately $29,000 to acquire the non-controlling interest in BDI, which was accounted for as an equity transaction.
The unaudited supplemental pro forma information for the nine months ended September 30, 2016, as if the BDI acquisition had occurred as of January 1, 2016, would have reflected total revenue of $174,000, net loss of $2,102,000 and loss per share of $0.47. These pro forma condensed consolidated financial results have been prepared for comparative purposes only and include certain adjustments to reflect the pro forma results of operations as if the acquisition had occurred as of the beginning of the periods presented, such as increased amortization for the fair value of acquired intangible assets. The pro forma information does not reflect the effect of costs or synergies that would have been expected to result from the integration of the acquisition. The pro forma information does not purport to be indicative of the results of operations that actually would have resulted had the combination occurred at the beginning of each period presented, or of future results of the consolidated entities.
As of December 31, 2016 inventories, included with current assets of discontinued operations, totaled approximately $416,000, consisting of $188,000 in raw materials and $228,000 in finished goods, all associated with the BDI operations. As of September 30, 2017 no inventories were on hand.
Discontinued operations:
During the first quarter ended March 31, 2017, the Company made the decision to discontinue the operations of its wholly-owned subsidiary BDI. BDI had developed a proprietary Enhanced Surface Plasmon Resonance technology platform for the detection of molecular interactions. The decision to adopt this plan was made following an evaluation by the Company's Board of Directors in January 2017 of the estimated results of operations projected during the near to mid-term period for BDI, including consideration of product development required and updated sales forecasts, and estimated additional cash resources required. The Company expects to dispose of the assets and operations during 2017 by selling the assets and licensing the intellectual property rights. The Company has recognized the exit of BDI in accordance with Accounting Standards Codification (ASC) 205-20, Discontinued Operations. As such, the historical results of BDI, following its 2016 acquisition, have been classified as discontinued operations.
The Company's historical financial statements have been revised to present the operating results of the BDI business as a discontinued operation. Assets and liabilities related to the discontinued operations of BDI are approximately as follows as of September 30, 2017 and December 31, 2016:
| | | September 30, 2017 | | | December 31, 2016 | |
| Current assets: | | | | | | |
| Accounts receivable | | $ | 8,000 | | | $ | 5,000 | |
| Inventories | | | - | | | | 416,000 | |
| Prepaid expenses | | | 4,000 | | | | 66,000 | |
| Total current assets | | $ | 12,000 | | | $ | 487,000 | |
| | | | | | | | | |
| Equipment and furnishings, net | | $ | - | | | $ | 36,000 | |
| Intangible assets, net | | | - | | | | 2,281,000 | |
| Deposit | | | - | | | | 37,000 | |
| Total noncurrent assets | | $ | - | | | $ | 2,354,000 | |
| | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable | | $ | 37,000 | | | $ | 174,000 | |
| Accrued expenses | | | 28,000 | | | | 85,000 | |
| Deferred revenue | | | 137,000 | | | | - | |
| Total current liabilities | | $ | 202,000 | | | $ | 259,000 | |
Summarized results of the discontinued operation are as follows for the three and nine months ended September 30, 2017:
| | | Three Months | | | Nine Months | |
| | | | | | | |
| Sales | | $ | 7,000 | | | $ | 37,000 | |
| Cost of sales | | | 2,000 | | | | 6,000 | |
| Gross margin | | | 5,000 | | | | 31,000 | |
| Operating expenses (credit) | | | (26,000 | ) | | | 975,000 | |
| Operating income (loss) | | | 31,000 | | | | (944,000 | ) |
| Escrow forfeiture gain | | | - | | | | 135,000 | |
| Impairment (loss) | | | - | | | | (2,754,000 | ) |
| | | | | | | | | |
| Income (loss) from discontinued operations | | $ | 31,000 | | | $ | (3,563,000 | ) |
| | | | | | | | | |
Included in the impairment loss recognized for the nine months ended September 30, 2017 on the discontinuance of BDI are impairment losses recognized on inventories of $453,000, equipment and furnishings of $29,000, identifiable intangible assets of $1,833,000, goodwill of $430,000, and a $9,000, net expense from all other items, all associated with the assets and operations of BDI. For the three and nine months ended September 30, 2016 the loss from discontinued operations of $236,000, consisted of revenues of $2,000, less operating and other expenses totaling $238,000, including amortization and depreciation of $24,000. Additional costs associated with the exit of operations of the Company's subsidiary BDI may be incurred as strategic options for BDI are evaluated.
Note 10. Commitments and contingencies:
Commitments:
The Company's subsidiary, BDI, had a lease commitment on its office and laboratory space that was scheduled to expire March 31, 2018, requiring future non-cancellable lease payments as of May 2017 of approximately $294,000 for the remainder of its original term. During May 2017, an agreement with the subsidiary's landlord was reached to terminate the lease by surrendering the facility in May 2017, making a $80,419 prepayment of rent through July 31, 2017 and surrendering the $37,000 lease deposit. Rent expense for the nine months ended September 30, 2017 totaled approximately $229,000, including $216,000 in rent expense for BDI, inclusive of the payment of the early termination fee and the surrender of the $37,000 lease deposit and $13,000 in rent expense incurred by the Company under short-term rent agreements. The Company’s rent expense for the nine months ended September 30, 2016 was immaterial.
On February 25, 2016, the Company completed the sale of its corporate headquarters, land, building and certain fixtures and equipment to a third party at a purchase price of $4,053,000. The sale resulted in a gain of approximately $1,933,000 and generated approximately $1,799,000 in net cash after expenses and mortgage payoffs. The Company is renting space in the building under short-term lease agreements that provide certain storage space.
As of September 30, 2017, the Company has an employment agreement with one officer providing aggregate annual minimum commitments totaling approximately $272,000. The agreement contains customary confidentiality and benefit provisions.
Contingencies:
In the ordinary course of business and in the general industry in which the Company is engaged, it is not atypical to periodically receive a third party communication which may be in the form of a notice, threat, or "cease and desist" letter concerning certain activities. For example, this can occur in the context of the Company's pursuit of intellectual property rights. This can also occur in the context of operations such as the using, making, having made, selling, and offering to sell products and services, and in other contexts. The Company makes rational assessments of each situation on a case-by-case basis as such may arise. The Company periodically evaluates its options for trademark positions and considers a full spectrum of alternatives for trademark protection and product branding.
We are currently not a party to any legal proceedings, the adverse outcome of which would, in our management's opinion, have a material adverse effect on our business, financial condition and results of operations.
Note 11. Subsequent Events:
Corporate Name Change:
On October 2, 2017 the Board of Directors of the Company approved a merger (the “Merger”) of the Company with its wholly-owned subsidiary, Riot Blockchain, Inc., a Nevada corporation (the “Merger Sub”), solely for the purpose of changing the name of the Company. Upon consummation of the Merger, the separate existence of Merger Sub ceased. As permitted by Chapter 92A.180 of Nevada Revised Statutes, the purpose of the Merger was to effect a change of the Company’s name to Riot Blockchain, Inc. from Bioptix, Inc. Upon approval by NASDAQ, on October 19, 2017, the Company’s name was thereupon changed.
Cash Dividend:
On October 2, 2017, the Company’s Board of Directors approved a cash dividend pursuant to which the holders of the Company’s common stock and530,001 Series AB Preferred Stock, would receive $1.00 for each share of Common Stock held, including each share of Common Stock that would be issuable upon conversion of the Series A Preferred Stock, on an as converted basis. The cash dividend totaled approximately $9,562,000 with a record date of the close of business on October 13, 2017 and payment date of October 18, 2017.
Temporary Reduction in Warrant Exercise Prices:
On October 10, 2017, the Company’s Board of Directors approved a temporary reduction in the exercise price of warrants issued in the March 2017 private offerings to $3.00 per share. The approval covered any of the 2,800,000 outstanding warrants which would be exercised by their holders from October 10, 2017 through October 20, 2017, for cash. During that period 620,000 warrants were exercised for cash, as described below. Any such warrant holder who exercises such warrants for cash at the reduced price shall not be entitled to the benefit of any cashless exercise feature on such exercised warrants for cash. The fair value of the temporary modification of the exercise price will be recorded as an additional expense and a credit to capital in the fourth quarter of 2017. The fair value will be computed based upon the 620,000 warrants actually exercised times the increase in value of the warrants immediately before and immediately after the reduction in exercise price.
Common Stock Transactions:
Subsequent to September 30, 2017, the holders of 8,284.04 shares of Series A Preferred Stock exercised their rightShares elected to convert suchthose shares into 828,404 shares of common stock. Separately, the holders of 620,000 warrants issued in the March 2017 private offerings (420,000 from the common stock offering and 200,000 from the convertible note offering), exercised their warrants for cash during the temporary reduction in exercise price period, described above, and were issued 620,000 shares of common stock generating $1,860,000 in cash proceeds. Additionally, the holders of 2,060,000 warrants issued in the March 2017 private offerings (360,000 from the common stock offering, exercisable at $3.50 per share and 1,700,000 from the convertible note offering, exercisable at $3.56 per share), exercised their warrants on a cashless basis, as provided in the offering agreements and were issued 1,228,690 shares of common stock in exchange for surrender of their warrants.
Tess Inc. Acquisition:
On October 20, 2017, the Company acquired approximately 52% of TESS which is developing blockchain solutions for telecommunications companies. Under the terms of the Purchase Agreement (the “Purchase Agreement”) the Company invested cash of $320,000 and issued 75,000 shares of restricted Common Stock in exchange for 2,708,333 shares of common stock of TESS. Accordingly, TESS became a majority-owned subsidiary of the Company. In connection with the transaction, the Company and TESS entered into a registration rights agreement pursuant to which the Company agreed to file a registration statement within three months to register the resale of 25,000 shares (of 75,000 shares) of Common Stock issued to TESS. As of October 20, 2017 TESS has net tangible assets of approximately $10,000 and the Company expects that the purchase price will be allocated to intangible assets including in-process research and development and goodwill.
Kairos Global Technology, Inc. Acquisition:
On November 1, 2017, the Company entered into a business combination share exchange agreement (the “Agreement”) with Kairos Global Technology, Inc., a Nevada corporation and on November 3, 2017, closed on the agreement. Under the Agreement, the shareholders of Kairos agreed to exchange all outstanding shares of Kairos’ common stock to the Company and the Company agreed to issue an aggregate of One Million Seven Hundred Fifty Thousand and One (1,750,001) newly-designated shares of Series B Convertible Preferred Stock (the “Series B Preferred Stock”) which are convertible into an aggregate of One Million Seven Hundred Fifty Thousand and One (1,750,001)530,001 shares of the Company’s common stock no par value per share (the transaction, the “Kairos Transaction”) to such shareholders. The shareholdersunder their original terms. As of Kairos also will receive a royalty to be paid from cash flow generated from operations, which shall entitle such shareholders to receive 40% of the gross profits generated on a monthly basis until they have received a total of $1,000,000, at which point the royalty is extinguished. Karios is the owner of certain computer equipment and other assets used for the mining of cryptocurrency, specifically servers consisting of 700 AntMiner S9s and 500 AntMiner L3s, all manufactured by Bitmain.
TheMarch 31, 2018, 928,000 shares of Series B Preferred Stock are convertible into shares of common stock based on a conversion calculation equal to the stated value of the Series B Preferred Stock, plus all accrued and unpaid dividends, if any, on such Series B Preferred Stock, as of such date of determination, divided by the conversion price. The stated value of each share of Series B Preferred Stock is $6.80 and the initial conversion price is $6.80 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions or other similar events. The holders of Series B Preferred Stock are entitled to receive dividends if and when declared by the Company’s board of directors. The Series B Preferred Stock will participate on an “as converted” basis, with all dividends when and if declared, on the Company’s common stock. Each holder is entitled to vote on all matters submitted to stockholders of the Company, and will have the number of votes equal to the number of shares of common stock issuable upon conversion of such holder’s Series B Preferred Stock. Under the agreement the Company is prohibited from effecting a conversion of the Series B Preferred Stock to the extent that, as a result of such conversion, the holder would beneficially own more than 4.99% percent of the number of shares of common stock outstanding immediately after giving effect to the issuance of shares of common stock upon conversion of the Series B Preferred Stock, which beneficial ownership limitation may be increased by the holder up to, but not exceeding, 9.99% percent. were outstanding. The Series B Preferred Stock contains a blocker pursuant to which, if the Company has not obtained the approval of its shareholders in accordance with NASDAQ Listing Rule 5635(d), then the Company may not issue upon conversion of the Series B Preferred Stock a number of shares of common stock, which, when aggregated with any other shares of common stock underlying the Series B Preferred Stock issued pursuant to the Agreement would exceed 19.99% of the shares of common stock issued and outstanding as of the date of the Agreement, subject to adjustment for reverse and forward stock splits, stock dividends, stock combinations and other similar transactions of the common stock that occur after the date of the Agreement. As of the date of this report shareholder approval has not been sought or obtained.
Common Stock:
On January 4, 2018, 19,533 shares of common stock were issued upon the exercise of an employee stock-option.
On January 25, 2018, 2,754 shares of common stock were issued at fair value for consulting services.
On February 14, 2018, 100,000 shares of common stock were issued in exchange for the exercise of 100,000 warrants issued in March 2017. The Company received $350,000 from the exercise of the warrants.
During the three months ended March 31, 2018, 13,009 warrants were exercised in exchange for 3,215 shares of common stock. See Note 10.
Common Stock issued in Asset Acquisition:
On February 21, 2018, the Company issued 1,000,000 shares of common stock at fair value in connection with the Prive asset purchase agreement, with 200,000 of these shares deposited into an escrow account with Corporate Stock Transfer, Inc. See Note 3.
Restricted Common Stock Units:
On March 28, 2018 the Company issued 50,000 shares of common stock related to a fully vested restricted stock unit were delivered for services performed in 2017. See Note 10.
Note 9. Stock based compensation, options and warrants:
Stock based compensation:
The Company recognized total expenses for stock-based compensation during the three months ended March 31, 2018 and 2017, which are included in the accompanying condensed consolidated statements of operations, as follows:
| | | Three Months Ended March 31, | |
| | | 2018 | | | 2017 | |
| Selling, general and administrative expenses | | $ | 883,943 | | | $ | 133,043 | |
| Total stock-based compensation | | $ | 883,943 | | | $ | 133,043 | |
Riot Blockchain, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The Company recognized total stock-based compensation expense during the three months ended March 31, 2018 and 2017, from the following categories:
| | | Three Months Ended March 31, | |
| | | 2018 | | | 2017 | |
| Restricted stock awards under the Plan | | $ | 766,949 | | | $ | 30,431 | |
| Stock option awards under the Plan | | | 116,994 | | | | 63,806 | |
| Non-qualified stock option awards | | | - | | | | 38,806 | |
| Total stock-based compensation | | $ | 883,943 | | | $ | 133,043 | |
Restricted stock units:
A summary of the Company’s restricted stock activity in the three months ended March 31, 2018 is presented here:
| | | Number of Shares | | | Weighted Average Grant-Date Fair Value | |
| Unvested at January 1, 2018 | | | 496,152 | | | $ | 5.97 | |
| Granted | | | 292,500 | | | | 13.08 | |
| Vested | | | (30,913 | ) | | | 12.35 | |
| Forfeited | | | (26,563 | ) | | | 10.58 | |
| Delivered | | | (50,000 | ) | | | 4.50 | |
| Unvested at March 31, 2018 | | | 681,176 | | | $ | 8.66 | |
During the three months ended March 31, 2018, the Company granted 225,000 and 67,500 restricted stock units to employees and non-employee directors, respectively. The weighted-average fair value of restricted stock units granted during the three months ended March 31, 2018 was $13.08 per share based upon the share price as of the date of grant. The total fair value of restricted stock units granted during the three months ended March 31, 2018 was approximately $3,825,000.
The value of restricted stock unit grants are measured based on their fair value on the date of grant and amortized over the vesting period of twenty-four months. As of March 31, 2018, there was approximately $5,603,000 of unrecognized compensation cost related to unvested restricted stock units, which is expected to be recognized over a remaining weighted-average vesting period of approximately one year.
Stock incentive plan options:
The Company currently provides stock-based compensation to employees, directors and consultants under the Plan. The Company granted 50,000 stock options to an employee of the Company for the three months ended March 31, 2018. There were no stock options granted to employees, directors or consultants for the three months ended March 31, 2017.
A summary of activity under the Plan for the three months ended March 31, 2018 is presented below:
| | | Shares Underlying Options | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (Years) | | | Aggregate Intrinsic Value | |
| Outstanding at January 1, 2018 | | | 119,533 | | | $ | 9.02 | | | | | | | |
| Granted | | | 50,000 | | | $ | 18.50 | | | | | | | |
| Exercised | | | (19,533 | ) | | $ | 4.02 | | | | | | | |
| Forfeited | | | - | | | $ | - | | | | | | | |
| Outstanding at March 31, 2018 | | | 150,000 | | | $ | 12.83 | | | | 9.7 | | | $ | - | |
| | | | | | | | | | | | | | | | | |
| Exercisable at March 31, 2018 | | | 108,333 | | | $ | 10.65 | | | | 9.6 | | | $ | - | |
Riot Blockchain, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company’s closing stock price on March 31, 2018 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders been able to, and in fact had, exercised their options on March 31, 2018.
In January 2018, 19,533 vested options granted under the Plan were exercised for cash proceeds of $78,522.
During the three months ended March 31, 2018, there were no options forfeited that were granted under the Plan. The vested options were exercisable at an average of $10.65 per share, the unvested options were exercisable at an average of $18.50 per share.
Other common stock purchase options and warrants:
Following is a summary of outstanding options and warrants that were issued outside of the Plan for the three months ended March 31, 2018:
| | | Shares Underlying Options/Warrants | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (Years) | | | Aggregate Intrinsic Value | |
| Outstanding at December 31, 2017 | | | 1,944,895 | | | $ | 35.06 | | | | 2.7 | | | $ | 6,135,000 | |
| Granted | | | - | | | | - | | | | | | | | | |
| Exercised | | | (113,009 | ) | | $ | 3.50 | | | | | | | | | |
| Forfeited | | | - | | | | - | | | | | | | | | |
| Outstanding at March 31, 2018 | | | 1,831,886 | | | $ | 36.96 | | | | 2.5 | | | $ | 62,400 | |
| | | | | | | | | | | | | | | | | |
| Exercisable at March 31, 2018 | | | 1,831,886 | | | $ | 36.96 | | | | 2.5 | | | $ | 62,400 | |
During the three months ended March 31, 2018, 13,009 of the warrants issued in the May 2013 private offering were surrendered for the issuance of 3,215 shares of common stock and 100,000 warrants issued in March 2017, were exercised for cash proceeds of $350,000.
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company’s closing stock price on March 31, 2018 and the exercise price, multiplied by the number of in-the-money options and warrants) that would have been received by the option and warrant holders, had all option and warrant holders been able to, and in fact had, exercised their options and warrants on March 31, 2018.
Note 10. Digital Currencies
The following table presents additional information about digital currencies:
| | | March 31, 2018 | |
| Digital currencies balance - January 1. 2018 | | $ | 200,164 | |
| Additions of digital currencies | | | 901,380 | |
| Purchase of digital currencies | | | 5,625,000 | |
| Change in fair value of digital currencies | | | (2,467,875 | ) |
| Digital currencies balance - March 31, 2018 | | $ | 4,258,669 | |
As March 31, 2018, the Company’s digital currencies consisted of bitcoin, with a fair value of approximately $4,259,000. Digital currencies are recorded at their fair value on the date they are received as revenues, and are revalued to their current market value at each reporting date. Fair value is determined by taking the spot rate from the most liquid exchanges.
Riot Blockchain, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 11. Discontinued Operations:
During the quarter ended March 31, 2017, the Company made the decision to discontinue the operations of its wholly-owned subsidiary BDI. BDI had developed a proprietary Enhanced Surface Plasmon Resonance technology platform for the detection of molecular interactions. The decision to adopt this plan was made following an evaluation by the Company’s Board of Directors in January 2017 of the estimated results of operations projected during the near to mid-term period for BDI, including consideration of product development required and updated sales forecasts, and estimated additional cash resources required. The Company substantially disposed of the BDI assets and operations during 2017 by selling the assets and licensing the intellectual property rights. The Company has recognized the exit of BDI in accordance with ASC 205-20, Discontinued Operations. As such, the historical results of BDI, following its 2016 acquisition, have been classified as discontinued operations.
The Company’s historical financial statements have been revised to present the operating results of the BDI business as a discontinued operation. Assets and liabilities related to the discontinued operations of BDI were approximately as follows as of March 31, 2018 (unaudited) and December 31, 2017:
| Current Liabilities | | March 31, 2018 | | | December 31, 2017 | |
| Accounts payable | | $ | 16,000 | | | $ | 16,000 | |
| Accrued expenses | | | - | | | | 28,000 | |
| Deferred revenue | | | - | | | | 137,000 | |
| Total current liabilities | | $ | 16,000 | | | $ | 181,000 | |
Summarized results of the discontinued operation are as follows for the three months ended March 31, 2018 and 2017 (unaudited):
| | | March 31, 2018 | | | March 31, 2017 | |
| Revenue | | $ | 137,000 | | | $ | 13,000 | |
| Cost of revenue | | | 41,000 | | | | 2,000 | |
| Gross margin | | | 96,000 | | | | 11,000 | |
| Operating expenses | | | - | | | | 654,000 | |
| Operating income (loss) | | | 96,000 | | | | (643,000 | ) |
| Impairment loss | | | - | | | | (2,704,000 | ) |
| Income (loss) from discontinued operations | | $ | 96,000 | | | $ | (3,347,000 | ) |
Note 12. Commitments and contingencies:
Commitments:
Oklahoma Lease Agreement.
On February 27, 2018, Kairos (“Tenant”) entered into a lease agreement (the “Lease”) with 7725 Reno #1, LLC (the “Landlord”), pursuant to which the Tenant leases an approximately 107,600 square foot warehouse located in Oklahoma City, Oklahoma, including improvements thereon. Pursuant to the terms of the Lease, the initial term of one year terminates on February 15, 2019, unless terminated earlier pursuant to the terms of the Lease, subject to the Tenant’s options to renew the Lease. Tenant has four one-year renewal options that may be exercised so long as Tenant is not in default, subject to increases in base rent. Tenant has the right to operate from the premises on a 24 hour/seven day a week basis. At least three months, but no more than six months, prior to the expiration of the initial Lease term or renewal term, as applicable, Tenant shall give Landlord written notice of its intent to exercise the applicable renewal option, which also includes incremental payment for additional electric capacity delivery. If Tenant does not elect to exercise a renewal option, all remaining renewal options, if any, shall terminate.
Riot Blockchain, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Base rent for the premises during the first 12 months is equal to $55.95/kW per month for a total of 4 Megawatts (MW) of available electrical power, or $223,800 per month. Base rent is calculated based upon the monthly electrical power made available to Tenant within the premises, and not based on Tenant’s actual usage. In connection with the Lease, Parent has provided a limited guarantee of Tenant’s failure to make payment of base rent or additional rent pursuant to the Lease. As soon as practicable after the effective date of the Lease, Landlord, at Landlord’s expense, agreed to provide additional 12.5 kV transformer equipment to increase the electrical power available for Tenant’s use by an additional 2MW, which will result in additional rent of $55.12/kW for the additional 2MW of power when it is made available. Provided that Tenant is not in default under the Lease beyond any applicable notice and cure periods, Tenant may request Landlord to further increase the electrical power available, in increments from 6.01 MW up to 12.0 MW, by giving written notice to Landlord of the requested increase. Landlord, at Landlord’s expense, would then provide an additional 12.5kV of electrical transforming equipment to increase the electrical power available for Tenant’s use by the additional MW requested by Tenant. Effective as of the date the additional power is made available to Tenant, base rent will increase by an amount equivalent to the additional MW requested by Tenant multiplied by $55.12 per kW. If Tenant exercises all of its renewal options, then the base rent for the first 4MW of available power would increase to $57.63 per kW in year two, $59.36 per kW in year three, $61.14 per kW in year four and $62.97 per kW in year five. In each case, available power of greater than 4MW and up to 12MW would result in base rent of $55.12 per kW.
On March 26, 2018, Kairos entered into a first amendment to the above lease, whereby 7725 Reno agreed to increase the electrical power available for Kairos’s use from 6MW to 12MW, and the base rent under the lease was increased to approximately $665,760 per month, effective as of the date when such additional power is available.
Registration Rights Agreement
On December 19, 2017, the Company accepted subscriptions for the sale of $37,000,000 of units of its securities, with each unit consisting of one share of Common Stock and one warrant to purchase one share of Common Stock, at a per unit price of $22.50. On December 21, 2017, the Company accepted subscriptions for an additional $37,528 of units. On December 21, 2017, the Company closed on the sale of $37,037,528 of units of its securities and issued 1,646,113 shares of Common Stock and warrants to purchase up to 1,646,113 shares of Common Stock.
The registration rights agreement required that the securities would be registered by March 5, 2018, the effectiveness date, and the registration statement was not declared effective by March 5, 2018. The Company accounted for registration rights agreements in accordance with ASC 825-20, “Registration Payment Arrangements.” ASC 825-20 addresses an issuer’s accounting for registration payment arrangements. This pronouncement specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument, should be separately recognized and accounted for as a contingency in accordance with ASC 450-20 “Loss Contingencies”. The Company recorded approximately $333,000 for this contingency as a liability in the first quarter of 2018.
Corporate Lease Agreement
See Note 14 for new corporate lease agreement commitment subsequent to March 31, 2018.
Ingenium International LLC Consulting Agreement.
On February 21, 2018, the Company entered into a Consulting Agreement with Ingenium International LLC (the “Consultant”) to provide consulting services related to the Company’s business for a 12-month period. Pursuant to the Consulting Agreement, Consultant’s services are defined as follows: complete the installation and deployment of 8,000+ ASIC cryptocurrency miners, which included the Prive Equipment and the BMSS Equipment; assist in managing and monitoring the operation of the 8,000+ cryptocurrency miners on an ongoing basis; promptly responding to and troubleshooting any issues as they arise in the management and monitoring of the operations; continuing the buildout of up to 40 Megawatts of energy capacity, with the ultimate goal to secure the power and build the location for up to 80 Megawatts of energy capacity; and to make strategic introductions to other cryptocurrency business opportunities and contacts in the sector. In connection with the Consulting Agreement the Company made a lump sum payment of $4,000,000 to the Consultant.
The controlling principals of Ingenium International LLC., as disclosed in Note 3, are shareholders in the Company by virtue of the previous Kairos and Prive transactions.
Contingencies:
On February 17, 2018, Creighton Takata filed an action asserting putative class action claims on behalf of the Riot Blockchain, Inc.'s shareholders in the United District Court for the District of New Jersey, Takata v. Riot Blockchain Inc., et al., Case No. 3:18-cv-02293. The complaint asserts violations of federal securities laws under Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 on behalf of a putative class of shareholders that purchased stock from November 13, 2017 through February 15, 2018. The complaint alleges that the Company and certain of its officers and directors made, caused to be made, or failed to correct false and/or misleading statements in press releases and public filings regarding its business plan in connection with its cryptocurrency business.
The following complaints are generally based on the same conduct alleged in the Takatoa putative class action and request damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief, as well as in the derivative action, corporate governance changes.
Riot Blockchain, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
On February 22, 2018 Richard Roys filed a complaint in the United District States Court for the Southern District of Florida (Roys v. Riot Blockchain Inc., et al., Case No. 9:18-cv-80225). On March 27, 2018, the court closed the Roys’ case.
On February 22, 2018 Bruce Greenawalt filed a complaint in the United States District Court for the District of Colorado (Greenawalt v. Riot Blockchain Inc., et al., Case No. 1:18-cv-00440). On April 2, 2018, Mr. Greenawalt filed a notice of voluntary dismissal of his action, which the court entered on the same date.
On April 5, 2018, Michael Jackson filed a shareholder derivative complaint on behalf of the Company in the Supreme Court of the State of New York, County of Nassau, against certain of the Company's officers and directors, as well as against an investor (Jackson v. Riot Blockchain, Inc., et al, Case No 604520/18).
On April 18, 2018, Joseph J. Klapper, Jr., filed a complaint against Riot Blockchain, Inc., and certain of its officers and directors in the United District Court for the District of New Jersey (Klapper v. Riot Blockchain Inc., et al., Case No. 3:18-cv-8031).
On April 9, 2018, the Company received a subpoena requesting documents from the U.S. Securities and Exchange Commission pursuant to a formal order of investigation.
As part of its ongoing review of the Company’s SEC filings, the Company has received and responded to comments from the staff of the SEC regarding certain developments and the Company’s ongoing development of a blockchain/cryptocurrency business model. These inquires include the proper asset classification, applicability of the Investment Company Act or 1940, to the Company’s business and affairs and accounting treatment of its cryptocurrency. The resolution of these matters is ongoing and has been described in more detail under “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
Note 13. Related Party Transactions:
Per Schedules 13D filed with the Securities and Exchange Commission, each of Barry Honig (together with other group members) and Catherine Johanna DeFrancesco during a portion of 2017 beneficially owned greater than 10% of the dispositive and voting power of the Company’s common stock. Mr. Honig reported beneficial ownership of approximately 11.2% of the Company’s common stock as of January 5, 2017 and Ms. DeFrancesco reported beneficial ownership of approximately 11.45% of the Company’s common stock as of January 10, 2017. Mr. Honig invested $1,750,000 in the Company’s March 2017 Convertible Note Private Placement. GRQ Consultants, Inc., a related party of Mr. Honig, received a cash payment of $50,000 for diligence services in connection with the Company’s September 2017 investment in Coinsquare. Each of Mr. Honig and Ms. DeFrancesco was a shareholder of Kairos at the time of its acquisition by the Company, with Mr. Honig having owned approximately 8.6% of Kairos and Ms. DeFrancesco having owned approximately 6.3% of Kairos. Each of Mr. Honig and Ms. DeFrancesco invested in the December 2017 Common Share Private Placement, with Mr. Honig investing $500,000 and Ms. DeFrancesco investing $360,000.
Note 14. Subsequent Events:
During May 2018, the Company executed a trade for 100 bitcoins generating $957,300 in cash proceeds.
Corporate Lease Agreement
On April 9, 2018 the Company entered into a commercial lease covering 1,694 rentable square feet of office space in Fort Lauderdale, Florida, with a third-party. The lease is for an initial term of thirty-nine months, with one five-year option to renew. The lease requires initial monthly rent of approximately $7,000, including base rent and associated operating expenses.
Stock Transactions
In April 2018, holders of 89,517 Series B preferred shares elected to convert those shares to 89,517 shares of the Company’s common stock under its original terms.
On April 20, 2018, 18,000 shares of the Company’s common stock were issued for consulting services.
On April 25, 2018 the Company issued 40,000 shares of common stock related to a restricted stock unit issuance for services performed in 2017.
Item 2. Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations
Management'sThe following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes in "Item 1. Condensed Consolidated Financial Statements." The following discussion includes forward-looking statements about our business, financial condition and results of operations, including discussions about management’s expectations for our business. These statements represent projections, beliefs and expectations based on current circumstances and conditions and in light of recent events and trends, and should not be construed either as assurances of performance or as promises of a given course of action. Instead, various known and unknown factors are likely to cause our actual performance and management’s actions to vary, and the results of these variances may be both material and adverse. See “Cautionary Note Regarding Forward-Looking Statements” and "Item 1A. Risk Factors."
Management’s plans and basis of presentation:
The Company has experienced recurring losses and negative cash flows from operations. At September 30, 2017,March 31, 2018, the Company had approximate balances of cash and cash equivalents of $13,140,000,$5,258,000, working capital of $12,555,000,$8,915,000, total stockholders'stockholders’ equity of $15,466,000$43,235,000 and an accumulated deficit of $120,823,000.$155,614,000. To date, the Company has in large part relied on debt and equity financing to fund itsour operations. The Company expects to continue to incur losses from operations for the near-term and these losses could be significant as we incur costs and expenses associated with our recent and potential future acquisitions and investments, as well as public company and administrative related expenses are incurred and winding-down BDI’s operations. The Company believes its upcoming near-term cash needs relative to the recent acquisitions will be covered by cash acquired in the acquisitions combined with the Company’s available cash. The Company believes that its current working capital position will be sufficient to meet its estimated cash needs for at least a year and a day from this filing. The Company is closely monitoring its cash balances, cash needs and expense levels.
The primary focus of the Company is our cryptocurrency mining operations currently located in Oklahoma City and potential establishment of other mining operations in other locations around the world, along with our investigation of the launch of a cryptocurrency exchange in the United States. That operational focus and our recently announcedcompleted Kairos Global Technology, Inc. (“Kairos”) and Tess Inc. (“Tess”) acquisitions and Coinsquare acquisitions,investment, as well as our new name, reflect a new focus (in addition to veterinary and life science oriented businesses of the Company) being pursuedstrategic decision by the Company. The decisionCompany to invest in companies exposed topursue blockchain and digital currency related risks is a strategic decision byoperation (in addition to the Company.historical legacy veterinary and life science-oriented businesses of the Company). The Company’sCompany's current strategy will be to continue to pursue opportunistic investments and controlling positions in these new and emerging technologies which will continue to expose the Company to the numerous risks and volatility associated within this evolving industry.
On January 2, 2018 the Company formed Digital Green Energy Corp. (Digital Green), a wholly owned subsidiary, which is seeking to identify environmentally friendly projects with this sector.large energy capacity and a cost-effective rate for energy for cryptocurrency mining operations and data center projects.
In February 2018, the Company acquired 3,800 miners from Prive Technologies, Inc. (“Prive”) and 3,000 miners from Blockchain Mining Supply & Services Ltd. (“BMSS”).
On February 27, 2018, Kairos entered into a lease agreement for approximately a 107,000-square foot facility in Oklahoma City, Oklahoma, which included data center improvements. Upon the execution of the facility lease the Company began consolidating all of our miners at the data center facility. As of March 31, 2018, 3,500 of the miners were installed and operating.
On March 26, 2018, the Company entered into and closed a stock purchase agreement pursuant to which the Company acquired 92.5% of Logical Brokerage Corp. (“Logical Brokerage”). Logical Brokerage is a futures introducing broker headquartered in Miami, Florida, registered with the Commodity Futures Trading Commission (“CFTC”), and a member of the National Futures Association (“NFA”). The Company intends to investigate launching a digital currency exchange and a futures brokerage operation within the United States.
Effective January 14, 2017, wethe Company adopted a plan to exit the business of BDI and commenced a significant reduction in the workforce.BiOptix Diagnostics, Inc. ("BDI"). The decision to adopt this plan was made following an evaluation by the Company's Board of Directors in January 2017 of the estimated results of operations projected during the near to mid-term period for BDI, including consideration of product development required and updated sales forecasts, and estimated additional cash resources required. WeAccordingly, the historical results of BDI have been classified as discontinued operations for all periods presented as those results are reviewing possible strategic alternatives relativemeaningless and unrelated to the business to maximize shareholder value.
Management's strategic plans include the following:
continuing to evaluate opportunities for investments in the blockchain and digital currency sector;
exploring other possible strategic options and financing opportunities available to the Company;
evaluating options to monetize, partner or license the Company's assets, including appendicitis product portfolio; and
continuing to implement cost control initiatives to conserve cash.
current operations.
NASDAQ listing:
On April 10, 2017, theThe Company was notified by The NASDAQ Stock Market, LLC of its failure to comply with Nasdaq Listing Rule 5605 (the "Rule") which requires that the Company's audit committee be comprised of at least three independent directors, as defined under the Rule. On May 5, 2017, the Company appointed a new independent director to the Board of Directors and to the Company’s audit committee, which resulted in the Company regaining compliance with the Rule.
Results of Operations
Comparative Results for the Nine Months Ended September 30, 2017 and 2016
During each of the nine month periods ended September 30, 2017 and 2016, $73,000 of license payments under the License Agreement was recognized as revenue. See further discussion regarding the License Agreement below under the heading “Liquidity and Capital Resources.”
Selling, general and administrative expenses in the nine months ended September 30, 2017 totaled $2,694,000, which is an approximately $639,000, or 19%, decrease as compared to the 2016 period. Compensation related expenses decreased by approximately $316,000 due to fewer employees and lower bonuses in the 2017 period. Legal and accounting expenses increased by $204,000 for the 2017 period due to additional legal services on various matters and costs associated with a change in audit firms. A decrease in strategic evaluation costs of approximately $373,000 related to the completion of strategic evaluations in 2016. Commercialization and marketing related expenses decreased by approximately $133,000 in the 2017 period as the Company had substantially wound down APPY1 commercialization activities in 2016. A decrease of $48,000 in general operating expenses was due to the winding down of operations combined with the sale of Company’s facility in 2016.
Research and development expenses in the nine months ended September 30, 2017 totaled $63,000, which is an approximately $436,000, or 87%, decrease as compared to the 2016 period. Substantially all of the decrease was due to winding down development and commercialization of APPY2 and APPY1 operations that had ceased in 2016.
Interest expense for the nine months ended September 30, 2017 totaled $4,802,000, compared to $28,000 in the 2016 period. The interest expense in the 2017 period primarily related to the accrual of interest on the March 2017 convertible note offering combined with the interest recognized in the period from the accretion of values allocated to the value of the warrants and the beneficial conversion feature computed upon the release of the securities from escrow. Interest in 2016, primarily related to the mortgage loans on the building that was paid off in the first quarter of 2016 upon the building’s sale. For the nine months ended September 30, 2017, the Company recorded investment income of approximately $83,000, compared to investment income of $103,000 in the 2016 period, with the difference resulting from an average lower invested balances and lower rates on average investments with shorter maturities.
On February 25, 2016, the Company completed the sale of its corporate headquarters, land, building and certain fixtures and equipment to a third party at a purchase price of $4,053,000. The sale including subsequent equipment sales resulted in a gain of approximately $1,933,000 and generated approximately $1,799,000 in net cash after expenses and mortgage payoffs.
No income tax benefit was recorded on the net loss for the nine months ended September 30, 2017 and 2016, as management was unable to determine that it was more likely than not that such benefit would be realized.
Comparative Results for the Three Months Ended September 30, 2017 and 2016
During each of the three month periods ended September 30, 2017 and 2016, $24,000 in each period, of license payments under the License Agreement was recognized as revenue.
Selling, general and administrative expenses in the three months ended September 30, 2017 totaled $597,000, which is approximately $883,000, or 60%, decrease as compared to the 2016 period. Compensation related expenses decreased by approximately $744,000 due to fewer employees and lower bonuses in the 2017 period. Legal and accounting expenses decreased by $86,000 for the 2017 period due the level of legal and audit services on various matters in the 2017 period. Stock based compensation decreased by approximately $36,000 for the three months ended September 30, 2017, as compared to the 2016 period due to less equity rights being outstanding. Commercialization and marketing related expenses decreased by approximately $49,000 in the 2017 period as the Company had substantially wound down APPY1 commercialization activities in 2016.
Research and development expenses in the three months ended September 30, 2017 totaled $18,000, which is approximately a $35,000, or 67%, decrease as compared to the 2016 period. This decrease resulted from the wind down activities of development and manufacturing activities from our previous area of focus, the APPY1 Test, in 2016, combined with lower animal health related expenses in 2017.
Interest expense for the three months ended September 30, 2017, totaled approximately $4,773,000 compared to virtually nil in the 2016 period. The interest expense in the 2017 period primarily related to the accrual of interest on the March 2017 convertible note offering combined with the interest recognized in the period from the accretion of values allocated to the value of the warrants and the beneficial conversion feature upon the release of the convertible note securities from escrow and conversion to Series A Preferred Stock.
Liquidity and Capital Resources
At September 30, 2017, we had working capital of $12,555,000, which included cash and cash equivalents of $13,140,000. We reported a net loss of $10,968,000, consisting of a net loss from continuing operations of $7,404,000 and a net loss from discontinued operations of $3,564,000, during the nine months ended September 30, 2017. The net loss from continuing operations included $5,113,000 in non-cash items consisting of amortization of debt discount to interest of $4,750,000, stock-based compensation totaling $380,000, depreciation and amortization totaling $56,000, net of amortization of license fees totaling $73,000.
In March 2017, the Company entered into private placement agreements, under which during the nine months ended September 30, 2017, the Company received net proceeds after offering expenses totaling $1,914,000 from the sale of 900,000 shares of common stock, including the issuance of 900,000 warrants.
In March 2017, the Company also closed on a convertible note financing with certain accredited investors with gross proceeds totaling $4,750,000. The convertible note financing proceeds were held in escrow until their release in August 2017, upon waiver of release conditions by the lead investor.
During the nine months ended September 30, 2017, the Company negotiated and executed agreements with holders of stock rights (stock options and restricted shares) to have such holders waive their rights to the stock rights in exchange for a one time cash payment. Under the agreements, a total of 532,911 rights were forfeited, consisting of; 494,578 stock options under the Company's 2002 Plan, 37,500 non-qualified options issued outside of the Plan and 833 restricted common shares. The total consideration under the agreements was $299,500. Of the total paid, $291,995 was charged to stockholders’ equity and $7,505 was charged to compensation expense.
In September 2017, the Company acquired a minority interest for $3,000,000 USD, in Coinsquare, which operates a digital crypto-currency exchange platform operating in Canada.
In October 2017, the Company acquired approximately 52% of TESS, which is developing blockchain solutions for telecommunications companies. Under the terms of the purchase agreement the Company invested cash of $320,000 and issued 75,000 shares of restricted common stock in exchange for 2,708,333 shares of common stock of TESS. Accordingly, TESS became a majority-owned subsidiary of the Company.
On October 2, 2017, the Company’s Board of Directors approved a cash dividend which was paid on October 18, 2017, and totaled approximately $9,562,000.
In October 2017, the holders of 620,000 warrants issued in the March 2017 private offerings (420,000 from the common stock offering and 200,000 from the convertible note offering), exercised their warrants and were issued 620,000 shares of common stock generating $1,860,000 in cash proceeds.
We expectexpects to continue to incur losses from operations for the near-term and these losses could be significant as we incur costs and expenses associated with our recentoperations and new business development, including potential future investments,acquisitions and the related capital and other costs that may be required for operations, as well as public company and administrative related expenses are incurred and any possible expenses which may be incurred from final shutdown of BDI’s operations. We believeexpenses. The Company believes that ourits current working capital position will be sufficient to meet ourits estimated operating cash needs for at least a year and a day from this filing. We may pursue potential additional financing opportunities. However, there can be no assurance that we will be able to obtain sufficient additional financing on terms acceptable to us, if at all. We areThe Company is closely monitoring ourits cash balances, cash needs and expense levels. The accompanying financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that might result in our possible inability to continue as a going concern.
In July 2012, we entered the License Agreement with the Licensee, pursuant to which we granted the Licensee an exclusive royalty-bearing license, until December 31, 2028, to our intellectual property and other assets, including patent rights and know-how, relating to recombinant single chain reproductive hormone technology for use in non-human mammals. The License Agreement is subject to termination by the Licensee (a) for convenience on 180 days prior written notice, (b) in the Licensee's discretion in the event of a sale or other disposal of the Company's Animal Health Assets, (c) in the Licensee's discretion upon a change in control of the Company, (d) for a material breach of the License Agreement by us, or (e) in the Licensee's discretion, if we become insolvent. The License Agreement is also terminable by us if there is a material breach of the License Agreement by the Licensee, or if the Licensee challenges our ownership of designated intellectual property. The License Agreement includes a sublicense of the technology licensed to the Company by WU. Under the terms of the WU license agreement, a portion of license fees and royalties we receive from sublicensing agreements will be paid to WU. The obligation for such license fees due to WU is included in accrued expenses at September 30, 2017.
Under the License Agreement, as of September 30, 2017, the following future milestone payments are provided, assuming future milestones are successfully achieved:
milestone payments, totaling up to a potential of $1.1 million in the aggregate, based on the satisfactory conclusion of milestones as defined in the License Agreement;
potential for milestone payments of up to an additional $2 million for development and receipt of regulatory approval for additional licensed products; and
royalties, at low double digit rates, based on sales of licensed products.
The Company periodically enters intoexpects the need to raise additional capital to expand our operations and pursue our growth strategies, including potential acquisitions of complementary businesses, and to respond to competitive pressures or unanticipated working capital requirements. We may not be able to obtain additional debt or equity financing on favorable terms, if at all, which could impair our growth and adversely affect our existing operations. If we raise additional equity financing, our shareholders may experience significant dilution of their ownership interests, and the per share value of our common stock could decline. Furthermore, if we engage in additional debt financing, the holders of debt would have priority over the holders of common stock, and we may be required to accept terms that restrict our ability to incur additional indebtedness and take other actions that would otherwise be in the interests of our shareholders, forcing us to maintain specified liquidity or other ratios.
Management's strategic plans include the following:
| • | continuing expansion of cryptocurrency mining operations; |
| • | continuing to evaluate opportunities for investments in the blockchain and digital currency sector; |
| • | establishing a virtual currency exchange; |
| • | exploring other possible strategic options and financing opportunities available to the Company; |
| • | evaluating options to monetize, partner or license the Company's assets; and |
| • | continuing to implement cost control initiatives to conserve cash. |
Results of Operations
Comparative Results for the Three Months Ended March 31, 2018 and 2017
Comparative results for the three months ended March 31, 2018 and 2017 are not indicative of the actual performance of the Company’s cryptocurrency business. The Company’s results for the three months ended March 31, 2017, do not reflect any cryptocurrency related operations, because the Company did not determine to pursue our new strategy until the third quarter of 2017. Rather, during the first quarter of 2017, the company was conducting the now discontinued operation of BDI, a wholly-owned subsidiary of the Company. BDI had developed a proprietary Enhanced Surface Plasmon Resonance technology platform for the detection of molecular interactions. Further, because the operations of BDI are considered a discontinued operation and BDI’s results are not reflected in the revenues and expenses explained below for the three months ended March 31, 2018 or 2017.
Revenue for the three months ended March 31, 2018 and 2017, consisted of our cryptocurrency mining revenue of $901,000, and $0, respectively, and other revenue consisting of license payments of $24,000 in each period.
Cost of revenue for the three months ended March 31, 2018 of $349,000 consisted primarily of direct production costs of the mining operations, including rent and utilities, but excluding depreciation and amortization which are separately stated. There was no cost of revenue recognized during the period ended March 31, 2017.
Selling, general and administrative expenses in the three months ended March 31, 2018 totaled $3,906,000, which is approximately $2,872,000, or a 277% increase, as compared to $1,035,000 in the 2017 period. Stock-based compensation increased by approximately $751,000 for the three months ended March 31, 2018 as compared to the 2017 period. Consulting fees increased approximately $415,000 for services related to our cryptocurrency machines. Investor, public relations and public company expenses were $530,000 for the three months ended March 31, 2018 compared to $45,000 in comparable expenses for the 2017 period. Legal fees increased approximately $264,000 due to legal matters associated with the increased level of corporate activities in the 2018 period. Compensation related expense increased by $56,000 due primarily to increased payroll related to the Company’s additional hiring activities in late 2017 and early 2018.
Research and development expenses in the three months ended March 31, 2018 totaled $5,000, which is approximately a $13,000 decrease as compared to the 2017 period. This change resulted from normal period to period fluctuations in the animal health business expenses.
Asset impairment charges of $11,480,000 were recognized for the three months ended March 31, 2018 to record our cryptocurrency machines at their fair value. There were no impairment charges recognized in the first quarter of 2017.
Interest expense for the three months ended March 31, 2018, decreased to $1,000 compared to $5,000 in the 2017 period. For the three months ended March 31, 2018, the Company recorded investment income of approximately $63,000 compared to investment income of $26,000 in the 2017 period, generally short-term consulting agreements, which at this time are primarilydue to a lower level of average outstanding interest-bearing debt.
Other expenses for assistancethe three months ended March 31, 2018 of $333,000 represents the penalty accrual related to our registration rights agreement associated with our December 19, 2017 private placement. The agreement provided that the Company register our securities by the effectiveness date of March 5, 2018. The registration rights were not registered by the effectiveness date and the Company recognized a contingency.
Income tax benefit for the three months ended March 31, 2018 of $3,053,000 reflects the change in the deferred tax assets related to the depreciation expense and the impairment charge recognized on our cryptocurrency machines for the three months ended March 31, 2018. There was no income tax benefit recognized for the three months ended March 31, 2017.
Liquidity and Capital Resources
We have historically experienced recurring losses and negative cash flows from operations. At March 31, 2018, we had working capital of $8,915,000, which included cash and cash equivalents of $5,258,000. We reported a net loss of $16,350,000 for the three months ended March 31, 2018. The net loss included $13,931,000 in non-cash items consisting of an impairment charge of $11,480,000, revaluation of our digital currencies of $2,468,000, depreciation and amortization totaling $2,156,00, stock-based compensation totaling $884,000 and common stock issued for services totaling $20,000, net of $3,053,000 of deferred income tax benefit and amortization of license fee revenue of $24,000.
As of March 31, 2018, we held bitcoins with a current value of approximately $4.3 million.
In February 2018, we completed two asset purchases under which a total of 6,800 bitcoin mining machines and related equipment were acquired in exchange for a total payment of $18.0 million in cash, a deferred short-term purchase price liability of $1.5 million payable in cash and the issuance of 1,000,000 restricted shares of our common stock, of which 200,000 shares are retained in escrow, subject to release conditions.
In February 2018 we entered into a consulting agreement with Ingenium International LLC to provide consulting services related to our business for a 12-month period. Services include completion of installation and deployment of the 8,000 acquired cryptocurrency mining machines; assist in managing and monitoring the operation of the 8,000 cryptocurrency miners on an ongoing basis; promptly respond and troubleshoot any issues as they arise in the management and monitoring of the operations; continue the facility buildout of up to 40 MW of energy capacity; and make strategic evaluations. Such commitments at any pointintroductions to other cryptocurrency business opportunities and contacts in time may be significant but the agreements typically contain cancellation provisions.sector. In connection with the agreement we paid $4,000,000 for the services.
In February 2018, Kairos entered into a lease agreement to lease an approximately 107,600 square foot warehouse located in Oklahoma City, Oklahoma, including improvements thereon. The initial term is for one year with four one-year renewal options, subject to increases in base rent as provided in the lease. Initial base rent including power for the facility totals approximately $330,000 per month. On March 26, 2018, Kairos entered into a first amendment to the lease, under which the landlord agreed to increase the electrical power available for Kairos's use from 6MW to 12MW, and the base rent under the lease was increased to approximately $650,000 per month, effective as of the date when such additional power is available. In April 2018, we entered into a commercial lease covering 1,694 rentable square feet of office space in Fort Lauderdale, Florida, with a third-party for an initial term of thirty-nine months, with one five-year option to renew. The lease requires initial monthly rent of approximately $7,000, including base rent and associated operating expenses.
On February 25, 2016,March 26, 2018, for a net payment of $500,000 in cash, we acquired 92.5% of Logical Brokerage Corp., a futures introducing broker headquartered in Miami, Florida, registered with the Commodity Futures Trading Commission (“CFTC”), and a member of the National Futures Association (“NFA”). We intend to investigate launching a digital currency exchange and a futures brokerage operation within the United States under the name RiotX.
We have historically funded our operations from sales of equity securities and convertible debt. We believe that our cash on hand, and the value of digital currencies as of March 31, 2018 and expected to be mined in upcoming periods, will be adequate to fund our present operations for at least 12-months from the date of this report. In the event that we seek to expand our activities or acquire additional businesses, we may be required to raise additional cash through equity or incurrence of debt.
Funding our operations on a go-forward basis will rely significantly on our ability to continue to mine cryptocurrency and the spot or market price of cryptocurrency, as well as the ease with which and lawfulness of conversion of cryptocurrency to fiat currency, such as US dollars. We expect to generate substantial revenues from the production of bitcoins, for example, in our mining facilities and our ability to liquidate bitcoins at future values will be evaluated from time to time to generate cash for operations. Generating bitcoins, for example, which exceed our production and overhead costs will determine our ability to maintain profit margins, although accounting for our reported profitability is significantly complex.
The ability to raise funds as equity, debt or conversion of cryptocurrency to maintain our operations is subject to many risks and uncertainties and, even if we were successful, future equity issuances would result in dilution to our existing stockholders and any future debt or debt securities may contain covenants that limit our operations or ability to enter into certain transactions. Our ability to realize revenue through bitcoin production and successfully convert bitcoin into cash or fund overhead with bitcoin is subject to a number of risks, including regulatory, financial and business risks, many of which are beyond our control. Additionally, the value of bitcoins has been extremely volatile recently and such volatility has recently been down and future prices cannot be predicted.
If we are unable to generate sufficient revenue from our bitcoin production when needed or secure additional sources of funding, it may be necessary to significantly reduce our current rate of spending or explore other strategic alternatives.
Recently, the Company completedhas been named a defendant in several lawsuits seeking class action status, and other lawsuits as more fully described in Part II of this report. In addition, the saleCompany has received comments, inquiries and subpoenas from regulatory bodies, including NASDAQ and the SEC, which are costly and time consuming to respond to. While the Company maintains policies of its corporate headquarters, land, buildinginsurance, such policies may not cover all of the costs or expenses associated with responding to such matters or any liability or settlement associated with any lawsuits, and certain fixtures and equipmentare subject to a third party at a purchase price of $4,053,000. The sale including subsequent equipment sales resulted in a gain of approximately $1,933,000 and generated approximately $1,749,000 in net cash after expenses and mortgage payoffs. The Company is leasing back space in the building under a short-term lease agreement that provide storage space.significant deductible or retention amounts.
Due to recent market events that have adversely affected all industries and the economy as a whole, management has placed increased emphasis on monitoring the risks associated with the current environment, particularly the investment parameters of the short-term investments, the recoverability of current assets, the fair value of assets, and the Company's liquidity. At this point in time, there has not been a material impact on the Company's assets and liquidity. Management will continue to monitor the risks associated with the current environment and their impact on the Company's results.
Operating Activities
Net cash used in operating activities was $5,630,000, consisting of $5,561,000 from continuing operations and $69,000 from discontinued operations during the three months ended March 31, 2018. Cash was consumed from continuing operations by the loss of $16,661,000, less non-cash items of $13,931,000 consisting of an asset impairment for the Company’s miners of $11,480,000, revaluation of our digital currencies of $2,468,000, depreciation and amortization of $2,156,000, stock-based compensation totaling $884,000, and other non-cash charges totaling $20,000, net of deferred income tax benefit of $3,053,000 and amortization of license fee revenue totaling $24,000. Prepaid contracts increased $3,585,000 due to the advance consulting payment made to Ingenium, for future services associated with the set-up of the new mining facility and its operations and other services, digital currencies increased $901,000, accounts payable and accrued expenses increased $1,628,000 related to the significant expansion of the Company’s operating activities in 2018, offset by a slight decrease in prepaid and other current assets.
Net cash consumed by operating activities was $3,164,000,$1,664,000, consisting of $2,234,000$1,002,000 from continuing operations and $930,000$662,000 from discontinued operations during the ninethree months ended September 30,March 31, 2017. Cash was consumed from continuing operations by the loss of $7,404,000,$1,007,000, less non-cash items of $5,113,000 in non-cash items$129,000 consisting of amortization of debt discount to interest of $4,750,000, stock-based compensation totaling $380,000,$133,000, depreciation, amortization and amortizationnon-cash charges totaling $56,000,$20,000, net of amortization of license fees totaling $73,000. Decreases in prepaid and other current assets of $192,000 provided cash, primarily related to reductions in operating activities. There was a net $135,000 decrease in accounts payable and accrued expenses in the nine months ended September 30, 2017, primarily due to reductions in operating activities and the payment of 2016 litigation settlement accrual in early 2017.
Net cash consumed by operating activities was $3,841,000, consisting of $3,466,000 from continuing operations and $375,000 from discontinued operations during the nine months ended September 30, 2016. Cash was consumed from continuing operations by the loss of $1,751,000, less non-cash expenses of $643,000 for stock-based compensation, depreciation and amortization, and impairment of patent costs, offset by the gain on sale of property and equipment of $1,933,000 and amortization of license fees totaling $73,000.$24,000. Increases in prepaid and other current assets of $222,000$63,000 used cash, primarily related to routine changes in operating activities. There was a $574,000net $190,000 decrease in accounts payable and accrued expenses in the ninethree months ended September 30, 2016,March 31, 2017, primarily due to the payment of 2015 accrued incentives2016 litigation settlement in early 2016, and a reduction in overall expenses due to the wind-down of the APPY1 activities.2017.
Investing Activities
Net cash used in investing activities during the three months ended March 31, 2018 was $32,207,000, primarily consisting of purchases of property and equipment of $18,923,000 related to the Company’s cryptocurrency machines, an additional investment in Coinsquare of $6,413,000, purchases of digital currencies of $5,625,000, security deposits of $673,000 and an investment in Logical Brokerage of $517,000.
Net cash inflows from investing activities provided cash of $4,497,000,$7,493,000, consisting of $4,493,000$7,495,000 from continuing operations and a cash inflowoutflow of $4,000$2,000 from discontinued operations during the ninethree months ended September 30,March 31, 2017. Sales of marketable securities investments totaling approximately $7,507,000 provided cash. Cash of $3,000,000 was used in the Coinsquare investment. A $14,000$12,000 use of cash was attributable to additional costs incurred from patent filings.
Financing Activities
Net cash inflows from investingprovided by financing activities provided cash of $4,505,000,was $1,443,000 during the three months ended March 31, 2018 primarily consisting of $4,489,000$775,000 of proceeds from continuing operations and a cash inflowdemand note, $350,000 from the exercise of $17,000warrants, $320,000 from discontinued operations during the nine months ended September 30, 2016. Sales of marketable securities investments totaling approximately $16,523,000 provided cash, net of marketable securities purchased totaling approximately $13,819,000. A $14,000 use of cash was attributable to additional costs incurred from patent filings. The sale of the land, buildingCompany’s shares of common stock held by Tess, and assets generated approximately $1,799,000$79,000 for the exercise of stock options, offset by $81,000 used in cash. As part of the BDI acquisition $17,000 in cash was acquired.
Financing Activitiesscheduled payments under debt agreements.
Net cash inflows from financing activities provided $6,277,000 from continuing operations,$623,000 during the ninethree months ended September 30,March 31, 2017 consisting of net proceeds of $4,750,000 from convertible notes payable, $2,012,000$706,000 from the sale of common stock and exercise of warrants and options, net of $193,000 in scheduled payments under debt agreements, and $292,000 consumed from the redemption of equity rights payments.
Net cash outflows from financing activities consumed $229,000 during the nine months ended September 30, 2016$83,000 in scheduled payments under debt agreements.
Critical Accounting Policies and Significant Judgments and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with revenue recognition, impairment analysis of intangibles and stock-based compensation.
The Company's financial position, results of operations and cash flows are impacted by the accounting policies the Company has adopted. In order to get a full understanding of the Company's financial statements, one must have a clear understanding of the accounting policies employed. A summary of the Company'sOur critical accounting policies follows:
Investments:and significant estimates are detailed in our 2017 Annual Report. Our investmentscritical accounting policies and significant estimates have not changed from those previously disclosed in equity securities of companies over which we do not have significant influence are accountedour 2017 Annual Report, except for underthose accounting subjects mentioned in the cost method. The investment is originally recorded at cost and adjusted for additional contributions or distributions. Management periodically reviews cost-method investments for instances where fair value is less than the carrying amount and the decline in value is determined to be other than temporary. If the decline in value is judged to be other than temporary, the carrying amountsection of the security is written downnotes to fair value and the resulting loss is charged to operations. We currently do not have investments in which we own 20% to 50% and exercise significant influence over operating andcondensed consolidated financial policies, therefore we do not account for any investment under the equity method.
Intangible Assets: Intangible assets primarily represent legal costs and filings associated with obtaining patents on the Company's new discoveries. The Company amortizes these costs over the shorterstatements titled Adoption of the legal life of the patent or its estimated economic life using the straight-line method. The Company tests intangible assets with finite lives upon significant changes in the Company's business environment. The testing resulted in no patent impairment charges written off during the nine month period ended September 30, 2017 and $168,000 net patent impairment charges written off during the nine months ended September 30, 2016.
Revenue Recognition: The Company's revenues are recognized when products are shipped or delivered to unaffiliated customers. The Securities and Exchange Commission's StaffRecent Accounting Bulletin (SAB) No. 104 provides guidance on the application of GAAP to select revenue recognition issues. The Company has concluded that its revenue recognition policy is appropriate and in accordance with SAB No. 104. Revenue is recognized under sales, license and distribution agreements only after the following criteria are met: (i) there exists adequate evidence of the transactions; (ii) delivery of goods has occurred or services have been rendered; and (iii) the price is not contingent on future activity; and (iv) collectability is reasonably assured.
Stock-based Compensation: ASC 718, Share-Based Payment, defines the fair-value-based method of accounting for stock-based employee compensation plans and transactions used by the Company to account for its issuances of equity instruments to record compensation cost for stock-based employee compensation plans at fair value as well as to acquire goods or services from non-employees. Transactions in which the Company issues stock-based compensation to employees, directors and consultants and for goods or services received from non-employees are accounted for based on the fair value of the equity instruments issued. The Company utilizes pricing models in determining the fair values of options and warrants issued as stock-based compensation. These pricing models utilize the market price of the Company's common stock and the exercise price of the option or warrant, as well as time value and volatility factors underlying the positions.Pronouncements.
Recently issued and adopted accounting pronouncements:
The Company has evaluated all recently issued accounting pronouncements and believes such pronouncements do not have a material effect on the Company's financial statements. See Note 2 of the condensed consolidated financial statements at March 31, 2018.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
GeneralNot required for a smaller reporting company.
We have limited exposure to market risks from instruments that may impact the Balance Sheets, Statements of Operations, and Statements of Cash Flows. Such exposure is due primarily to changing interest rates.27
Interest Rates
The primary objective for our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing excess cash in highly liquid debt and equity investments of highly rated entities which are classified as trading securities. As of September 30, 2017, 100% of the investment portfolio was in cash and cash equivalents with very short-term maturities and therefore not subject to any significant interest rate fluctuations. We have no investments denominated in foreign currencies and therefore our investments are not subject to foreign currency exchange risk.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Management of the Company, including the Chief Executive Officer and the Chief Financial Officer, has conductedWe carried out an evaluation, under the supervision and with the participation of the effectiveness of the Company's disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rule 13a-15(e)) as of the last day of the period of the accompanying financial statements. Based on that evaluation, theour management, including our Chief Executive Officer and Chief Financial Officer, concluded thatof the effectiveness of our disclosure controls and procedures are effective(as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2017.the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported accurately and within the time frames specified in the SEC's rules and forms and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There was no change in the Company's internal control over financial reporting that occurred during the fiscal quarter to which this report relates that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
Inherent Limitations on the Effectiveness of Controls
Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on 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. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies and procedures.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are not a party
Disclosure under this Item is incorporated by reference to any legal proceedings, the adverse outcome of which would,disclosure provided in our management's opinion, have a material adverse effect on our business, financial condition and results of operations.
this Report under Part I, Item 1., Financial Statements in Note 12., contingencies.
Item 1A. Risk Factors
If any of the risks asOur risk factors are disclosed below or as disclosed in our Annual Report on Form 10-K, for the year ended December 31, 2016, actually occur, they could materially adversely affect our2017. Our business, financial condition or operating results. In that case,results could materially and adversely be affected, and the trading price of our common stock could decline.
RISK FACTORS
An investment in the Company’s common stock involves a high degree of risk. In determining whether to purchase the Company’s common stock, an investor should carefully consider all of the material risks described below, together with the other information contained in this report and the Company’s other public filings before making a decision to purchase the Company’s securities. An investor should only purchase the Company’s securities if he or she can afford to suffer the loss of his or her entire investment.
The following risk factors are intended to supplement and should be read along with the “Risk Factors” contained in our Annual Report on Form 10-K filed with the SEC, and our other filings and reports with the SEC, which risk factors are incorporated herein by reference.
General Cryptocurrency Risks
Cryptocurrency exchanges and other trading venues (including the Company’s Coinsquare exchange) are relatively new and, in most cases, largely unregulated and may therefore may be subject to fraud and failures
When cryptocurrency exchanges or other trading venues (whether involving the Company’s Coinsquare exchange or others) are involved in fraud or experience security failures or other operational issues, such events could result in a reduction in cryptocurrency prices or confidence and impact the success of the Company and have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company.
Cryptocurrency market prices depend, directly or indirectly, on the prices set on exchanges and other trading venues, which are new and, in most cases, largely unregulated as compared to established, regulated exchanges for securities, commodities or currencies. For example, during the past three years, a number of bitcoin exchanges have closed due to fraud, business failure or security breaches. In many of these instances, the customers of the closed exchanges were not compensated or made whole for partial or complete losses of their account balances. While smaller exchanges are less likely to have the infrastructure and capitalization that may provide larger exchanges with some stability, larger exchanges may be more likely to be appealing targets for hackers and "malware" (i.e., software used or programmed by attackers to disrupt computer operation, gather sensitive information or gain access to private computer systems) and may be more likely to be targets of regulatory enforcement action. The Company does not maintain any insurance to protect from such risks, and does not expect any insurance for customer accounts to be available (such as federal deposit insurance) at any time in the future, putting customer accounts at risk from such events. In the event the Company faces fraud, security failures, operational issues or similar events such factors would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company.
Regulatory changes or actions may alter the nature of an investment in the Company or restrict the use of cryptocurrencies in a manner that adversely affects the Company’s business, prospects or operations.
As cryptocurrencies have grown in both popularity and market size, governments around the world have reacted differently to cryptocurrencies, with certain governments deeming them illegal while others have allowed their use and trade. On-going and future regulatory actions may impact the ability of the Company to continue to operate and such actions could affect the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company.
The effect of any future regulatory change on the Company or any cryptocurrency that the Company may mine or hold for others is impossible to predict, and such change could have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company.
Governments may in the future curtail or outlaw the acquisition, use or redemption of cryptocurrencies. Ownership of, holding or trading in cryptocurrencies may then be considered illegal and subject to sanction. Governments may also take regulatory action that may increase the cost and/or subject cryptocurrency companies to additional regulation.
On July 25, 2017 the SEC released an investigative report which states that the United States would, in some circumstances, consider the offer and sale of blockchain tokens pursuant to an initial coin offering (“ICO”) subject to federal securities laws. Thereafter, China released statements and took similar actions. Although the Company does not participate in ICOs, its clients and customers may participate in ICOs and these actions may be a prelude to further action which chills widespread acceptance of blockchain and cryptocurrency adoption and have a material adverse effect the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company.
Governments may in the future take regulatory actions that prohibit or severely restrict the right to acquire, own, hold, sell, use or trade cryptocurrencies or to exchange cryptocurrencies for fiat currency. Similar actions by governments or regulatory bodies (such as an exchange on which the Company’s securities are listed, quoted or traded) could result in restriction of the acquisition, ownership, holding, selling, use or trading in the Company’s securities. Such a restriction could result in the Company liquidating its inventory at unfavorable prices and may adversely affect the Company's shareholders and have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, raise new capital or maintain a securities listing with an exchange (such as the Company’s current listing with NASDAQ) which would have a material adverse effect on the business, prospects or operations of the Company and harm investors in the Company’s securities.
The development and acceptance of cryptographic and algorithmic protocols governing the issuance of and transactions in cryptocurrencies is subject to a variety of factors that are difficult to evaluate.
The use of cryptocurrencies to, among other things, buy and sell goods and services and complete transactions, is part of a new and rapidly evolving industry that employs digital assets based upon a computer-generated mathematical and/or cryptographic protocol. The growth of this industry in general, and the use of cryptocurrencies in particular, is subject to a high degree of uncertainty, and the slowing or stopping of the development or acceptance of developing protocols may occur and is unpredictable. The factors include, but are not limited to:
| • | Continued worldwide growth in the adoption and use of cryptocurrencies; |
| • | Governmental and quasi-governmental regulation of cryptocurrencies and their use, or restrictions on or regulation of access to and operation of the network or similar cryptocurrency systems; |
| • | Changes in consumer demographics and public tastes and preferences; |
| • | The maintenance and development of the open-source software protocol of the network; |
| • | The availability and popularity of other forms or methods of buying and selling goods and services, including new means of using fiat currencies; |
| • | General economic conditions and the regulatory environment relating to digital assets; and |
| • | Negative consumer sentiment and perception of bitcoin specifically and cryptocurrencies generally. |
Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors in the Company’s securities.
Banks and financial institutions may not provide banking services, or may cut off services, to businesses that provide cryptocurrency-related services or that accept cryptocurrencies as payment, including financial institutions of investors in the Company’s securities.
A number of companies that provide bitcoin and/or other cryptocurrency-related services have been unable to find banks or financial institutions that are willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial institutions. We also may be unable to obtain or maintain these services for our business. The difficulty that many businesses that provide bitcoin and/or other cryptocurrency-related services have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness of cryptocurrencies as a payment system and harming public perception of cryptocurrencies and could decrease its usefulness and harm its public perception in the future. Similarly, the usefulness of cryptocurrencies as a payment system and the public perception of cryptocurrencies could be damaged if banks or financial institutions were to close the accounts of businesses providing bitcoin and/or other cryptocurrency-related services. This could occurdecline, as a result of compliance risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national stock and commodities exchanges, the over the counter market and the Depository Trust Company, which, if any of such entities adopts or implements similar policies, rules or regulations, could result in the inability of our investors to open or maintain stock or commodities accounts, including the ability to deposit, maintain or trade the Company’s securities. Such factors would have athese risks. There were no material adverse effect the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and harm investors.
The price of the Company’s shares could be subject to wide price swings since the value of cryptocurrencies may be subject to pricing risk and have historically been subject to wide swings in value.
The Company’s shares are subject to arbitrary pricing factors that are not necessarily associated with traditional factors that influence stock prices or the value of non-cryptocurrency assets such as revenue, cashflows, profitability, growth prospects or business activity levels since the value and price, as determined by the investing public, may be influenced by future anticipated adoption or appreciation in value of cryptocurrencies or the blockchain generally, factors over which the Company has little or no influence or control. The Company’s share prices may also be subject to pricing volatility due to supply and demand factors associated with few or limited public company options for investment in the segment, which may benefit the Company in the near term and change over time.
Cryptocurrency market prices are determined primarily using data from various exchanges, over-the-counter markets, and derivative platforms. Furthermore, such prices may be subject to factors such as those that impact commodities, more so than business activities, which could be subjected to additional influence from fraudulent or illegitimate actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue to result in, speculation regarding future appreciation in the value of cryptocurrencies, or the Company or its share price, inflating and making their market prices more volatile or creating “bubble” type risks.
In addition, the success of the Company, the Company’s share price, and the interest in investors and the public in the Company as an early entrant into the blockchain and cryptocurrency ecosystem may in large part be the result of the Company’s early emergence as a publicly traded company in which holders of appreciated cryptocurrency have an opportunity to invest inflated cryptocurrency profits for shares of the Company, which could be perceived as a way to maintaining investing exposure to the blockchain and cryptocurrency markets without exposing the investorchanges to the risk in a particular cryptocurrency. Cryptocurrency holders have realized exponential value due to large increasesfactors in the pricesthree months ended March 31, 2018.
Item 2. Unregistered Sales of cryptocurrenciesEquity Securities and may seek to lock in cryptocurrency appreciation, which investing inUse of Proceeds.
During the Company’s securities may be perceived as a way to achieve that result, but may l not continue in the future. As a result, the value of the Company’s securities, and the value of cryptocurrencies generally may be more likely to fluctuate due to changing investor confidence in future appreciation (or depreciation) in market prices, profits from related or unrelated investments or holdings of cryptocurrency. Such factors or events would have a material adverse effect on the ability ofthree months ended March 31, 2018, the Company to continue as a going concern or to pursue this segmentissued 530,001 shares of common stock upon conversion of 530,001 shares of Series B Preferred Stock.
On January 4, 2018, the Company issued 19,533 shares of common stock upon the exercise of employee stock options.
On January 25, 2018, the Company issued 2,754 shares of common stock at all, or onfair value for consulting services.
On February 14, 2018, the Company issued 100,000 shares of common stock upon the exercise of 100,000 warrants for an aggregate exercise price of $350,000.
During the Company’s securities, which would have a material adverse effect on the business, prospects or operations ofthree months ended March 31, 2018, the Company and potentially the valueissued 3,215 shares of any cryptocurrenciescommon stock in exchange for 13,009 warrants.
On March 28, 2018 the Company holds or expectsissued 50,000 shares of common stock related to acquirea fully vested restricted stock unit issuance for its own account.
services performed in 2017.
The impact of geopolitical events onIn connection with the supply and demand for cryptocurrencies is uncertain.
Crises may motivate large-scale purchases of cryptocurrencies which could increase the price of cryptocurrencies rapidly. This may increase the likelihood of a subsequent price decrease as crisis-driven purchasing behavior wanes, adversely affecting the value of the Company's inventory. Such risks are similar to the risks of purchasing commodities in general uncertain times, such as the risk of purchasing, holding or selling gold.
As an alternative to gold or fiat currencies that are backed by central governments, cryptocurrencies, which are relatively new, are subject to supply and demand forces. How such supply and demand will be impacted by geopolitical events is uncertain but could be harmful toforegoing, the Company and investors in the Company’s securities. Nevertheless, political or economic crises may motivate large-scale acquisitions or sales of cryptocurrencies either globally or locally. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
Acceptance and/or widespread use of cryptocurrency is uncertain
Currently, there is a relatively small use of bitcoins and/or other cryptocurrencies in the retail and commercial marketplace for goods or services. In comparison there is relatively large use by speculators contributing to price volatility. .
The relative lack of acceptance of cryptocurrencies in the retail and commercial marketplace limits the ability of end-users to use them to pay for goods and services. Such lack of acceptance or decline in acceptances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
Possibility of the cryptocurrency algorithm transitioning to proof of stake validation and other mining related risks
Proof of stake is an alternative method in validating cryptocurrency transactions. Should the algorithm shift from a proof of work validation method to a proof of stake method, mining would require less energy and may render any Company that maintains advantages in the current climate (for example from lower priced electric, processing, real estate, or hosting) less competitive. The Company, which does not presently own or operate a mining facility, may be exposed to risk if it owns or acquires such a facility in the future, but may still be impacted to the extent that counterparties with which the Company interacts or who participate with Coinsquare, are affected. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
If a malicious actor or botnet obtains control of more than 50% of the processing power on a cryptocurrency network, such actor or botnet could manipulate the blockchain to adversely affect the Company which would adversely affect an investment in the Company or the ability of the Company to operate.
If a malicious actor or botnet (a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority of the processing power dedicated to mining a cryptocurrency, it may be able to alter the blockchain on which transactions of cryptocurrency resides and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. The malicious actor or botnet could control, exclude or modify the ordering of transactions, though it could not generate new units or transactions using such control. The malicious actor could “double-spend” its own cryptocurrency (i.e., spend the same bitcoins in more than one transaction) and prevent the confirmation of other users’ transactions for so long as it maintained control. To the extent that such malicious actor or botnet did not yield its control of the processing power on the network or the cryptocurrency community did not reject the fraudulent blocks as malicious, reversing any changes made to the blockchain may not be possible. The foregoing description is not the only means by which the entirety of the blockchain or cryptocurrencies may be compromised, but is only and example.
Although there are no known reports of malicious activity or control of the blockchain achieved through controlling over 50% of the processing power on the network, it is believed that certain mining pools may have exceeded the 50% threshold in bitcoin. The possible crossing of the 50% threshold indicates a greater risk that a single mining pool could exert authority over the validation of bitcoin transactions. To the extent that the bitcoin ecosystem, and the administrators of mining pools, do not act to ensure greater decentralization of bitcoin mining processing power, the feasibility of a malicious actor obtaining control of the processing power will increase, which may adversely affect an investment in the Company. Such lack of controls and responses to such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
To the extent that the profit margins of bitcoin mining operations are not high, operators of bitcoin mining operations are more likely to immediately sell bitcoins earned by mining in the market, resulting in a reduction in the price of bitcoins that could adversely impact the Company and similar actions could affect other cryptocurrencies.
Over the past two years, bitcoin mining operations have evolved from individual users mining with computer processors, graphics processing units and first generation ASIC servers. Currently, new processing power is predominantly added by incorporated and unincorporated “professionalized” mining operations. Professionalized mining operations may use proprietary hardware or sophisticated ASIC machines acquired from ASIC manufacturers. They require the investment of significant capital for the acquisition of this hardware, the leasing of operating space (often in data centers or warehousing facilities), incurring of electricity costs and the employment of technicians to operate the mining farms. As a result, professionalized mining operations are of a greater scale than prior miners and have more defined, regular expenses and liabilities. These regular expenses and liabilities require professionalized mining operations to more immediately sell bitcoins earned from mining operations, whereas it is believed that individual miners in past years were more likely to hold newly mined bitcoins for more extended periods. The immediate selling of newly mined bitcoins greatly increases the supply of bitcoins, creating downward pressure on the price of bitcoins.
The extent to which the value of bitcoin mined by a professionalized mining operation exceeds the allocable capital and operating costs determines the profit margin of such operation. A professionalized mining operation may be more likely to sell a higher percentage of its newly mined bitcoin rapidly if it is operating at a low profit margin—and it may partially or completely cease operations if its profit margin is negative. In a low profit margin environment, a higher percentage could be sold more rapidly, thereby potentially reducing bitcoin prices. Lower bitcoin prices could result in further tightening of profit margins, particularly for professionalized mining operations with higher costs and more limited capital reserves, creating a network effect that may further reduce the price of bitcoin until mining operations with higher operating costs become unprofitable and remove mining power. The network effect of reduced profit margins resulting in greater sales of newly mined bitcoin could result in a reduction in the price of bitcoin that could adversely impact the Company.
The foregoing risks associated with bitcoin could be equally applicable to other cryptocurrencies, existing now or introduced in the future. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
Political or economic crises may motivate large-scale sales of Bitcoins and Ethereum, or other cryptocurrencies, which could result in a reduction in value and adversely affect the Company.
As an alternative to fiat currencies that are backed by central governments, digital assets such as bitcoins and Ethereum, which are relatively new, are subject to supply and demand forces basedrelied upon the desirability of an alternative, decentralized means of buying and selling goods and services, and it is unclear how such supply and demand will be impactedexemption from registration provided by geopolitical events. Nevertheless, political or economic crises may motivate large-scale acquisitions or sales of bitcoins and Ethereum and other cryptocurrencies either globally or locally. Large-scale sales of bitcoins and Ethereum or other cryptocurrencies would result in a reduction in their value and could adversely affect the Company. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
It may be illegal now, or in the future, to acquire, own, hold, sell or use bitcoins, Ethereum, or other cryptocurrencies, participate in the blockchain or utilize similar digital assets in one or more countries, the ruling of which would adversely affect the Company.
Although currently bitcoins, Ethereum, and other cryptocurrencies, the blockchain and digital assets generally are not regulated or are lightly regulated in most countries, including the United States, one or more countries such as China and Russia may take regulatory actions in the future that could severely restrict the right to acquire, own, hold, sell or use these digital assets or to exchange for fiat currency. Such restrictions may adversely affect the Company. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
If regulatory changes or interpretations require the regulation of bitcoins or other digital assetsSection 4(a)(2) under the securities laws of the United States or elsewhere, including the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Company Act of 1940 or similar laws of other jurisdictions and interpretations by the SEC, CFTC, IRS, Department of Treasury or other agencies or authorities, the Company may be required to register and comply with such regulations, including atas amended, for transactions not involving a state or local level. To the extent that the Company decides to continue operations, the required registrations and regulatory compliance steps may result in extraordinary expense or burdens to the Company. The Company may also decide to cease certain operations. Any disruption of the Company’s operations in response to the changed regulatory circumstances may be at a time that is disadvantageous to the Company.
Current and future legislation and SEC rulemaking and other regulatory developments, including interpretations released by a regulatory authority, may impact the manner in which bitcoins or other cryptocurrency is viewed or treated for classification and clearing purposes. In particular, bitcoins and other cryptocurrency may not be excluded from the definition of “security” by SEC rulemaking or interpretation requiring registration of all transactions, unless another exemption is available, including transacting in bitcoin or cryptocurrency amongst owners and require registration of trading platforms as “exchanges” such as Coinsquare. The Company cannot be certain as to how future regulatory developments will impact the treatment of bitcoins and other cryptocurrencies under the law. If the Company determines not to comply with such additional regulatory and registration requirements, the Company may seek to cease certain of its operations or be subjected to fines, penalties and other governmental action. Any such action may adversely affect an investment in the Company. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
Lack of liquid markets, and possible manipulation of blockchain/cryptocurrency based assets
Digital assets that are represented and trade on a ledger-based platform may not necessarily benefit from viable trading markets. Stock exchanges have listing requirements and vet issuers, requiring them to be subjected to rigorous listing standards and rules and monitoring investors transacting on such platform for fraud and other improprieties. These conditions may not necessarily be replicated on a distributed ledger platform, depending on the platform’s controls and other policies. The more lax a distributed ledger platform is about vetting issuers of digital assets or users that transact on the platform, the higher the potential risk for fraud or the manipulation of digital assets. These factors may decrease liquidity or volume, or increase volatility of digital securities or other assets trading on a ledger-based system, which may adversely affect the Company. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
public offering.
Company Blockchain and Cryptocurrency Risks
The Company has an evolving business modelItem 3. Defaults Upon Senior Securities
As digital assets and blockchain technologies become more widely available, the Company expects the services and products associated with them to evolve. As a result to stay current with the industry, the Company’s business model may need to evolve as well. From time to time, the Company may modify aspects of its business model relating to its product mix and service offerings. The Company cannot offer any assurance that these or any other modifications will be successful or will not result in harm to the business. The Company may not be able to manage growth effectively, which could damage its reputation, limit its growth and negatively affect its operating results. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
The Company operations, investment strategies, and profitability may be adversely affected by competition from other methods of investing in cryptocurrencies.
The Company competes with other users and/or companies that are mining cryptocurrencies and other potential financial vehicles, including securities backed by or linked to cryptocurrencies through entities similar to the Company, such as ETF (exchange traded fund). Market and financial conditions, and other conditions beyond the Company's control, may make it more attractive to invest in other financial vehicles, or to invest in cryptocurrencies directly which could limit the market for the Company's shares and reduce their liquidity. The emergence of other financial vehicles and ETFs have been scrutinized by regulators and such scrutiny and negative impressions or conclusions could be applicable to the Company and impact the ability of the Company to successfully pursue this segment or operate at all, or to establish or maintain a public market for its securities. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.N/A - none
Cryptocurrency inventory, including that maintained by or for the Company, may be exposed to cybersecurity threats and hacks.
As with any computer code generally, flaws in cryptocurrency codes may be exposed by malicious actors. Several errors and defects have been found previously, including those that disabled some functionality for users and exposed users' information. Flaws in and exploitations of the source code allow malicious actors to take or create money have previously occurred. A hacking occurred in July 2017 and a hacker exploited a critical flaw to drain three large wallets that had a combined total of over $31 million worth of Ethereum. If left undetected, the hacker could have been able to steal an additional $150 million. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.Item 4. Mine Safety Disclosures
Competing blockchain platforms and technologies
The development and acceptance of competing blockchain platforms or technologies may cause consumers to use alternative distributed ledgers or an alternative to distributed ledgers altogether. This may adversely affect the Company and its exposure to various blockchain technologies. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
The Company's coins may be subject to loss, theft or restriction on access.
There is a risk that some or all of the Company's coins could be lost or stolen. Access to the Company's coins could also be restricted by cybercrime (such as a denial of service ("DOS") attack) against a service at which the Company maintains a hosted online wallet. Any of these events may adversely affect the operations of the Company and, consequently, its investments and profitability. The loss or destruction of a private key required to access the Company's digital wallets may be irreversible and the Company denied access for all time to its cryptocurrency holdings or the holdings of others. The Company's loss of access to its private keys or its experience of a data loss relating to the Company's digital wallets could adversely affect its investments and assets.Item 5. Other Information
Cryptocurrencies are controllable only by the possessor of both the unique public and private keys relating to the local or online digital wallet in which they are held, which wallet's public key or address is reflected in the network's public blockchain. The Company will publish the public key relating to digital wallets in use when it verifies the receipt of transfers and disseminates such information into the network, but it will need to safeguard the private keys relating to such digital wallets. To the extent such private keys are lost, destroyed or otherwise compromised, the Company will be unable to access its cryptocurrency coins and such private keys will not be capable of being restored by any network. Any loss of private keys relating to digital wallets used to store the Company's or its client’s cryptocurrencies would have a material adverse effect the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
Incorrect or fraudulent coin transactions may be irreversible
Cryptocurrency transactions are irrevocable and stolen or incorrectly transferred coins may be irretrievable. As a result, any incorrectly executed or fraudulent coin transactions could adversely affect the Company's investments and assets.
Coin transactions are not, from an administrative perspective, reversible without the consent and active participation of the recipient of the transaction. In theory, cryptocurrency transactions may be reversible with the control or consent of a majority of processing power on the network. Once a transaction has been verified and recorded in a block that is added to the blockchain, an incorrect transfer of a coin or a theft of coin generally will not be reversible and the Company may not be capable of seeking compensation for any such transfer or theft. It is possible that, through computer or human error, or through theft or criminal action, the Company's coins could be transferred in incorrect amounts or to unauthorized third parties, or to uncontrolled accounts. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
N/A - none
If the award of coins for solving blocks and transaction fees are not sufficiently high, miners may not have an adequate incentive to continue mining and may cease their mining operations.
As the number of coins awarded for solving a block in the blockchain decreases, the incentive for miners to continue to contribute processing power to the network will transition from a set reward to transaction fees. Either the requirement from miners of higher transaction fees in exchange for recording transactions in the blockchain or a software upgrade that automatically charges fees for all transactions may decrease demand for the relevant coins and prevent the expansion of the network to retail merchants and commercial businesses, resulting in a reduction in the price of the relevant cryptocurrency that could adversely impact the Company's cryptocurrency inventory and investments.
In order to incentivize miners to continue to contribute processing power to the network, the network may either formally or informally transition from a set reward to transaction fees earned upon solving for a block. This transition could be accomplished either by miners independently electing to record on the blocks they solve only those transactions that include payment of a transaction fee or by the network adopting software upgrades that require the payment of a minimum transaction fee for all transactions. If transaction fees paid for the recording of transactions in the Blockchain become too high, the marketplace may be reluctant to accept the network as a means of payment and existing users may be motivated to switch between cryptocurrencies or to fiat currency. Decreased use and demand for coins may adversely affect their value and result in a reduction in the market price of coins.
If the award of coins for solving blocks and transaction fees for recording transactions are not sufficiently high to incentivize miners, miners may cease expending processing power to solve blocks and confirmations of transactions on the Blockchain could be slowed temporarily. A reduction in the processing power expended by miners could increase the likelihood of a malicious actor or botnet obtaining control in excess of 50 percent of the processing power active on the blockchain, potentially permitting such actor or botnet to manipulate the blockchain in a manner that adversely affects the Company's activities.
If the award of coins for solving blocks and transaction fees are not sufficiently high, miners may not have an adequate incentive to continue mining and may cease their mining operations. Miners ceasing operations would reduce collective processing power, which would adversely affect the confirmation process for transactions (i.e., decreasing the speed at which blocks are added to the blockchain until the next scheduled adjustment in difficulty for block solutions) and make the network more vulnerable to a malicious actor or botnet obtaining control in excess of 50 percent of the processing power. A reduction in confidence in the confirmation process or processing power of the network could result and be irreversible. Such events would have a material adverse effect on the ability of the Company to continue to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
The price of coins may be affected by the sale of coins by other vehicles investing in coins or tracking cryptocurrency markets.
To the extent that other vehicles investing in coins or tracking cryptocurrency markets form and come to represent a significant proportion of the demand for coins, large redemptions of the securities of those vehicles and the subsequent sale of coins by such vehicles could negatively affect cryptocurrency prices and therefore affect the value of the inventory held by the Company. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
Risk related to shortages, technological obsolescence and difficulty in obtaining hardware
Should new services/software embodying new technologies emerge, the Company’s or its investments’ ability to recognize the value of the use of existing hardware and equipment and its underlying technology, may become obsolete and require substantial capital to replace such equipment.
The increase in interest and demand for cryptocurrencies has led to a shortage of mining hardware as individuals purchase equipment for mining at home and large scale mining evolved. For example, according to PC Gamer, AMD's Radeon RX 580 and Radeon RX 570 have been out of stock for months and are widely viewed as hardware that is unique for cryptocurrency purposes. Equipment in the mining facilities will require replacement from time to time. Shortages of graphics processing units may lead to unnecessary downtime for miners and limit the availability or accessibility of mining processing capabilities in the industry. Such events would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account.
Since there has been limited precedence set for financial accounting of bitcoin, Ethereum, and other digital assets, it is unclear how the Company will be required to account for digital assets transactions in the future.
Since there has been limited precedence set for the financial accounting of digital assets, it is unclear how the Company will be required to account for digital asset transactions or assets. Furthermore, a change in regulatory or financial accounting standards could result in the necessity to restate the Company’s financial statements. Such a restatement could negatively impact the Company’s business, prospects, financial condition and results of operation. Such circumstances would have a material adverse effect on the ability of the Company to continue as a going concern or to pursue this segment at all, which would have a material adverse effect on the business, prospects or operations of the Company and potentially the value of any cryptocurrencies the Company holds or expects to acquire for its own account and harm investors.
Item 6. Exhibits
The following exhibit list includes agreements that we entered into or that became effective during the three months ended March 31, 2018.
| EXHIBIT | | DESCRIPTION |
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| 101 | | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Balance Sheets, (ii) the Statements of Operations, (iii) the StatementStatements of Cash Flows and (iv) the Notes to Condensed Financial Statements. * |
* Filed herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Reportreport to be signed on its behalf by the undersigned, thereunto duly authorized.
| | Riot Blockchain, Inc. (Registrant) |
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Dated: November 13, 2017May 17, 2018 | |
| | /s/ John O’Rourke |
| | John O’Rourke Chief Executive Officer and Chairman of the Board (Principal Executive Officer) |
| | /s/ Jeffrey G. McGonegalRobby Chang |
Dated: November 13, 2017May 17, 2018 | Jeffrey G. McGonegalRobby Chang
Chief Financial Officer (Principal Financial and Accounting Officer) |
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