DIGITAL POWER CORPORATIONDPW HOLDINGS, INC. AND SUBSIDIARYSUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited (Continued)
SEPTEMBER 30, 2017MARCH 31, 2018
U.S. dollars in thousands, except share and per share data
Warrant Issued to Financial Advisor
In connection withThe Series B Convertible Preferred Stock is convertible at any time, in whole or in part, at the transactions contemplated by the Nov. Purchase Agreement, on November 2, the Company paid to Aegis Capital Corp. (“Aegis”), its financial advisor, a cash feeoption of $81 and issued to Aegis a warrant to purchase up to 148,133Philou, into shares of common stock with an exerciseat a fixed conversion price, of $0.66 per share (the “Warrant”),which is subject to adjustment for stock splits, stock dividends, combinations or similar events. The Warrant is exercisable at any time commencing six months fromevents, of $0.70 per share. As the effective conversion price of the Series B Convertible Preferred Stock on a converted basis was below the market price of the Company’s common stock on the date of issuance, through five years fromit was determined that these discounts represent beneficial conversion features, which were valued at $108 based on the difference between the effective conversion price and the market price of the Company’s common stock on the date of issuance. The Warrant may be exercised for cash or onThese features are analogous to preference dividends and are recorded as a “cashless” basis if there is no effective registration statement registering, or no current prospectus available for the resale of, all of the shares of Common Stock underlying the Warrant. Holders of the Warrant have “piggy-back” registration rights for a period of five years from the date of issue.
Loan and Security Agreement with I.AM, Inc.
On November 1, 2017, the Company and I.AM, Inc. (“I.AM”) entered into a Loan and Security Agreement (“Loan Agreement”) pursuantnon-cash return to which the Company will provide I.AM a non-revolving credit facility of up to $1,300, for a period ending on September 25, 2022, subject to the terms and conditions stated in the Loan Agreement, including that the Company having available funds to grant such credit. Advances on the credit facility accrue at a rate of 6.0% on the outstanding daily balance. The Loan Agreement is secured by the assets of I.AM’s membership interests in three restaurant LLCs.preferred shareholders through accumulated deficit.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this quarterly report, the “Company,” “Digital Power,“DPW Holdings,” “we,” “us” and “our” refer to Digital Power Corporation,DPW Holdings, Inc., a CaliforniaDelaware corporation, our wholly-owned subsidiaries, Coolisys Technologies, Inc., Power-Plus Technical Distributors, LLC, Digital Power Lending, LLC, Super Crypto Mining, Inc., Digital Power Limited and our majority owned subsidiary, Microphase Corporation.
Recent Developments
On December 31, 2017, CooliSys entered into a Share Purchase Agreement (the “Purchase Agreement”) with Micronet Enertec Technologies, Inc. (“MICT”), a Delaware corporation, Enertec Management Ltd., an Israeli corporation and wholly owned subsidiary of MICT (“EML” and, together with MICT, the “Seller Parties”), and Enertec Systems 2001 Ltd. (“Enertec”), an Israeli corporation and wholly owned subsidiary of EML, pursuant to which Coolisys shall acquire Enertec, subject to the terms and conditions set forth in the Purchase Agreement. The Company anticipates the acquisition to close during the quarter ending June 30, 2018. The purchase price consists of a cash payment of $5,250 and the assumption of $4,000 in Enertec’s liabilities, with the cash portion to be adjusted for any increase or decrease of the $4,000 in liabilities.
In January 2018, we formed Super Crypto Mining, Inc. (“SC Mining”), a wholly-owned subsidiary. SC Mining was established to operate our newly formed cryptocurrency business, which is pursuing a variety of digital currencies. We are mining the top three cryptocurrencies for our own account. These cryptocurrencies include Bitcoin, Litecoin and Ethereum. On January 25, 2018, we issued two 5% promissory notes, each in the principal face amount of $2,500 for an aggregate debt of $5,000 to two institutional investors. The proceeds from the two promissory notes were used to purchase 1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with our mining operations. We received delivery of the Miners on February 1, 2018. On March 27, 2018, we paid the principal and accrued interest on each of the 5% promissory notes.
On February 27, 2018, we entered into a sales agreement with H.C. Wainwright & Co., LLC (“HCW”) to sell shares of our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the “ATM Offering”) under which HCW will act as sales agent. As of May 15, 2018, we had received net proceeds of $13,404 through the sale of 13,050,762 shares of our common stock through the ATM Offering. The offer and sale of the shares through the ATM Offering are made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018.
On March 8, 2018, SC Mining, entered into an Asset Purchase Agreement (the “APA”) with Blockchain Mining Supply & Services Ltd. (“BMSS”). Pursuant to the APA, SC Mining has agreed to acquire 1,100 Antminer S9s (the “BMSS Miners”) manufactured by Bitmain from BMSS. Pursuant to the APA, SC Mining will pay an aggregate of $3,200 to BMSS for the BMSS Miners. As of March 31, 2018, we had paid BMSS $264. As of May 17, 2018, we had paid in aggregate $1,676. We intend to fund the remaining balance of $1,524, or approximately 48% of the aggregate purchase price, though the proceeds derived from our ongoing ATM Offering.
On March 22, 2018, SC Mining entered into a Master Services Agreement with a U.S. based entity, whereby SC Mining secured the right to 25 megawatts of power in support of SC Mining’s operations.
GENERAL
We are a growth company seeking to increase our revenues through acquisitions. Our strategy reflects our management and Board’s current philosophy that occurred as a result of awhich we began implementing upon the change in control that was completed inon September 22, 2016. Our acquisition and development target strategy includesinclude companies that have developed a “new way of doing business” in mature, well-developed industries experiencing changes due to new technology; companies that may become profitable or more profitable through efficiency and reduction of costs; companies that are related to our core business in the commercial and defense industries; and companies that will enhance our overall revenues. It is our goal to substantially increase our gross revenues in the near future.
We were originally a solution-driven organization that designs, develops, manufactures and sells high-grade customized and flexible power system solutions for the medical, military, telecom and industrial markets. Although we intend to seek growth through acquisitions, we will continue to focus on high-grade and custom product designs for the commercial, medical and military/defense markets, where customers demand high density, high efficiency and ruggedized products to meet the harshest and/or military mission critical operating conditions.
We have operations located in Europe through our wholly-owned subsidiary, Digital Power Limited ("(“DP Limited"Limited”), Salisbury, England, which operates under the brand name of “Gresham Power Electronics” (“(“Gresham”). DP Limited designs, manufactures and sells power products and system solutions mainly for the European marketplace, including power conversion, power distribution equipment, DC/AC (Direct Current/Active Current) inverters and UPS (Uninterrupted Power Supply) products. Our European defense business is specialized in the field of naval power distribution products.
On November 30, 2016, Digital PowerDPW Holdings formed Digital Power Lending, LLC (“(“DP Lending”), a wholly-owned subsidiary. DP Lending is engaged in providing commercial loans to companies throughout the United States to provide them with operating capital to finance the growth of their businesses. The loans will primarily be short-term, ranging from six to twelve months.months, but may be of longer duration.
On June 2, 2017, Digital PowerDPW Holdings purchased 56.4% of the outstanding equity interests of Microphase Corporation (the “(“Microphase”). Microphase is a design-to-manufacture original equipment manufacturer (“(“OEM”) industry leader delivering world-class radio frequency (“(“RF”) and microwave filters, diplexers, multiplexers, detectors, switch filters, integrated assemblies and detector logarithmic video amplifiers (“(“DLVA”) to the military, aerospace and telecommunications industries. Microphase is headquartered in Shelton, Connecticut.
On April 25, 2017, Digital PowerDPW Holdings formed Coolisys Technologies, Inc. (“Coolisys”(“Coolisys”), a wholly-owned subsidiary. The Company intends to operate its existing businesses in the customized and flexible power system solutions for the medical, military, telecom and industrial markets, other than the European markets which are primarily served by DP Limited, in Coolisys.
Further, on September 1, 2017, Coolisys acquired all of the outstanding membership interests in Power-Plus Technical Distributors, LLC, a California limited liability company ((““Power-Plus”Power-Plus”). Power-Plus is an industrial distributor of value added power supply solutions, UPS systems, fans, filters, line cords, and other power-related components. In addition to its current business, Power-Plus will serve as an extended sales organization for the Company’s overall flexible power system solutions.
We are a Delaware corporation with our corporate office located at 201 Shipyard Way, Suite E, Newport Beach, California corporation formed in 1969 and located in the heart of the Silicon Valley at 48430 Lakeview Blvd, Fremont, California 94538-3158.92663. Our phone number is 510-657-2635 and our website address is www.digipwr.com.www.dpwholdings.com.
Results of Operations
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2018 AND 2017 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2016
The following table summarizes the results of our operations for the three months ended March 31, 2018 and 2017.
| | | For the Three Months Ended | |
| | | March 31, | |
| | | 2018 | | | 2017 | |
| | | | | | | |
| Revenue | | $ | 3,403 | | | $ | 1,628 | |
| Revenue, related party | | | 1,793 | | | | — | |
| Total revenue | | | 5,196 | | | | 1,628 | |
| Cost of revenue | | | 3,803 | | | | 920 | |
| Gross profit | | | 1,393 | | | | 708 | |
| Total operating expenses | | | 4,360 | | | | 1,495 | |
| Loss from operations | | | (2,967 | ) | | | (787 | ) |
| Interest expense | | | (3,132 | ) | | | (207 | ) |
| Loss before income taxes | | | (6,099 | ) | | | (994 | ) |
| Income tax benefit | | | 4 | | | | — | |
| Net loss | | | (6,095 | ) | | | (994 | ) |
| Less: Net loss attributable to non-controlling interest | | | 36 | | | | — | |
| Net loss available to common stockholders | | $ | (6,059 | ) | | $ | (994 | ) |
| Basic and diluted net loss per common share | | $ | (0.17 | ) | | $ | (0.12 | ) |
Basic and diluted weighted average common shares
outstanding | | | 36,709,506 | | | | 8,382,713 | |
| Comprehensive Loss | | | | | | | | |
| Loss available to common stockholders | | $ | (6,059 | ) | | $ | (994 | ) |
| Other comprehensive income (loss) | | | | | | | | |
| Foreign currency translation adjustment | | | 26 | | | | 21 | |
| Net unrealized loss on securities available-for-sale | | | (4,741 | ) | | | — | |
| Other comprehensive income (loss) | | | (4,715 | ) | | | 21 | |
| Total Comprehensive loss | | $ | (10,774 | ) | | $ | (973 | ) |
Revenues
Our revenues increased by $1,394$1,775 or 76%109% to $3,220$3,403 for the three months ended September 30, 2017,March 31, 2018, from $1,826$1,628 for the three months ended September 30, 2016.March 31, 2017. The increase in revenue was primarily due to our acquisition of 56.4% of the outstanding equity interests of Microphase on June 2, 2017, combined with our acquisition of all of the outstanding equity interests of Power-Plus on September 1, 2017. Revenues generated by Microphase and Power-Plus during the three months ended September 30, 2017,March 31, 2018, were $1,340$1,290 and $224,$575, respectively. Excluding revenues that were generated by our recent acquisitions of Microphase and Power-Plus, the Company generated revenues of $1,656,$1,538, which represented a decrease of $170$115. As discussed below, the decrease of $115 from the three months ended September 30, 2016.March 31, 2017, was primarily due to a decrease in revenues from our European operations.
Revenues from our U.S. operations increased by 130.5%$2,039, or 196.4%, to $2,877$3,077 for the three months ended September 30, 2017,March 31, 2018, from $1,248$1,038 for the three months ended September 30, 2016.March 31, 2017. As previously noted, our consolidated revenues include $1,564$1,865 in revenues generated from our recent acquisitions of Microphase and Power-Plus. If we had not closed on these acquisition,acquisitions, then revenues from our U.S. operations would have been $1,313,$1,212, an increase of 5.2%16.8%. The increase in revenues from our U.S. operations is attributed to the recognition$237 of $109 in revenue from the MLSE $50 million purchase order contract revenues generated by SC Mining, our digital currency blockchain mining subsidiary, which was offset by a slight decrease in sales of our legacy products. The recognition of revenue from the MLSE contract during the three months ended September 30, 2017, represents the first revenues recognized from this contract, which is expected to extend over several years.
Revenues from our European operation in Gresham, U.K. (“DP Limited”)Limited decreased by $235$290 to $343$326 for the three months ended September 30, 2017,March 31, 2018, from $578$615 for the three months ended September 30, 2016,March 31, 2017, a decrease of 40.7%47.1%. The decrease was primarily attributable to a decrease of military and commercial products sales and the impact of a weakening of the British Pound and Euro against the USD.sales. The decline in commercial product sales was mainly attributed to standard commodity products. Theproducts whereas the decline in military product sales was attributed to technical changesthe development stage of current projects. During the three months ended March 31, 2017, DP Limited recognized approximately $240 on delivery of a large military project. During the three months ended March 31, 2018, the Company did not recognize significant revenue from any single military project, in part due to the early nature of existing military orders which are primarily in the designengineering phase of onedevelopment.
Revenues, related party
During the three months ended March 31, 2018, we recognized $1,793 in revenues resulting from our relationship with MTIX Limited, a company formed under the laws of our development contracts.England and Wales (“MTIX”). MTIX was acquired by Avalanche on August 22, 2017 and is therefore deemed to be a related party. In March 2017, the Company was awarded a 3-year, $50 million purchase order by MTIX to manufacture, install and service the Multiplex Laser Surface Enhancement (“MLSE”) plasma-laser system. Management believes that the MLSE purchase order will be a source of revenue and generate significant cash flows for the Company. However, at March 31, 2018, the $1,793 in revenues had not yet been received and was reflected on the financial statements as accounts receivable, related party.
Gross Margins
Gross margins decreased to 34.0% for the three months September 30, 2017 compared to 38.5%26.9% for the three months ended September 30, 2016.March 31, 2018 compared to 43.5% for the three months ended March 31, 2017. The decrease in gross margins was partially attributable to the lower margin revenue of $1,793 from MTIX, a related party, with gross margins of 21.9% combined with negative margins of (26.5%) on revenues of $237 at SC Mining. The negative gross margins at SC Mining are attributed to monthly recurring fixed costs at our colocation facilities which temporarily exceed the revenues from our mining operations while we place our miners in service. If we had not recognized revenue, and the related cost of revenue, from SC Mining and our contract with MTIX, then our adjusted gross margins for the three months ended March 31, 2018 would have been 33.6%. The decrease in gross margins from 43.5% to 33.6% is mainly attributable to the decreasean increase in sales fromcosts of our Europeancommercial products sold in our U.S. operations, combined with slightly lower margins of 34.5% generated by our Microphase and Power-Plus subsidiaries. As the Company integrates its recent acquisitions of Microphase and Power-Plus, it expects thatwhich historically have had much greater gross margins from its U.S. based operations will be fairly consistent among the three companies.margins.
Engineering and Product Development
Engineering and product development expenses increased by $159$116 to $306$343 for the three months ended September 30, 2017March 31, 2018 from $147$227 for the three months ended September 30, 2016.March 31, 2017. The increase is partly attributed to our acquisition of Microphase, which reported $118$122 in engineering and product development expenses. The remaining increase was primarily related to an increase in direct manpower cost from the addition of a new Head of Engineering and Technology, a highly-compensated position that was created during the fourth quarter of 2016.
Selling and Marketing
Selling and marketing expenses were $423$725 for the three months ended September 30, 2017March 31, 2018 compared to $235$295 for the the three months ended September 30, 2016,March 31, 2017, an increase of $188.$430. Our acquisition of Microphase and Power-Plus accounted for $46$56 and $55,$205, respectively, of the increase in selling and marketing expenses. The remaining increase of $169 is attributed to an increase in personnel costs directly attributed to sales and marketing personnel at the Company’sour U.S. and UK based operations. Beginning in December 2016 and throughoutThroughout the quarter ended March 31, 2017, we augmented our sales and marketing team in the U.S. with the addition of a Vice President of Business Development and two regional sales managers. During the three months ended September 30, 2016, the services of our current Chief Executive Officer were reported within selling and marketing expenses due to the significant amount of time in which he devoted to the sales process. The increase in the headcount of our sales and marketing team allowed our CEO to spend the majority of his time on general corporate matters related to our restructuring and expansion. As such, during the three months ended September 30, 2017, the salary of our Chief Executive officer, which is $300 per year, or $75 per quarter, was reported within general and administrative expenses. The increase in selling and marketing expenses is partially attributed to the increase in salaries and benefits and travel related costs for the three new sales and marketing positions andpositions. Due to the timing of these personnel additions, the full cost was only partially offset byrealized during the allocation ofthree months ended March 31, 2017. Further, during December 2017, we hired a Sales Director at our Chief Executive Officer’s salary to general and administrative expense.UK operations.
General and Administrative
General and administrative expenses were $1,685$3,222 for the three months ended September 30, 2017March 31, 2018 compared to $404$973 for the three months ended September 30, 2016,March 31, 2017, an increase of $1,281.$2,249. Our acquisition of Microphase accounted for $410$235 of the increase in general and administrative expenses. The adjusted increase of $871$2,014 from the comparative prior period was mainly due to higher stock basedstock-based compensation expenses, an increase in legal and audit costs, an increase in investor relationship costs and hiring of additional consultants to build an infrastructure in anticipation of our future growth and the allocationincrease in cost attributed to the hiring of oura new Chief Executive Officer’s salary to general and administrative expense.Financial Officer. The remaining increase in general and administrative expenses is due to various costs, none of which are significant individually.
| · | In aggregate, we incurred $517$1,364 of stock-based compensation during the three months ended September 30, 2017.March 31, 2018. Of this amount, $365$515 was from issuances of equity basedequity-based awards pursuant to our Plans and $152$849 was from stock, options and warrants which were issued outside the Plans. It has been our policy to allocate the majority of stock basedstock-based compensation to general and administrative expense. During the three months ended September 30, 2016March 31, 2018 and 2017, and inclusive of equity basedequity-based awards issued outside the Plans, we recorded $35$1,085 and $311,$144, respectively, of stock-based compensation in general and administrative expense. |
| · | We experienced an aggregate increase of $168$234 in audit and legal fees due to an overall increase in the operations conducted and the level of complexity and significant number of the transactions entered into during the three months ended September 30, 2017.March 31, 2018. |
| · | Beginning during the quarter ended December 31, 2016, we spent significant effort on expanding our investor base and on hiring additional consultants to assist building an infrastructure to support our anticipated growth. As a result, we experiencedThese efforts were continued during the three months ended March 31, 2018 and resulted in an increase of $220$170 in costs attributed to investor relations and other consulting fees. |
| · | Finally,During January 2018 we hired a new Chief Financial Officer salary and in September 2017 we hired a senior executive to assist in management at Coolisys. These two hires resulted in an overall increase in payroll expense of approximately $125 during the three months ended September 30, 2016, March 31, 2018. |
| · | Finally, in January 2018 we established SC Mining, our Chief Executive Officer’s salary was reflected in selling and marketing expenses. As discussed above, our current practice is to recorddigital currency blockchain mining subsidiary. During the salary and benefits of our Chief Executive Officer tothree months ended March 31, 2018, general and administrative expense.costs attributed to this subsidiary were $214. |
Interest (expense) income, net
Interest expense net was $753$3,132 for the three months ended September 30, 2017March 31, 2018 compared to income of $23$207 for the three months ended September 30, 2016.March 31, 2017. The increase in interest expense for the three months ended September 30, 2017March 31, 2018 is primarily related to the amortization of debt discount, in the aggregate amount of $669,$3,051, resulting from original issue discount the issuance of warrants in conjunction with the sale of debt and equity instruments in the aggregate amount of $3,452.$13,352. During the three months ended September 30, 2017,March 31, 2018, as a result of these issuances, non-cash interest expense of $669$3,051 was recorded from the amortization of debt discount and debt financing costs. The remaining increase in interest expense net, was due to an increase in the amount of the Company’s total borrowings. At September 30, 2017, the outstanding balance of the Company’s convertible notes payableborrowings and notes payablewhich was $3,458. Conversely, at September 30, 2016, the Company did not have any outstanding convertible notes payable or notes payable. Interest expense was partiallyprimarily offset by interest income and the accretion of original issue discount pursuant to the Loan and Security Agreement entered into on September 6, 2017, between the Company and AVLP (“(“AVLP Loan Agreement”) of $141.
$634.
Operating Loss
The Company recorded an operating loss of $1,318$2,976 for the three months ended September 30, 2017March 31, 2018 compared to an operating loss of $83$787 for the three months ended September 30, 2016.March 31, 2017. The increase in operating loss is mostly attributable from the increase of general and administrative expenses.
Net Loss
The Company recorded aFor the foregoing reasons, our net loss of $2,071 for the three months ended September 30, 2017March 31, 2018, was $6,095 compared to a net loss of $38$994 for the three months ended September 30, 2016 as a result of the aforementioned changes.March 31, 2017. After taking into consideration the loss attributable to the non-controlling interest of the minority shareholders of Microphase during the three months ended March 31, 2018 of $36, the net loss attributableavailable to common shareholders during the Companythree months ended March 31, 2018 and 2017, was $1,967$6,059 and 38$994, respectively.
NINE MONTHS ENDED SEPTEMBER 30, 2017 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2016
Our revenues increased by $1,067 or 19% to $6,670As reflected in our consolidated statement of cash flows for the ninethree months ended September 30,March 31, 2018 and 2017, from $5,603our reported net loss is comprised of non-cash charges of $4,152 and 378, respectively. A summary of these non-cash charges is as follows:
| | | For the Three Months Ended | |
| | | March 31, | |
| | | 2018 | | | 2017 | |
| Interest expense – debt discount | | $ | 3,051 | | | $ | 195 | |
| Stock-based compensation | | | 1,438 | | | | 157 | |
| Depreciation and amortization | | | 148 | | | | 33 | |
| Interest income on conversion of promissory notes to common stock | | | — | | | | — | |
| Accretion of original issue discount on notes receivable – related party | | | (485 | ) | | | (7 | ) |
| Non-cash items included in net loss | | $ | 4,152 | | | $ | 378 | |
Other comprehensive income (loss)
Other comprehensive loss was $10,774 and $973, respectively, for the ninethree months ended September 30, 2016. The increase in revenue was primarily due to our acquisition of 56.4% ofMarch 31, 2018 and 2017. Other comprehensive loss for the outstanding equity interests of Microphase on June 2, 2017, combined with our acquisition of all of the outstanding equity interests of Power-Plus on September 1, 2017. Revenues generated by Microphase and Power-Plus during the ninethree months ended September 30, 2017, were $1,563 and $224, respectively. Excluding revenues that were generated byMarch 31, 2018, which decreased our recent acquisitions of Microphase and Power-Plus, the Company generated revenues of $4,883. As discussed below, the decrease of $720 from the nine months ended September 30, 2016, was primarily due to a decrease in revenues from our European operations.
Revenues from our U.S. operations increased by $1,798, or 52.8%, to $5,206 for the nine months ended September 30, 2017, from $3,408 for the nine months ended September 30, 2016. As previously noted, our consolidated revenues include $1,787 in revenues generated from our recent acquisitions of Microphase and Power-Plus. If we had not closed on these acquisition, then revenues from our U.S. operations would have been $3,419, an increase of 0.3%. The increase in revenues from our U.S. operations is attributed to the recognition of $109 in revenue from the MLSE $50 million purchase order contract which was offset by a slight decrease in sales of our legacy products.
Revenues from our European operation in Gresham, U.K. (“DP Limited”) decreased by $731 to $1,464 for the nine months ended September 30, 2017, from $2,195 for the nine months ended September 30, 2016, a decrease of 33.3%. The decrease was primarily attributable to a decrease of military and commercial products sales andequity, reflects the impact of athe weakening of the British Pound and Euro againston the USD. The declineequity of DP Limited combined with unrealized losses in commercial product sales was mainly attributed to standard commodity products. The declineour investments in military product sales was attributed to technical changesmarketable securities, primarily in the design of onewarrants that we received as a result of our development contracts.
Gross Margins
Gross margins increased to 38.0% for the nine months September 30, 2017 compared to 37.1% for the nine months ended September 30, 2016. The increaseinvestment in gross margins was mainly attributable to the increase in sales of our commercial products sold in our U.S. operations, which have greater gross margins, combined with the decrease in sales from our European operations.
Engineering and Product Development
Engineering and product development expenses increased by $287 to $798 for the nine months ended September 30, 2017 from $511 for the nine months ended September 30, 2016. The increase is partly attributed to our acquisition of Microphase, which reported $173 in engineering and product development expenses. The remaining increase is attributed toAvalanche International, Corp, a $95 increase in personnel costs directly attributed to engineering and product development at Digital Power’s U.S. based operations.related party. During the fourth quarter of 2016, as part of its growth plan, Digital Power hired a new Head of Engineering and Technology, a highly-compensated position.
Selling and Marketing
Selling and marketing expenses were $1,045 for the ninethree months ended September 30, 2017 compared to $723 for the nine months ended September 30, 2016, an increase of $322. Our acquisition of Microphase and Power-Plus accounted for $55 and $65, respectively, of the increase in selling and marketing expenses. The remaining increase is attributed to an increase in personnel costs directly attributed to sales and marketing personnel at Digital Power’s U.S. based operations. Beginning in December 2016 and throughout the quarter ended March 31, 2017, we augmented our sales and marketing team with the additioneffect of a Vice Presidentthe foreign currency adjustment from the weakening of Business Development and two regional sales managers. During the nine months ended September 30, 2016,British Pound was the servicesonly component of our current Chief Executive Officer were reported within selling and marketing expenses due to the significant amount of time in which he devoted to the sales process. The increase in the headcount of our sales and marketing team allowed our CEO to spend the majority of his time on general corporate matters related to our restructuring and expansion. As such, during the nine months ended September 30, 2017, the salary of our Chief Executive officer, which is $300 per year, was reported within general and administrative expenses. The increase in selling and marketing expenses is attributed to the increase in salaries and benefits and travel related costs for the three new sales and marketing positions and partially offset by the allocation of our Chief Executive Officer’s salary to general and administrative expense.
General and Administrative
General and administrative expenses were $4,240 for the nine months ended September 30, 2017 compared to $1,115 for the nine months ended September 30, 2016, an increase of $3,125. Our acquisition of Microphase accounted for $577 of the increase in general and administrative expenses. The adjusted increase of $2,548 from the comparative prior period was mainly due to higher stock based compensation expenses, an increase in legal and audit costs, an increase in investor relationship costs and hiring of additional consultants to build an infrastructure in anticipation of our future growth and the allocation of our Chief Executive Officer’s salary to general and administrative expense. The remaining increase in general and administrative expenses is due to various costs, none of which are significant individually.
| · | In aggregate, we incurred $1,269 of stock-based compensation during the nine months ended September 30, 2017. Of this amount, $1,061 was from issuances of equity based awards pursuant to our Plans and $208 was from stock, options and warrants which were issued outside the Plans. It has been our policy to allocate the majority of stock based compensation to general and administrative expense. During the nine months ended September 30, 2016 and 2017, and inclusive of equity based awards issued outside the Plans, we recorded $108 and $980, respectively, of stock-based compensation in general and administrative expense. |
| · | We experienced an aggregate increase of $486 in audit and legal fees due to an overall increase in the operations conducted and the level of complexity and significant number of the transactions entered into during the nine months ended September 30, 2017. |
| · | Beginning during the quarter ended December 31, 2016, we spent significant effort on expanding our investor base and on hiring additional consultants to assist building an infrastructure to support our anticipated growth. As a result, we experienced an increase of $589 in costs attributed to investor relations and other consulting fees. |
| · | Finally, during the nine months ended September 30, 2016, our Chief Executive Officer’s salary was reflected in selling and marketing expenses. As discussed above, our current practice is to record the salary and benefits of our Chief Executive Officer to general and administrative expense. |
Interest (expense) income, net
Interest expense, net was $1,367 for the nine months ended September 30, 2017 compared to income of $85 for the nine months ended September 30, 2016. The increase in interest expense for the nine months ended September 30, 2017 is primarily related to debt discount, in the aggregate amount of $1,269, resulting from the issuance of warrants in conjunction with the sale of debt and equity instruments of $6,706. During the nine months ended September 30, 2017, as a result of these issuances, non-cash interest expense of $1,269 was recorded from the amortization of debt discount and debt financing costs. The remaining increase in interest expense, net, was due to an increase in the amount of the Company’s total borrowings. Interest expense was partially offset by interest income and the accretion of original issue discount on the AVLP Loan Agreement of $242.
Operating Loss
The Company recorded an operatingother comprehensive loss of $3,549 for the nine months ended September 30, 2017 compared to an operating loss of $272 for the nine months ended September 30, 2016. The increase in operating loss is mostly attributable from the increase of general and administrative expenses.
Net Loss
The Company recorded a net loss of $4,916 for the nine months ended September 30, 2017 compared to a net loss of $187 for the nine months ended September 30, 2016 as a result of the aforementioned changes. After taking into consideration the loss attributable to the non-controlling interest of the minority shareholders of Microphase and an income tax benefit that was recognized during the nine months ended September 30, 2016, the net loss attributable to the Company was $4,700 and $165, respectively.$973.
LIQUIDITY AND CAPITAL RESOURCES
On September 30, 2017,March 31, 2018, we had cash and cash equivalents of $314.$630. This compares with cash and cash equivalents of $996$1,478 at December 31, 2016.2017. The decrease in cash and cash equivalents was primarily due to cash used in operating and investing activities in an amount in excess of funds provided by financing activities.
Net cash used in operating activities totaled $1,577$2,959 for the ninethree months ended September 30, 2017,March 31, 2018, compared to net cash providedused by operating activities of $138$272 for the ninethree months ended September 30, 2016.March 31, 2017. During the ninethree months ended September 30, 2017,March 31, 2018, the decreaseincrease in net cash provided byused in operating activities compared to the ninethree months ended September 30, 2016March 31, 2017 was mainly due to the September 30, 2017 ninenet loss for the three months lossended March 31, 2018 of $4,916.$6,095. The net loss was partially offset by a number of non-cash charges, the amortization of debt discount of $1,239$3,051 and stock-based compensation of $1,269,$1,438, an increase in accounts receivable, related party of $1,793 and accounts payable and accrued expenses of $2,083$527 and decreases in our accounts receivable of $737 and other current liabilities of $595.$344.
Net cash used in investing activities was $4,384$9,765 for the ninethree months ended September 30, 2017March 31, 2018 compared to $12$692 of net cash provided byused in investing activities for the ninethree months ended September 30, 2016.March 31, 2017. The increase of the net usage of cash from investing activities was primarily relatedattributed to the purchase of property and equipment at SC Mining, the investment in AVLP, loans to third parties and the purchase of Power-Plus.investments in marketable securities.
Net cash provided by financing activities was $5,194$11,892 and nil$1,097 for the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, respectively. The financing activities related to the sale of 1,309,5455,120,812 shares of common stock through our ATM Offering for net proceeds of $672, the sale of Series B and Series C Preferred Stock of $1,540,$6,243, gross proceeds from the Company’s debt financings of $2,649, gross proceedsand from advances of future receipts of $1,772$5,542 and payments on debt facilitiesproceeds from the exercise of $626.
options and warrants of $965.
Historically, the Company has financed its operations principally through issuances of convertible debt, promissory notes and equity securities. During 2017,2018, as reflected below, the Company continuescontinued to successfully obtain additional equity and debt financing and in restructuring existing debt. The following financings transactions were consummated during 2017:
| · | In February 2017, the Company issued demand promissory notes and warrants to purchase 333,333 shares of common stock at $ 0.70 per share for aggregate proceeds of $400. Further in February 2017, the holders of $400 in demand promissory notes agreed to extinguish their $400 of debt by cancelling their notes to purchase 666,667 shares of common stock of the Company at $0.60 per share. |
41
| · | On March 9, 2017, the Company entered into a Preferred Stock Purchase Agreement with Philou Ventures LLC (“Philou”), a related party, pursuant to which Philou was granted the right to invest up to $5,000 in the Company through the purchase of Series B Preferred Stock over a term of 36 months. On March 24, 2017, Philou purchased 25,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement in consideration of cancellation of Company debt of $250 due to MCKEA, an affiliate of Philou. On May 5, 2017, Philou purchased an additional 50,000 shares of Series B Preferred Stock pursuant to the Preferred Stock Purchase Agreement for $500.
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| · | On March 15, 2017, the CompanyJanuary 23, 2018, we entered into a subscriptionsecurities purchase agreement with onean institutional investor to sell, for an aggregate purchase price of $1,000, a 10% senior convertible promissory note (the “Note”) with an aggregate principal face amount of $1,250, a warrant to purchase an aggregate of 625,000 shares of our common stock and 543,478 shares of our common stock. The transactions contemplated by the salesecurities purchase agreement closed on February 8, 2018. The Note is convertible into 625,000 shares of 500,000our common stock, a conversion price of $2.00 per share, subject to adjustment. The exercise price of the warrant to purchase 625,000 shares of our common stock is $2.20 per share, subject to adjustment. On February 9, 2018, in addition to the 543,478 shares of common stock at $0.60 per shareprovided for pursuant to the securities purchase agreement, we issued to the investor an aggregate purchase price of $300.691,942 shares of our common stock upon the conversion of the entire outstanding principal and accrued interest on the Note of $1,384. |
| · | On March 20, 2017, the Company issued $250 in demand promissory note to one of the Company's shareholders. |
| · | On March 28, 2017, the Company issued $270 in demand promissory notes to several investors. The Company received gross proceeds of $220 on March 31, 2017 and the remaining balance of $50 was received on April 3, 2017. On April 5, 2017, the Company canceled these promissory notes by issuing to the holders 360,000 shares of common stock at $0.75 per share and warrants to purchase 180,000 shares of common stock at $0.90 per share. |
| · | On April 17, 2017, the Company entered intoJanuary 25, 2018, we issued two 7% convertible5% promissory notes, (the “7% Convertible Notes”)each in the aggregate principal face amount of $250.$2,500 for an aggregate debt of $5,000 to two institutional investors. The 7% Convertible Notes accrue interest at 7% simple interest on the principal amount and were due on June 2, 2017. The 7% Convertible Notes were not repaid on the maturity date and as such were in default at June 30, 2017. During July 2017, these two 7% Convertible Notes were repaid. |
| · | On April 26, 2017, the Company entered into a 7% convertible note in the aggregate principal amount of $104. On June 28, 2017, the noteholder converted the outstanding balance into 189,091 shares of Digital Power’s common stock. |
| · | Between May 5, 2017 and June 30, 2017, the Company received additional short-term loans of $140 from four accredited investors of which $75 wasproceeds from the Company’s corporate counsel, a related party. As additional consideration, the investors received five-year warrantstwo promissory notes was used to purchase 224,371 shares of common stock at a weighted average exercise price of $0.77 per share.During June 2017, the holders of $55 of these short-term loans agreed to cancel their notes for the purchase of 100,001 shares of the Digital Power’s common stock at a price of $0.55 per share. An additional $52 in short-term loans from the related party was converted into one of the Series C Units.
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| · | Between May 24, 2017 and June 19, 2017, Digital Power entered into subscription agreements (the “Series C Subscription Agreement”) with approximately twenty accredited investors (the “Series C Investors”)1,000 Antminer S9s manufactured by Bitmain Technologies, Inc. in connection with the sale of twenty-one Units at a purchase price of $52 per Unit raising in the aggregate $1,092 with each Unit consisting of Series C Preferred Stock and Warrants.
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| · | Between July 6, 2017 and September 13, 2017, the Companyour mining operations. We received funding as a result of entering into multiple Agreements for the Purchase and Sale of Future Receipts with TVT Capital LLC pursuant to which the Company sold in the aggregate $2,585 in Future Receiptsdelivery of the Company for $1,772. UnderMiners on February 1, 2018.On March 27, 2018, we paid the termsprincipal and accrued interest on each of the agreements, the Company will be obligated to pay the initial daily amount of $13 until the $2,585 has been paid in full. The term Future Receipts means cash, check, ACH, credit card, debit card, bank card, charged card or other form of monetary payment.5% promissory notes. |
| · | On July 24, 2017,February 20, 2018, we issued a promissory note in the principal face amount of $900 to an accredited investor. This promissory note included an original issue discount (“OID”) of $150 resulting in net proceeds of $750. The principal and OID on this note was due and payable on March 22, 2018. On March 23, 2018, we entered into subscription agreements with six investors, and on July 25, 2017 we entered into securities purchase agreements (the “Securities Purchase Agreement”) with an institutional investor, under which we agreed to issue and sell in the aggregate 851,363 shares of common stock to the investors at $0.55 per share for an aggregate purchase price of $468. Of the aggregate purchase price of $468, $445 was paid in cash and $23 was in consideration for the cancellation of debt from a related party of the Company. |
| · | On July 28, 2017, we entered into an exchange agreement with an institutional investor who was the owner of (i) a 7% Convertible Notenew promissory note in the principal amount of $125 and$1,750 for a term of two months, subject to our ability to prepay within one month. The interest rate payable on this new promissory note shall be twenty percent per thirty calendar days, payable in a lump sum on the maturity date. We also issued to the lender a warrant dated April 17, 2017 to purchase 83,3341,250,000 shares of our common stock at $0.90. Under the termsan exercise price of $1.15 per share, pursuant to a consulting agreement. The principal amount of the exchange agreement, we agreed to exchange the 7% Convertible Note for three new promissory notes in the principal amountsnote consisted of $110 due August 1, 2017; $35 due August 1, 2017;net proceeds of $1,000 and $34 due August 8, 2017 (individually an Exchange Note and collectively the Exchange Notes) and to exchange the prior warrant for a new warrant to purchase 83,334 shares of common stock at $0.55 per share. Concurrent with entering into this exchange agreement, the institutional investor entered into a subscription agreement under which we issued and sold in a registered direct offering 200,000 shares of common stock at $0.55 per share for an aggregate purchase price of $110. The 200,000 shares of common stock were purchased through the cancellation of the Exchange Noteprincipal of $750 from the February 20, 2018 promissory note. The interest on the February 20, 2018 note in the principal amount of $110. In addition, in a concurrent private placement,$150 was paid to the institutional investor enteredlender prior to entering into a separate securities purchase agreement under whichthe new promissory note. On April 23, 2018, we issuedpaid the entire outstanding principal and sold 63,600 sharesaccrued interest on the new promissory note of common stock at $0.55 per share for an aggregate of purchase price of $35. The 63,600 shares of common stock were purchased through the cancellation of the Exchange Note in the principal amount of $35. Further, we issued a warrant to purchase 120,000 shares of common stock at $0.55 per share.$2,100. |
| · | On August 3, 2017,February 26, 2018, we issued a 10% promissory note in the Companyprincipal face amount of $330 to an accredited investor. This promissory note included an OID of $30 resulting in net proceeds to us of $300. The principal and accrued interest on this note is due and payable on April 12, 2018, subject to a 30-day extension available to us. |
| · | On February 27, 2018, we entered into a Securities Purchase Agreementsales agreement with H.C. Wainwright & Co., LLC (“HCW”) to sell shares of our common stock, having an aggregate offering price of up to $50 million from time to time, through an “at the market offering” program (the “ATM Offering”) under which HCW acts as sales agent. As of May 16, 2018, we had received net proceeds of $13,404 through the sale of 13,050,762 shares of our common stock through the ATM Offering. The offer and sale of the shares through the ATM Offering will be made pursuant to our effective “shelf” registration statement on Form S-3 and an accompanying base prospectus contained therein (Registration Statement No. 333-222132) filed with the SEC on December 18, 2017, amended on January 8, 2018, and declared effective by the SEC on January 11, 2018, and a prospectus supplement related to the ATM Offering, dated February 27, 2018. |
| · | On March 23, 2018, we entered into a securities purchase agreement to sell and issue a 12% Convertible (“12% Convertible Note”)promissory note and a warrant to purchase 666,666300,000 shares of common stock to an accredited investor (the “Investor”). The principal ofif the Convertible Note may be converted intopromissory note is paid in full on or before May 23, 2018, or up to 450,000 shares of common stock, at $0.55 per share and underif the terms of the Warrant, up to 666,666 shares of common stock may be purchased at an exercise price of $0.70 per share. promissory note is paid by June 22, 2018. The Convertible Notepromissory note was issued with a 10% OID. The promissory note is in the principal amount of $400$1,000 and was sold for $360,$900, bears interest at 12% simple interest on the principal amount, and is due on August 13,June 22, 2018. Interest only payments are due, in arrears, on a quarterlymonthly basis and the principal is duecommencing on August 3,April 23, 2018. The principal may be converted into sharesexercise price of the Company’s common stock at $0.55warrant is $1.15 per share. The promissory note is unsecured by any of our assets but is guaranteed by our Chief Executive Officer. |
| · | On August 10, 2017,March 27, 2018, we issued a 10% promissory note in the Company,principal face amount of $200 to an accredited investor. The principal and accrued interest on this note was due and payable on March 29, 2018. Between March 29 and April 24, 2018, we paid the entire outstanding principal on this 10% promissory note of $200. |
| · | On April 16, 2018, we entered into Securities Purchase Agreements (“Agreements”)securities purchase agreements with fivethree institutional investors (the “Investors”) to sell, for an aggregate purchase price of $800, 10% Senior Convertible Promissory Notes$1,550, 12% secured convertible promissory notes (“Convertible Notes”) with an aggregate principal face amount of $880 and $1,722, warrants to purchase an aggregate of 1,475,000993,588 shares of our common stock, and an aggregate of 200,926 shares of our common stock. The principal of the Convertible Notes and interest earned thereon may be converted into shares of common stock at $0.60 per share and under the terms of the Warrant, up to 1,475,000 shares of common stock may be purchased at an exercise price of $0.66 per share. The Convertible Notes are in the aggregate principal amount of $880 and were sold for $800 and bear simple interest at 10%12% on the principal amount and principal andwith a guarantee of interest are due on February 10, 2018.during the initial six months in the amount of $103. Subject to certain beneficial ownership limitations each Investorand an event of default having occurred and not been cured, the investors may convert the principal amount of the Convertible NoteNotes and accrued interest earned thereon at any time into shares of our common stockStock at $0.60$0.70 per share. The conversion price of the Convertible Notes isshare, subject to adjustment for customary stock splits, stock dividends, combinations or similar events. Beginning on May 16, 2018, we are required to make six monthly cash payments in the aggregate amount of $304 until the Convertible Notes are satisfied in full, which is to occur on October 16, 2018. The warrants entitle the holders to purchase, in the aggregate, up to 993,588 shares of our common stock at an exercise price of $1.30 per share for a period of five years subject to certain beneficial ownership limitations. In connection with these three securities purchase agreements, we entered into security agreements pursuant to which we granted to each investor a security interest in, among others, SC Mining’s accounts, chattel paper, documents, equipment, general intangibles, instruments and inventory, and all proceeds, as set forth in the security agreements. |
| · | On May 15, 2018, we entered into securities purchase agreements with certain investors for the sale and issuance of an aggregate of 7,691,775 shares of our Class A common stock, and five-year warrants to purchase such number of shares of common stock equal to the shares of common stock purchased by the investors. We received aggregate consideration of $6,000, consisting of cash and the cancellation of short-term advances of $3,225 and $2,775, respectively. These securities were issued pursuant to our registration statement filed with the Securities and Exchange Commission (File No. 333-222132) which became effective on January 11, 2018. |
| · | On May 15, 2018, we entered into a securities purchase agreement with an institutional investor providing for the issuance of (i) a Senior Secured Convertible Promissory Note (the “Convertible Note”) with a principal face amount of $6,000, which Convertible Note is, subject to certain conditions, convertible into 8,000,000 shares (the “Conversion Shares”) of the Company’s common stock at $0.75 per share; (ii) a five-year warrant to purchase 1,111,111 shares of the Company’s common stock (the “Series A Warrant Shares”) at an exercise price of $1.35 (the “Series A Warrant”); (iii) a five-year warrant to purchase 1,724,138 shares of the Company’s Class B common stock (the “Series B Warrant Shares” and with the Series A Warrant Shares, the “Warrant Shares”) at an exercise price of $0.87 per share (the “Series B Warrant” and together with the Series A Warrant, the “Warrants”); and (iv) 344,828 shares of our common stock (the “Commitment Shares” and with the Conversion Shares and the Warrant Shares, the “Issuable Shares”). The Warrant Shares and the Commitment Shares will be registered under the Securities Act pursuant to the Company’s currently effective registration statement on Form S-3 (File No. 333-222132). Pursuant to a registration rights agreement entered into with the Investor on the Closing Date, the Company agreed to file a registration statement on Form S-3 to register the Note and the Conversion Shares within twenty-one (21) days of the Closing Date. |
The Convertible Note bears interest at 10% per annum, with 50% of the total interest due on the principal payable at the closing and the remaining 50% payable as Amortization Payments. We are required to make amortization payments in cash to the investor for a period of 26 weeks in 13 equal payments every 2 weeks until the Convertible Note is satisfied in full (each, an “Amortization Payment”). The Convertible Note is convertible into common stock at $0.75 per share, subject to adjustment, but may only be converted if an event of default thereunder has occurred and not been cured on a timely basis. The conversion price of the Convertible Note is subject to adjustment for customary stock splits, stock dividends, combinations or similar events. The Convertible Note contains standard and customary events of default including, but not limited to, failure to make payments when due under the Convertible Note, failure to comply with certain covenants contained in the Convertible Note, or bankruptcy or insolvency of the Company. We may prepay the full outstanding principal and accrued and unpaid interest at any time without penalty.
In connection with the financing, pursuant to an engagement agreement with Alliance Global Partners (“AGP”), a licensed broker-dealer with FINRA, we agreed to pay to AGP a cash fee, or placement agent fee, equal to 5% of the aggregate gross proceeds raised. Such fee was paid at the closing of the offering. In addition, AGP shall receive a cash fee equal to 5% of such cash exercise price proceeds received by us, payable within 48 hours of our receipt of any cash exercise price proceeds from the exercise of any warrants sold, provided that no such fee is due and payable hereunder in the event the warrants are not exercised for cash. AGP is also entitled to receive a warrant to purchase 150,000 shares of common stock with an exercise price of $1.00, which warrant shall be exercisable for 5-years via cashless exercise until registered and via cash thereafter.
We expect to continue to incur losses for the foreseeable future and will be required to raise additional capital to continue to support our working capital requirements. We believe that the MLSE purchase order contract of $50 million and revenue generated by SC Mining will contribute to generate meaningful revenue and corresponding cash in 2017.2018. In addition, we have been successful over the last 12 months in raising capital to support our working capital requirements. We anticipate that we will continue to raise capital through public and private equity offerings, debt financings, or other means. If we are unable to secure additional capital, we may be required to curtail our current operations and take additional measures to reduce costs expenses, including reducing our workforce, eliminating outside consultants, ceasing or reducing our due diligence of potential future acquisitions, including the associated legal fees, in order to conserve cash in order to sustain operations and meet our obligations.
Based on the above, these matters raise substantial doubt about the Company’s ability to continue as a going concern.
CRITICAL ACCOUNTING POLICIES
In our Annual Report on Form 10-K for the year ended December 31, 2016,2017, we identified the critical accounting policies which affect our more significant estimates and assumptions used in preparing our consolidated financial statements. The basis for developing the estimates and assumptions within our critical accounting policies is based on historical information and known current trends and factors. The estimates and assumptions are evaluated on an ongoing basis and actual results have been within our expectations. We have not changed these policies from those previously disclosed in our Annual Report.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable for a smaller reporting company.
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
Our principal executive officer and principal financial officer, with the assistance of other members of the Company's management, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report and has determined that our disclosure controls and procedures were not effective as of June 30, 2017March 31, 2018 due to certain material weaknesses as described herein.
A material weakness is a control deficiency (within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following two material weaknesses:
| (i) | a lack of sufficient internal accounting resources to provide reasonable assurance that information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure and |
| (ii) | a lack of segregation of duties to ensure adequate review of financial statement preparation. |
Planned Remediation
Management, in coordination with the input, oversight and support of our Board of Directors, has identified the measures below to strengthen our control environment and internal control over financial reporting.
Until such time asDuring January 2018 we hirehired a new Chief Financial Officer and engaged the services of a financial accounting advisory firm. Further, until we expand our internal accounting department, the Chairman of the Audit Committee shall perform the following:
| · | assists with documentation and implementation of policies and procedures and monitoring of controls, |
| · | reviews all anticipated transactions that are not considered in the ordinary course of business to assist in the early identification of accounting issues and ensure that appropriate disclosures are made in the Company’s financial statements. |
We are currently working to improve and simplify our internal processes and implement enhanced controls, as discussed above, to address the material weaknesses in our internal control over financial reporting and to remedy the ineffectiveness of our disclosure controls and procedures.
Changes in Internal Controls over Financial Reporting.
DuringExcept as detailed above, during the most recent fiscal quarter 20172018 there were no significant changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
PART II — OTHER INFORMATION
None
The risks described in Part I, Item 1A, "Risk Factors," in our 20162017 Form 10-K, could materially and adversely affect our business, financial condition and results of operations, and the trading price of our common stock could decline. These risk factors do not identify all risks that we face - our operations could also be affected by factors that are not presently known to us or that we currently consider to be immaterial to our operations. Due to risks and uncertainties, known and unknown, our past financial results may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. The Risk Factors section of our 20162017 Annual Report on Form 10-K remains current in all material respects except that we identified material weaknesses in our internal control over financial reporting and in our disclosure controls and procedures.respects.
If We Fail to Establish and Maintain an Effective System of Internal Control, We May Not Be Able to Report Our Financial Results Accurately or Prevent Fraud. Any Inability to Report and File Our Financial Results Accurately and Timely Could Harm Our Reputation and Adversely Impact the Trading Price of Our Common Stock.
Effective internal control is necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial reports or prevent fraud, we may not be able to manage our business as effectively as we would if an effective control environment existed, and our business and reputation with investors may be harmed. As a result, our small size and any current internal control deficiencies may adversely affect our financial condition, results of operations and access to capital. We have also experienced complications reporting as a result of material weaknesses which resulted in the restatement of our Form 10-Q for the quarterly period ended June 30, 2017, which was filed with the Securities and Exchange Commission (“SEC”) on August 21, 2017, and amended on November 14, 2017. We have carried out an evaluation under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the most recent period covered by this report. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses described below.
A material weakness is a deficiency, or a combination of deficiencies, within the meaning of Public Company Accounting Oversight Board (“PCAOB”) Audit Standard No. 5, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Management has identified the following material weaknesses which have caused management to conclude that as of June 30, 2017 our internal controls over financial reporting (“ICFR”) were not effective at the reasonable assurance level:
| 1. | We do not have sufficient resources in our accounting function, which restricts our ability to gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals. Management evaluated the impact of our failure to have segregation of duties during our assessment of our disclosure controls and procedures and concluded that the control deficiency that resulted represented a material weakness.
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| 2. | We have inadequate controls to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting. Management evaluated the impact of the lack of timely communication between non–financial and financial personnel on our assessment of our reporting controls and procedures and has concluded that the control deficiency represented a material weakness. |
We have taken steps to remediate some of the weaknesses described above, including a greater level of involvement by our Audit Committee. We intend to continue to address these weaknesses as resources permit.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
During the three months ended March 31, 2018, the Company issued an aggregate of 1,683,059 shares of its common stock as payment for services to its consultants. The shares were valued at $3,033, an average of $1.80 per share.
On July 7, 2017,January 3, 2018, accrued interest of $23 on a 10% convertible note was satisfied through the Company entered into an assetissuance of 37,750 shares of the Company’s common stock.
On January 10, 2018, principal and accrued interest of $208 on a 12% convertible note was satisfied through the issuance of 377,678 shares of the Company’s common stock.
On January 12, 2018, principal and accrued interest of $553 on a 5% convertible note was satisfied through the issuance of 921,645 shares of the Company’s common stock.
On February 9, 2018, principal and accrued interest of $1,384 on a 10% convertible note was satisfied through the issuance of 691,942 shares of the Company’s common stock. In conjunction with the securities purchase agreement to acquiresell the intellectual property of Coolisys.com, in consideration for, in part, 50,00010% convertible note, the Company issued an additional 543,478 shares of common stock. The seller of the intellectual property and purchaser of therestricted common stock was an accreditedto the institutional investor.
On August 16, 2017,During January 2018, the Company approved the issuance and saleissued a total of (i) 272,72760,000 shares of ourits common stock atupon the cash exercise of options to purchase shares of its common stock. These options were issued pursuant to the Company’s stock incentive plans. The Company received cash of $98 as a purchase price equal to $0.55 per shareresult of these option exercises.
During January 2018, the Company issued a total of 1,866,471 shares of its common stock upon the cash and (ii)cashless exercise of warrants to purchase up to 272,727an aggregate of 2,187,646 shares of ourits common stock. These warrants were issued between August 2017 and December 2017 in conjunction with various common stock at $0.65 per share, which become exercisable six months after the issuance date, to two accredited investors for an aggregate purchase priceand debt financings. The Company received cash of $150. The shares have yet to be issued by the Company and are subject to approval from the NYSE American prior to issuance.$867 as a result of these warrant exercises.
In addition, on September 9, 2017, the Company approved the issuance of 100,000 shares of our common stock to Spartan Capital for capital advisory services. Spartan Capital is an accredited investor. The shares of common stock have yet to be issued by the Company and are subject to approval from the NYSE American prior to issuance.
On October 5, 2017, Ault & Company purchased 75,000 shares of our common stock at $0.60 per share and a warrant to purchase up to 75,000 shares of our common stock at $0.60 per share for an aggregate purchase price of $45. These shares and warrants have yet to bewere issued by the Company and are subject to approval from the NYSE American prior to issuance.on May 8, 2018. Ault & Company is controlled by Mr. Milton Ault, our Executive Chairman.
The Company engaged Divine Capital Markets, LLC (“Divine”) to act as Placement Agent (the “Placement Agent”) for the 2017 private placement of the Series C Preferred Stock and warrants. For its services, the Placement Agent received, in addition to a 10.0% commission on the sale of each Unit and a 3.0% non-refundable expense allowance, warrants to purchase 10% of the Units sold at 120% of the Unit purchase price. The warrants to purchase 2.1 Units equates to a warrant to purchase 182,003 shares of the Company’s common stock at $0.72 per share and a second warrant to purchase 182,003 shares of the Company’s common stock at $1.00 per share. On May 8, 2018, the Company issued 279,190 shares of common stock pursuant a cashless exercise of these warrants.
On September 9, 2017, the Company approved the issuance of 100,000 shares of our common stock to Spartan Capital for capital advisory services. On February 2, 2018, the Company amended the terms of the consulting agreement with Spartan Capital and agreed to issue an additional 200,000 shares of the Company’s common stock. Spartan Capital is an accredited investor. The shares of common stock were issued by the Company on May 8, 2018.
On May 8, 2018, the Company issued 400,000 shares of its common stock as payment for services to a consultant. The shares were valued at $328, an average of $0.82 per share.
The foregoing issuances and sales and purchases were exempt from registration upon reliance of Section 4(a)(2) and Regulation D promulgated thereunder.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
None
None