UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016

 

OR

 

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

 

FOR THE TRANSITION PERIOD FROM __________________ TO ______________________

 

COMMISSION FILE NUMBER: 000-32037

 

INTERCLOUD SYSTEMS, INC.
(Name of registrant as specified in its charter)

 

DELAWARE   65-0963722

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1030 BROAD STREET, SUITE 102,

SHREWSBURY, NJ

  07702
(Address of principal executive offices)   (Zip Code)

 

(732) 898-6308
(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer Accelerated filer
Non-accelerated filer Smaller reporting company

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 38,462,234 shares of common stock were issued and outstanding as of August 5, 2016.

 

 

 

 

 

  TABLE OF CONTENTS  
     
  Page No.
  PART I. - FINANCIAL INFORMATION  
     
Item 1. Unaudited Condensed Consolidated Financial Statements. 1
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 48
     
Item 3.  Quantitative and Qualitative Disclosures About Market Risk. 55
     
Item 4. Controls and Procedures. 55
     
  PART II. - OTHER INFORMATION  
     
Item 1. Legal Proceedings. 56
     
Item 1A. Risk Factors. 56
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 56
     
Item 3.  Defaults Upon Senior Securities. 57
     
Item 4. Mine Safety Disclosures. 57
     
Item 5. Other Information. 57
     
Item 6. Exhibits. 57

 

 

 

FORWARD-LOOKING STATEMENTS

 

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

 

You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. You should also consider carefully the statements under Item 1A. Risk Factors appearing in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission on June 17, 2016, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements. Such risks and uncertainties include:

 

  our ability to successfully execute our business strategies, including the acquisition of other businesses to grow our company and integration of recent and future acquisitions;
     
  changes in aggregate capital spending, cyclicality and other economic conditions, and domestic and international demand in the industries we serve;
     
  our ability to adopt and master new technologies and adjust certain fixed costs and expenses to adapt to our industry’s and customers’ evolving demands;
     
  our ability to obtain additional financing in sufficient amounts or on acceptable terms when required;
     
  our ability to adequately expand our sales force and attract and retain key personnel and skilled labor;
     
  shifts in geographic concentration of our customers, supplies and labor pools and seasonal fluctuations in demand for our services;
     
  our dependence on third-party subcontractors to perform some of the work on our contracts;
     
  our competitors developing the expertise, experience and resources to provide services that are equal or superior in both price and quality to our services;
     
  our material weaknesses in internal control over financial reporting and our ability to maintain effective controls over financial reporting in the future;
     
  our ability to comply with certain financial covenants of our debt obligations;
     
  the impact of new or changed laws, regulations or other industry standards that could adversely affect our ability to conduct our business;
     
  changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural or man-made disasters;
     
  we may incur goodwill and intangible asset impairment charges, which could harm our profitability; and
     
  our auditors have expressed doubt about our ability to continue as a going concern.

 

 

 

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

 

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

 

OTHER PERTINENT INFORMATION

 

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

 

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

 

 

 

PART 1 - FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

INTERCLOUD SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

(UNAUDITED)

 

    June 30,     December 31,  
    2016     2015  
          (Revised)  
ASSETS            
Current Assets:            
Cash   $ 2,432     $ 7,944  
Accounts receivable, net of allowances of $1,233 and $1,290, respectively     18,179       16,616  
Inventories, net     365       1,181  
Loans receivable     2,044       400  
Other current assets     3,968       2,321  
Current assets of discontinued operations     -       91  
Total current assets     26,988       28,553  
                 
Restricted cash     14,190       -  
Property and equipment, net     691       659  
Goodwill     24,481       23,658  
Intangible assets, net     16,279       16,713  
Investment     770       800  
Other assets     209       96  
Non-current assets of discontinued operations     -       21,752  
Total assets   $ 83,608     $ 92,231  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT                
                 
Current Liabilities:                
Accounts payable   $ 9,822     $ 7,932  
Accrued expenses     12,072       10,787  
Deferred revenue     3,511       5,145  
Income taxes payable     39       653  
Bank debt, current portion     124       131  
Notes, related parties     11,751       11,103  
Contingent consideration     515       -  
Derivative financial instruments     5,911       408  
Term loans, current portion, net of debt discount     5,066       3,787  
Current liabilities of discontinued operations     -       5  
Total current liabilities     48,811       39,951  
                 
Long-term Liabilities:                
Notes, related parties, net of current portion     8,726       8,183  
Deferred income taxes     986       909  
Term loans, net of current portion and debt discount     32,932       30,258  
Derivative financial instruments     8,462       17,130  
Total long-term liabilities     51,106       56,480  
                 
Total liabilities     99,917       96,431  
                 
                 
Commitments and contingencies (Note 1)                
                 
Stockholders' deficit:                
Common stock; $0.0001 par value; 500,000,000 shares authorized; 34,545,540 and 29,461,377 issued and 33,918,335 and 29,032,622 shares outstanding as of June 30, 2016 and December 31, 2015, respectively     3       3  
Common stock warrants; 190,609 warrants outstanding as of June 30, 2016 and December 31, 2015, no par     259       259  
Treasury stock; at cost; 627,205 and 428,755 shares as of June 30, 2016 and December 31, 2015, respectively     (1 )     -  
Additional paid-in capital     123,256       117,706  
Accumulated deficit     (140,224 )     (122,500 )
Total InterCloud Systems, Inc. stockholders' deficit     (16,707 )     (4,532 )
Non-controlling interest     398       332  
Total stockholders' deficit     (16,309 )     (4,200 )
                 
Total liabilities, non-controlling interest and stockholders’ deficit   $ 83,608     $ 92,231  

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

  1  

 

 

INTERCLOUD SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

  For the three months ended     For the six months ended  
  June 30,     June 30,  
    2016     2015     2016     2015  
          (Revised)               (Revised)  
Service revenue   $ 20,860     $ 15,432     $ 35,471     $ 29,766  
Product revenue     1,734       4,127       4,752       8,031  
  Total revenue     22,594       19,559       40,223       37,797  
Cost of revenue     17,375       15,162       30,590       28,334  
Gross profit     5,219       4,397       9,633       9,463  
Operating expenses:                                
  Depreciation and amortization     556       863       1,112       1,871  
  Salaries and wages     4,205       8,319       8,311       13,360  
  Selling, general and administrative     4,776       2,495       8,070       5,320  
  Change in fair value of contingent consideration     -       -       -       (370 )
  Total operating expenses     9,537       11,677       17,493       20,181  
Loss from operations     (4,318 )     (7,280 )     (7,860 )     (10,718 )
Other income (expenses):                                
Change in fair value of derivative instruments     1,910       (1,221 )     4,796       (196 )
Loss on settlement of contingent consideration     -       (152 )     -       (205 )
Interest expense     (3,418 )     (1,806 )     (8,133 )     (4,955 )
Gain (loss) on conversion of debt     -       (1,096 )     348       (1,113 )
Loss on extinguishment of debt     (6,969 )     (1,753 )     (7,812 )     (2,960 )
Loss on modification of debt     -       -       -       (2,990 )
Loss on exchange of shares     -       (2,331 )     -       (2,331 )
Loss on investment in unconsolidated subsidiary     -       -       (29 )     -  
Other (expense) income     714       (62 )     683       (74 )
Total other income (expense)     (7,763 )     (8,421 )     (10,147 )     (14,824 )
Loss from operations before benefit from income taxes     (12,081 )     (15,701 )     (18,007 )     (25,542 )
(Benefit from) provision for income taxes     56       (1,367 )     116       (1,224 )
Net loss from continuing operations     (12,137 )     (14,334 )     (18,123 )     (24,318 )
Net income (loss) on discontinued operations, net of tax (Note 14)     (1,198 )     (179 )     465       (362 )
Net loss     (13,335 )     (14,513 )     (17,658 )     (24,680 )
Net income (loss) attributable to non-controlling interest     (81 )     37       (66 )     (150 )
Net loss attributable to InterCloud Systems, Inc. common stockholders   $ (13,416 )   $ (14,476 )   $ (17,724 )   $ (24,830 )
Basic and diluted loss per share attributable to InterCloud Systems, Inc. common stockholders:                                
Net loss from continuing operations   $ (0.39 )   $ (0.68 )   $ (0.59 )   $ (1.28 )
Net income (loss) on discontinued operations, net of tax   $ (0.04 )   $ (0.01 )   $ 0.01     $ (0.02 )
Net loss per share   $ (0.43 )   $ (0.69 )   $ (0.58 )   $ (1.30 )
Basic and diluted weighted average common shares outstanding     31,422,412       20,883,458       30,662,143       19,056,275  

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

  2  

 

 

INTERCLOUD SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

(UNAUDITED)

 

          Common Stock           Additional           Non-        
    Common Stock     Warrants     Treasury Stock     Paid-in     Accumulated     Controlling        
    Shares     $     Shares     $     Shares     $   Capital     Deficit     Interest     Total  
                                                             
Ending balance, December 31, 2015     29,032,622     $ 3       190,609     $ 259       428,755     $ -     $ 117,706     $ (122,500 )   $ 332     $ (4,200 )
Issuance of shares of common stock to third parties for services and non-employees     271,761       -       -       -       -       -       156       -       -       156  
Issuance of shares pursuant to promissory notes     1,802,693       -       -       -       -       -       1,620       -       -       1,620  
Issuance of shares pursuant to Smithline convertible note     536,190       -       -       -       -       -       267       -       -       267  
Issuance of shares pursuant to bridge financing provision     500,000       -       -       -       -       -       320       -       -       320  
Issuance of shares pursuant to acquisition of assets of SDN Essentials, LLC     1,000,000       -       -       -       -       -       1,000       -       -       1,000  
Issuance of shares of common stock to employee for incentive earned     73,519       -       -       -       -       -       50       -       -       50  
Issuance of shares pursuant to loan covenants     900,000       -       -       -       -       -       828       -       -       828  
Stock compensation expense     -       -       -       -       -       -       1,309       -       -       1,309  
Purchase of treasury shares     (198,450 )     -       -       -       198,450       (1 )     -       -       -       (1 )
Net loss attributable to InterCloud Systems, Inc. common stockholders     -       -       -       -       -       -       -       (17,724 )     66       (17,658 )
Ending balance, June 30, 2016     33,918,335     $ 3       190,609     $ 259       627,205     $ (1 )   $ 123,256     $ (140,224 )   $ 398     $ (16,309 )

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

  3  

 

 

INTERCLOUD SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLAR AMOUNTS IN THOUSANDS)

(UNAUDITED)

 

    For the six months ended
June 30,
 
    2016     2015  
          (Revised)  
             
Cash flows from operating activities:            
Net loss   $ (17,658 )   $ (24,680 )
                 
Adjustments to reconcile net loss from operations to net cash (used in) provided by operations:                
(Income) loss from discontinued operations     (465 )     362  
Depreciation and amortization     1,112       1,871  
Provision for bad debts     100       103  
Amortization of debt discount     3,906       3,037  
Loss on disposal of equipment     -       14  
Stock compensation for services     1,309       6,049  
Issuance of shares to non-employees for services     71       434  
Shares issued to third party     -       5  
Change in fair value of derivative instruments     (4,796 )     196  
Deferred income taxes     (51 )     (1,298 )
Loss on settlement of contingent consideration     -       205  
Change in fair value of contingent consideration     -       (370 )
(Gain) loss on conversion of debt     (348 )     1,113  
Loss on extinguishment of debt     7,812       2,960  
Loss on modification of debt     -       2,990  
Loss on exchange of shares     -       2,331  
Loss on investment in unconsolidated subsidiary     29       -  
Changes in operating assets and liabilities:                
Accounts receivable     (1,333 )     2,264  
Inventory     816       (52 )
Other assets     (1,760 )     1,124  
Accounts payable and accrued expenses     941       935  
Deferred revenue     (1,634 )     243  
Net cash used in operating activities of continuing operations     (11,949 )     (164 )
Net cash provided by operating activities of discontinued operations     414       916  
Net cash (used in) provided by operating activities     (11,535 )     752  
                 
Cash flows from investing activities:                
Purchases of equipment     (107 )     (48 )
Capitalization of software costs     -       (277 )
Restricted cash     (12,190 )     -  
Issuance of notes receivable     (1,644 )     (400 )
Consideration paid for acquired assets, net of cash received     95       -  
Net cash used in investing activities of continuing operations     (13,846 )     (725 )
Net cash provided by (used in) investing activities of discontinued operations     21,887       (537 )
Net cash provided by (used in) investing activities     8,041       (1,262 )
                 
Cash flows from financing activities:                
Repayments of bank borrowings     (6 )     (115 )
Proceeds from notes and loans payable     -       2,654  
Repayments of notes and loans payable     (2,011 )     (2,225 )
Repurchase of common stock     (1 )     -  
Net cash (used in) provided by financing activities of continuing operations     (2,018 )     314  
Net cash used in financing activities of discontinued operations     -       -  
Net cash (used in) provided by financing activities     (2,018 )     314  
                 
Net change in cash   $ (5,512 )   $ (196 )
                 
Cash, beginning of period     7,944       5,470  
                 
Cash, end of period   $ 2,432     $ 5,274  
                 
Supplemental disclosures of cash flow information:                
Cash paid for interest   $ 2,572     $ 1,152  
Cash paid for income taxes   $ 83     $ 95  
                 
Non-cash investing and financing activities:                
Issuance of shares pursuant to conversion of debt   $ 2,207     $ 5,510  
Issuance of shares pursuant to modification of debt   $ -     $ 920  
Issuance of shares pursuant to extinguishment of debt   $ -     $ 1,086  
Issuance of shares pursuant to restructuring of debt   $ -     $ 292  
Issuance of shares upon conversion of related party debt   $ -     $ 844  
Issuance of shares pursuant to acquisition   $ 1,000     $ -  
Additional note payable issued as part of related party debt modification   $ -     $ 1,728  
Addition to debt discount   $ 1,581     $ 6,365  
Conversion of accrued interest to note payable   $ -     $ 390  
Issuance of shares for earn out provisions related to prior year acquisitions   $ -     $ 1,457  
Issuance of shares for settlement of interest   $ -     $ 343  
Issuance of warrants for settlement of accounts payable   $ -     $ 674  
Issuance of warrants pursuant to bridge financing agreement   $ -     $ 1,276  
Issuance of shares for payout of incentives earned   $ 50     $ 374  
Issuance of shares in lieu of cash compensation   $ 156     $ -  
Issuance of shares pursuant to loan covenants   $ 828     $ -  

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

  4  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Overview

 

InterCloud Systems, Inc. (the “Company”) was incorporated on November 22, 1999 under the laws of the State of Delaware and is a leading provider of cloud networking orchestration and automation, for software-defined networking and network function virtualization cloud environments to the telecommunications service provider and corporate enterprise markets through cloud solutions and professional services. The Company’s cloud solutions offer enterprise and service-provider customers the opportunity to adopt an operational expense model by outsourcing cloud deployment and management rather than the capital expense model that has dominated in recent decades in IT infrastructure management. The Company’s professional services group offers a broad range of solutions to enterprise and service provider customers, including application development teams, analytics, project management, program management, unified communications, network management and field support services on a short and long-term basis. The Company’s applications and infrastructure division offers enterprise and service provider customers specialty contracting services, including engineering, design, installation and maintenance services, that support the build-out and operation of some of the most advanced small cell, Wi-Fi and distributed antenna system networks.

 

Principles of Consolidation and Accounting for Investments in Affiliate Companies

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which include Tropical Communications, Inc. (“Tropical”) (since August 2011), Rives-Monteiro Leasing, LLC (“RM Leasing”) (since December 2011), ADEX Corporation, ADEX Puerto Rico, LLC and HighWire (collectively, “ADEX” or “ADEX Entities”) (since September 2012), TNS, Inc. (“TNS”) (since September 2012), AW Solutions, Inc. and AW Solutions Puerto Rico, LLC (collectively, the “AWS Entities”) (since April 2013), Integration Partners – NY Corporation (“IPC”) (since January 2014), RentVM Inc. (“RentVM”) (since February 2014), and SDN Essentials, LLC (“SDN”) (since January 2016). The results of operations of the Company’s former subsidiaries, VaultLogix, LLC (“VaultLogix”) (since October 2014) and PCS Holding LLC (“Axim”) (since December 2014), have been included as discontinued operations on the accompanying financial statements. In February 2016, the Company consummated the sale of certain assets of VaultLogix and in April 2016, the Company consummated the sale of all assets of Axim (see Note 14, Discontinued Operations). All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The Company consolidates all entities in which it has a controlling voting interest and a variable interest in a variable interest entity (“VIE”) in which the Company is deemed to be the primary beneficiary.

 

The unaudited condensed consolidated financial statements include the accounts of Rives-Montiero Engineering, LLC ("RM Engineering") (since December 2011), in which the Company owns an interest of 49%. The Company has the ability to exercise its call option to acquire the remaining 51% of RM Engineering for a nominal amount and thus makes all significant decisions related to RM Engineering even though it absorbs only 49% of the losses. Additionally, substantially all of the entity’s activities either involve or are conducted on behalf of the entity by the 51% holder of RM Engineering.

 

The unaudited condensed consolidated financial statements include the accounts of Nottingham Enterprises LLC (“Nottingham”), in which the Company owns an interest of 40%. Nottingham is a VIE because it meets the following criteria: (i) the entity has insufficient equity to finance its activities without additional subordinated financial support from other parties and the 60% owner guarantees its debt, (ii) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the legal entity, and (iii) substantially all of the legal entity’s activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights. The Company has the ability to exercise its call option to acquire the remaining 60% of Nottingham for a nominal amount and thus makes all significant decisions related to Nottingham even though it absorbs only 40% of the losses. Additionally, substantially all of the entity’s activities either involve or are conducted on behalf of the entity by the 60% holder of Nottingham.

 

  5  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The unaudited condensed consolidated financial statements include the Company’s 13.7% ownership interest in NGNWare, LLC (“NGNWare”). The Company does not hold a controlling financial interest in NGNWare but has the ability to exercise significant influence over the operating and financial policies of NGNWare. As such, the Company accounts for the investment in NGNWare under the equity method of accounting.

 

The unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of such statements. These unaudited condensed consolidated financial statements have been prepared in accordance with GAAP pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Additionally, the results of operations for the three and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2015 included in the Company’s 2015 Annual Report on Form 10-K, filed with the SEC on June 17, 2016.

 

Segment Information

 

The Company operates in three operating segments – as an applications and infrastructure provider, as a professional services provider, and as a managed services provider. The applications and infrastructure segment provides engineering and professional consulting services and voice, data and optical solutions. The engineering, design, installation and maintenance services of the applications and infrastructure segment support the build-out and operation of enterprise, fiber optic, Ethernet and wireless networks. The professional services segment provides outsourced services to the wireless and wireline industry and information technology industry. The managed services segment provides hardware and software products to customers and provides maintenance and support for those products.

  

The Company’s reporting units have been aggregated into one of three operating segments due to their similar economic characteristics, products, or production and distribution methods. The first operating segment is applications and infrastructure, which is comprised of the components TNS, the AWS Entities, Tropical, RM Leasing, and RM Engineering. The Company’s second operating segment is professional services, which consists of the ADEX Entities and SDN. The Company’s third operating segment is managed services, which consists of the IPC, RentVM and Nottingham components. The operating segments mentioned above constitute reporting segments.

 

During 2016, the Company consummated the sale of certain assets of its former VaultLogix and Axim subsidiaries. These subsidiaries comprised the Company’s former cloud services segment. The cloud services segment provided cloud computing and storage services to customers.

 

Revenue Recognition

 

The Company’s revenues are generated from its three reportable segments: applications and infrastructure, professional services, and managed services. The Company recognizes revenue on arrangements in accordance with Accounting Standards Codification (“ASC”) Topic 605-10, Revenue Recognition . The Company recognizes revenue only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.

 

The applications and infrastructure segment revenues are derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. The contracts of TNS, Tropical and RM Engineering provide that payment for the Company’s services may be based on either direct labor hours at fixed hourly rates or fixed-price contracts. The services provided under the contracts are generally provided within one month. Occasionally, the services may be provided over a period of up to six months.

 

  6  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The AWS Entities generally recognize revenue using the percentage of completion method. Revenues and fees on these contracts were recognized utilizing the units-of-delivery method, which used measures such as task completion within an overall contract. The units-of-delivery approach is an output method used in situations where it is more representative of progress on a contract than an input method, such as the efforts-expended approach. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. Changes in job performance conditions and final contract settlements may result in revisions to costs and income, which are recognized in the period in which revisions are determined.

 

The AWS Entities also generate revenue from service contracts with certain customers. These contracts are accounted for under the proportional performance method. Under this method, revenue is recognized in proportion to the value provided to the customer for each project as of each reporting date.

 

The revenues of the Company’s professional services segment, which is comprised of the ADEX Entities and SDN, are derived from contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. The contracts provide that payments made for the Company’s services may be based on either direct labor hours at fixed hourly rates or fixed-price contracts. The services provided under these contracts are generally provided within one month. Occasionally, the services may be provided over a period of up to four months. If it is anticipated that the services will span a period exceeding one month, depending on the contract terms, the Company will provide either progress billing at least once a month or upon completion of the clients’ specifications. The aggregate amount of unbilled work-in-progress recognized as revenues was insignificant at June 30, 2016 and 2015.

 

ADEX’s HighWire division generates revenue through its telecommunications engineering group, which contracts with telecommunications infrastructure manufacturers to install the manufacturer’s products for end users. The High Wire division recognizes revenue using the proportional performance method. Under the proportional performance method, the Company recognizes revenue when a project within a contract is completed. Management judgments and estimates must be made and used in connection with revenue recognized using the proportional performance method. If management made different judgments and estimates, then the amount and timing of revenue for any period could differ materially from the reported revenue.

 

The Company’s TNS and IPC subsidiaries, as well as ADEX’s HighWire division, sometimes require customers to provide a deposit prior to beginning work on a project. When this occurs, the deposit is recorded as deferred revenue and is recognized in revenue when the work is complete.

  

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

 

IPC also generates revenue through the sale of a subscription-based cloud services to its customers. Revenue related to these customers is deferred until the services are performed.

 

  7  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

For multiple-element arrangements, IPC recognizes revenue in accordance with ASC Topic 605-25, Arrangements with Multiple Deliverables . The Company allocates revenue for such arrangements based on the relative selling prices of the elements applying the following hierarchy: first vendor specific objective evidence (“VSOE”), then third-party evidence (“TPE”) of selling price if VSOE is not available, and finally the Company’s estimate of the selling price if neither VSOE nor TPE is available. VSOE exists when the Company sells the deliverables separately and represents the actual price charged by the Company for each deliverable. Estimated selling price reflects the Company’s best estimate of what the selling prices of each deliverable would be if it were sold regularly on a stand-alone basis taking into consideration the cost structure of the Company’s business, technical skill required, customer location and other market conditions. Each element that has stand-alone value is accounted for as a separate unit of accounting. Revenue allocated to each unit of accounting is recognized when the service is provided or the product is delivered. 

 

The Company’s former VaultLogix subsidiary, which was included in the Company’s cloud services segment, provided on-line data backup services to its customers. Revenue for these customers was deferred until the services were performed.

 

Restricted Cash

 

As of June 30, 2016, the Company had $14,190 of restricted cash related to the Senior Secured Convertible Note with JGB (Cayman) Concord Ltd. in which 105% of the proceeds received are restricted based on certain terms and conditions of the note.

  

Inventory

 

The inventory balance at June 30, 2016 and December 31, 2015 related to the Company’s IPC subsidiary. IPC purchases inventory for resale to customers and records it at the lower of cost or market until sold. As inventory relates to specific customer orders, the Company determines the cost of the inventory using the specific identification method. Inventory consisted of networking equipment for which title had not passed to customers as of June 30, 2016 and December 31, 2015.

 

Goodwill and Indefinite Lived Intangible Assets

 

Goodwill was generated through the acquisitions made by the Company. As the total consideration paid exceeded the value of the net assets acquired, the Company recorded goodwill for each of the completed acquisitions. At the date of acquisition, the Company performed a valuation to determine the value of the intangible assets, along with the allocation of assets and liabilities acquired. The goodwill is attributable to synergies and economies of scale provided to the Company by the acquired entity.

 

The Company tests its goodwill and indefinite-lived intangible assets for impairment at least annually (as of October 1) and whenever events or circumstances change that indicate impairment may have occurred. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in the Company’s expected future cash flows; a sustained, significant decline in the Company’s stock price and market capitalization; a significant adverse change in legal factors or in the business climate of the Company’s segments; unanticipated competition; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of goodwill, the indefinite-lived intangible assets and the Company’s consolidated financial results.

 

During 2015, indicators of potential impairment of goodwill and indefinite-lived intangible assets were identified by management in the managed services segment. The Company's management then determined that the IPC reporting unit assets were impaired and recognized an impairment loss as of December 31, 2015 related to intangible assets as the carrying value of the IPC reporting unit was in excess of its fair value. If IPC’s projected long-term sales growth rate, profit margins or terminal rate continue to change, or the assumed weighted-average cost of capital is considerably higher, future testing may indicate additional impairment in this reporting unit and, as a result, the remaining assets may also be impaired.

During 2015, indicators of potential impairment of goodwill and indefinite-lived intangible assets were identified by management in the Company’s former cloud services segment. The Company's management then determined that the Axim operating segment assets were impaired and recognized an impairment loss as of December 31, 2015 related to intangible assets as the carrying value of the Axim reporting unit was in excess of its fair value. If Axim’s projected long-term sales growth rate, profit margins or terminal rate continue to change, or the assumed weighted-average cost of capital is considerably higher, future testing may indicate additional impairment in this reporting unit and, as a result, the remaining assets may also be impaired.

During December 2015, the Company entered into a letter of intent with a third-party to sell VaultLogix and its two subsidiaries, which were included in the cloud services segment. The agreement was executed in February 2016. The Company’s management assessed the carrying amounts of VaultLogix and its subsidiaries assets and liabilities as compared to the selling price and determined that an impairment existed as of December 31, 2015. The Company recognized an impairment loss as of December 31, 2015, as the carrying value of the VaultLogix business unit was in excess of the amount for which it was sold in an arm’s-length transaction. 

 

As of June 30, 2016, the Company did not identify any indicators of impairment.

 

  8  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Commitments and Contingencies

 

In the normal course of business, the Company is subject to various contingencies. The Company records any contingencies in the consolidated financial statements when it is probable that a liability will be incurred and the amount of the loss is reasonably estimable, or otherwise disclosed, in accordance with ASC Topic 450, Contingencies ("ASC Topic 450"). Significant judgment is required in both the determination of probability and the determination as to whether a loss is reasonably estimable. In the event the Company determines that a loss is not probable, but is reasonably possible, and it becomes possible to develop what the Company believes to be a reasonable range of possible loss, then the Company will include disclosures related to such matter as appropriate and in compliance with ASC Topic 450. To the extent there is a reasonable possibility that the losses could exceed the amounts already accrued, the Company will, when applicable, adjust the accrual in the period in which the determination is made, disclose an estimate of the additional loss or range of loss, indicate that the estimate is immaterial with respect to its financial statements as a whole or, if the amount of such adjustment cannot be reasonably estimated, disclose that an estimate cannot be made.

 

Purported Class Action Suit

 

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

 

On November 3, 2014, the United States District Court for the District of New Jersey issued an order appointing Robbins Geller Rudman & Dowd LLP as lead plaintiffs’ counsel and Cohn Lifland Pearlman Herrmann & Knopf LLP as liaison counsel for the pending actions. The lead filed an amended complaint in January 2015 adding additional third-party defendants. The Company filed a motion to dismiss the amended complaint in late January 2015 and the plaintiffs filed a second amended complaint in early March 2015. The Company filed a motion to dismiss the second amended complaint on March 13, 2015. The Company’s motion to dismiss was denied by the Court on October 29, 2015. The Court held a status conference on February 29, 2016, and entered a PreTrial Scheduling Order on February 29, 2016. The parties are currently engaged in discovery.

 

Derivative Action s

 

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

 

In June 2016, a derivative compliant entitled Wasseem Hamdan, derivatively and on behalf of InterCloud Systems, Inc. v. Mark Munro, Mark F. Durfee, Charles K. Miller, Neal Oristano, and Roger M. Ponder, Defendants, and InterCloud Systems, Inc., Nominal Defendant, Case No.: 3:16-cv-03706 (D.N.J.) was filed in the New Jersey Federal District Court. This action arises out of the same conduct at issue in the purported class action lawsuit. In the complaint, nominal plaintiff alleges that the individual defendants breached their fiduciary duty as directors and officers, grossly mismanaged, and unjustly enriched themselves during the relevant period (December 2013 to the present) by having knowingly hired a stock promotion firm that caused analyst reports to be disseminated that falsely stated they were not paid for by such stock promotion firm and the Company, and were written on behalf of the Company for the purpose of promoting the Company and driving up its stock price. Plaintiffs seek unspecified damages, amendments to the Company’s articles of incorporation and by-laws, disgorgement from the individual defendants and costs and disbursements in the action. On June 24, 2016, the plaintiff’s counsel requested that the defendant’s counsel agree to accept service, which is under consideration.

 

  9  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

In July 2016, a derivative compliant entitled John Scrutchens, derivatively and on behalf of InterCloud Systems, Inc. v. Mark E. Munro, Mark F. Durfee, Charles K. Miller, Neal Oristano, and Roger Ponder, Defendants, and InterCloud Systems, Inc., Nominal Defendant, Case No.: 3:16-CV-04207-FLW-DEA (D.N.J.) was filed in the United States Federal District Court for the District of New Jersey. This action arises out of the same conduct at issue in the purported class action lawsuit filed against the Company. In the complaint, nominal plaintiff alleges that the individual defendants violated Section 14(a) of the Securities Exchange Act of 1934, as amended, and Rule 14a-9 promulgated thereunder because in exercising reasonable care as directors of the Company, the defendants knew or should have known that statements contained in the Company’s proxy statements for the Company’s annual stockholders’ meetings held in 2013 and 2014 were false and misleading in that such proxy statements (i) omitted material information regarding, among other wrongdoings, the purported wrongdoings of the defendants that generally are at issue in the purported class action lawsuit filed against the Company and the other derivative actions filed against the defendants, and (ii) included by reference materially false and misleading financial statements.  Plaintiffs seek unspecified damages, amendments to the Company’s corporate governance and internal procedures to comply with applicable laws and to protect the Company and its stockholders from a repeat of the purported wrongdoings of the defendants, punitive damages from the individual defendants, disgorgement from the individual defendants and costs and disbursements in the action.

 

IPC-Related Litigation

 

The Company acquired IPC in January 2014, and during 2014 advised the sellers of IPC that a post-closing financial audit of IPC’s historical financial statements showed a discrepancy in the adjusted EBITDA of IPC as represented by the sellers. The Company made a claim for such misrepresentation against a cash portion of the IPC purchase price that remains in escrow. In January 2015, a complaint was filed in the United States District Court of the Southern District of New York against the Company, Mr. Munro and Daniel J. Sullivan, the Company’s Chief Accounting Officer and former Chief Financial Officer. The complaint alleges, among other claims, the Company’s breach of contract, breach of implied covenant of good faith and fair dealing and unjust enrichment relating to the Company’s purported failure to pay certain post-closing purchase price payments to the sellers of IPC in connection with the Company’s purchase of IPC in January 2014. The complaint also alleges that Messrs. Munro and Sullivan intentionally interfered with such contractual obligations of the Company under the related stock purchase agreement between the Company and the plaintiffs. The complaint seeks unspecified damages, attorney and expert fees and other unspecified litigation costs. In addition, the complaint seeks specific performance of the enforcement of the terms of the purchase contract and the Company’s payment of not less than $2.5 million.

 

On April 23, 2015, the Company and the other defendants filed a motion to dismiss the principal substantive claims in the complaint with the exception of the claim for breach of contract. On January 12, 2016, the court granted the Company’s motion to dismiss the claims for breach of the covenant of good faith and fair dealing, for intentional breach, for estoppel and for declaratory relief, but denied the Company’s motions to dismiss the claims for unjust enrichment and for tortious interference with contractual relations against Messrs. Munro and Sullivan. On February 9, 2016, the Company filed its answer with respect to the remaining claims in this action and asserted counterclaims based on the individual plaintiffs’ breach of contract and misrepresentations in the purchase agreement.

 

Securities and Exchange Commission Subpoenas

 

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

 

In connection with the SEC investigation, in May 2015, the Company received information from the SEC that it is continuing an investigation of the Company and certain of its current and former officers, consultants of the Company and others, of “possible violation[s]” of Section 17(a) of the Securities Act of 1933, as amended, and Sections 9(a) and 10(b) of the Securities Exchange Act of 1934, as amended, and the rules of the SEC thereunder in the offer or sale of securities and certain other matters with respect to which the SEC claims it has information, including the possible market manipulation of the Company’s securities dating back to January 2013. Based upon the Company’s internal investigations, the Company does not believe either the Company or any of its current or former officers or directors engaged in any activities that violated applicable securities laws. The Company intends to continue to work with the staff of the SEC towards a resolution and to supplement the Company’s disclosure regarding the SEC’s investigation accordingly.

 

  10  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

  

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

 

As of June 30, 2016, no accruals for loss contingencies have been recorded as the outcomes of these cases are neither probable or reasonably estimable.

 

The Company has obligations contingent on the performance of its subsidiaries. These contingent obligations, payable to the former owners of the subsidiaries, are based on metrics that contain escalation clauses. The Company believes that the amounts recorded within the liabilities section of the consolidated balance sheets are indicative of fair value and are also considered the most likely payout of these obligations. If conditions were to change, these liabilities could potentially impact the Company’s results of operations, financial condition and future cash flows.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation in accordance with ASC Topic 718, Compensation-Stock Compensation ("ASC Topic 718"). Under the fair value recognition provisions of this topic, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense on a straight-line basis over the requisite service period, based on the terms of the awards.

 

Net Loss Per Share

 

The Company follows ASC Topic 260, Earnings Per Share , which requires presentation of basic and diluted earnings per share (“EPS”) on the face of the income statement for all entities with complex capital structures, and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation.

 

In the accompanying financial statements, basic loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period.

 

Potential common shares includable in the computation of fully-diluted per share results are not presented for the three and six months ended June 30, 2016 or 2015 in the unaudited condensed consolidated financial statements as their effect would be anti-dilutive.

 

Diluted loss per share is computed in a manner similar to the basic loss per share, except the weighted-average number of shares outstanding is increased to include all common shares, including those with the potential to be issued by virtue of warrants, options, convertible debt and other such convertible instruments. Diluted loss per share contemplates a complete conversion to common shares of all convertible instruments only if they are dilutive in nature with regards to earnings per share.

 

The anti-dilutive shares of common stock outstanding for the three and six months ended June 30, 2016 and 2015 were as follows:

   

    For the three months ended     For the six months ended  
    June 30,     June 30,  
    2016     2015     2016     2015  
                         
Warrants     1,024,842       1,783,712       1,024,842       1,783,712  
Options     175,000       175,000       175,000       175,000  
Convertible notes     6,969,800       2,830,835       6,969,800       2,830,835  
Convertible debenture     14,408,041       6,403,577       14,408,041       6,403,577  
      22,577,683       11,193,124       22,577,683       11,193,124  

   

Fair Value of Financial Instruments

 

ASC Topic 820 Fair Value Measurements and Disclosures ("ASC Topic 820") provides a framework for measuring fair value in accordance with generally accepted accounting principles. 

 

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).

 

  11  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under ASC Topic 820 are described as follows:

 

  Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.
       
  Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
       
  Level 3 — Inputs that are unobservable for the asset or liability.

 

The following section describes the valuation methodologies that the Company used to measure different financial instruments at fair value.

 

Debt

 

The fair value of the Company’s debt, which approximated the carrying value of the Company’s debt as of June 30, 2016 and December 31, 2015, was estimated at $57,461 and $58,613, respectively. Factors that the Company considered when estimating the fair value of its debt included market conditions, liquidity levels in the private placement market, variability in pricing from multiple lenders and term of the debt. The level of the debt would be considered as Level 2.

 

Contingent Consideration

 

The fair value of the Company’s contingent consideration is based on the Company’s evaluation as to the probability and amount of any earn-out that will be achieved based on expected future performance by the acquired entity. The Company utilizes a third-party valuation firm to assist in the calculation of the contingent consideration at the acquisition date. The Company evaluates the forecast of the acquired entity and the probability of earn-out provisions being achieved when it evaluates the contingent consideration at initial acquisition date and at each subsequent reporting period. The fair value of contingent consideration is measured at each reporting period and adjusted as necessary. The Company evaluates the terms in contingent consideration arrangements provided to former owners of acquired companies who become employees of the Company to determine if such amounts are part of the purchase price of the acquired entity or compensation.

 

Additional Disclosures Regarding Fair Value Measurements

 

The carrying value of cash, accounts receivable, inventory, other assets, and accounts payable and accrued expenses approximate their fair value due to the short-term maturity of those items. 

 

Fair Value of Derivatives

 

The Company has historically utilized a Black-Scholes option pricing model to determine the fair value of the derivative liability related to the warrants and the put and effective price of future equity offerings of equity-linked financial instruments. During the quarter ended September 30, 2015, the Company determined that it should utilize a binomial lattice pricing model to determine the fair value of the derivative liability related to the warrants and the put and effective price of future equity offerings of equity-linked financial instruments. The Company has evaluated its derivative instruments and determined that the value of those derivative instruments, using a binomial lattice pricing model instead of a Black-Scholes pricing model, would be immaterial on its historical unaudited condensed consolidated statements of operations for the three and six months ended June 30, 2015.

 

  12  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Derivative Warrant Liabilities

 

The fair value of the derivative liabilities is classified as Level 3 within the Company’s fair value hierarchy. Please refer to Note 8, Derivative Instruments, for a further discussion of the measurement of fair value of the derivatives and their underlying assumptions.

   

The fair value of the Company's financial instruments carried at fair value at June 30, 2016 and December 31, 2015 were as follows:

 

    Fair Value Measurements at Reporting Date Using  
    Quoted Prices     Significant        
    in Active     Other     Significant  
    Markets for     Observable     Unobservable  
    Identical Assets     Inputs     Inputs  
    (Level 1)     (Level 2)     (Level 3)  
    June 30, 2016  
Liabilities:                  
Derivative features related to convertible debentures   $ -     $ -     $ 5,911  
Contingent consideration     -       -       515  
Long-term warrant derivatives     -       -       12  
Long-term derivative features related to convertible debentures     -       -       8,450  
Total liabilities at fair value   $ -     $ -     $ 14,888  
                         
    December 31, 2015  
Liabilities:                  
Derivative features related to convertible debentures   $ -     $ -     $ 408  
Long-term warrant derivatives     -       -       22  
Long-term derivative features related to convertible debentures     -       -       17,108  
Total liabilities at fair value   $ -     $ -     $ 17,538  

 

The changes in Level 3 financial instruments measured at fair value on a recurring basis for the six months ended June 30, 2016 were as follows:

 

    Amount  
Balance as of December 31, 2015   $ 17,538  
Change in fair value of derivative features related to convertible debentures     (2,903 )
Change in fair value of warrant derivative     17  
Fair value of contingent consideration     515  
Addition to debt discount related to JGB (Cayman) Concord Ltd. term loan     1,350  
Balance as of March 31, 2016   $ 16,517  
         
Change in fair value of derivative features related to convertible debentures     (6,762 )
Change in fair value of warrant derivative     (27 )
Adjustment of derivative liability upon extinguishment of debt     4,880  
Fair value of make-whole provision     280  
Balance as of June 30, 2016   $ 14,888  

 

  13  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Treasury Stock

 

The Company records treasury stock at the cost to acquire it and includes treasury stock as a component of stockholders’ deficit.

 

Reclassifications

 

Certain 2015 activities and balances were reclassified as “discontinued operations” to conform to classifications used in the current period related to the sale of VaultLogix, VaultLogix’s subsidiaries, and Axim.

  

2. GOING CONCERN UNCERTAINTY, FINANCIAL CONDITION AND MANAGEMENT’S PLANS

 

The Company’s management believes that there is substantial doubt about the Company’s ability to continue as a going concern. The Company believes that its available cash balance as of the date of this filing will not be sufficient to fund its anticipated level of operations for at least the next 12 months. The Company’s management believes the Company’s ability to continue operations depends on the ability to sustain and grow revenue and results of operations as well as the Company’s ability to access capital markets when necessary to accomplish the Company’s strategic objectives. The Company’s management believes that the Company will continue to incur losses for the immediate future. For the quarter ended June 30, 2016, the Company generated gross profits from operations but failed to achieve positive cash flow from operations. The Company expects to finance future cash needs from the results of operations and, depending on the results of operations, the Company may need additional equity or debt financing until the Company can achieve profitability and positive cash flows from operating activities, if ever.

 

During the three and six months ended June 30, 2016 and the year ended December 31, 2015, the Company suffered recurring losses from operations. At June 30, 2016 and December 31, 2015, the Company had a stockholders’ deficit of $16,309 and $4,200, respectively. The decrease of $10,425 in the Company’s working capital from December 31, 2015 to June 30, 2016 was primarily the result of incurring indebtedness of $2,745 and $5,220 in May 2016, of which $2,655 is payable through June 30, 2017. The Company was required to restrict an additional $3,828 of cash as a result of incurring such indebtedness. In addition, certain of the Company’s derivative instruments in the amount of $5,911 are now due to mature by June 30, 2017, whereas only $408 of these derivative instruments were current as of December 31, 2015.

 

On or prior to June 30, 2017, the Company has obligations relating to the payment of indebtedness as follows:

 

  $6,865 relating to promissory notes held by related parties that matures on July 1, 2017;

 

  $5,755 relating to a promissory note held by a related party that matured on May 30, 2016;

 

  $4,688 relating to senior secured convertible term loans with current portions payable through June 30, 2017;

 

  $1,754 relating to current maturities of a convertible note that matures in January 2017;
     
  $525 relating to current maturities of a convertible note that matures in November 2016;

 

  $307 relating to current maturities of a convertible note that matures in January 2017;

 

  $225 relating to a promissory note held by a related party that matured on May 30, 2016;

 

  $106 relating to a promissory note held by a former owner of Tropical that matures in November 2016; and

 

  $75 relating to a promissory note held by a related party that is due on demand.

 

The Company anticipates meeting its cash obligations on indebtedness that is payable on or prior to June 30, 2017 from earnings from operations and possibly from the proceeds of additional indebtedness or equity raises. If the Company is not successful in obtaining additional financing when required, the Company expects that it will be able to renegotiate and extend certain of its notes payable as required to enable it to meet its remaining debt obligations as they become due, although there can be no assurance that the Company will be able to do so.

 

  14  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The Company’s future capital requirements for its operations will depend on many factors, including the profitability of its businesses, the number and cash requirements of other acquisition candidates that the Company pursues, and the costs of operations. The Company has been investing in sales personnel in anticipation of increasing revenue opportunities in the cloud and managed services segments of its business, which contributed to the losses from operations. The Company’s management has taken several actions to ensure that it will have sufficient liquidity to meet its obligations, including the reduction of certain general and administrative expenses, consulting expenses and other professional services fees. During the six months ended June 30, 2016, the Company exchanged certain term loans in connection with the disposal of certain assets for additional funding. Additionally, if the Company’s actual revenues are less than forecasted, the Company anticipates implementing headcount reductions to a level that more appropriately matches then-current revenue and expense levels. The Company is evaluating other measures to further improve its liquidity, including the sale of equity or debt securities and entering into joint ventures with third parties. Lastly, the Company may elect to reduce certain related-party and third-party debt by converting such debt into common shares. The Company’s management believes that these actions will enable the Company to meet its liquidity requirements through June 30, 2017. There is no assurance that the Company will be successful in any capital-raising efforts that it may undertake to fund operations over the next 12 months.

 

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

 

3. LOAN RECEIVABLE

 

Loans receivable as of June 30, 2016 and December 31, 2015 consisted of the following:

 

    June 30,     December 31,  
    2016     2015  
Loans to NGNWare   $ 507     $ 100  
Loans to employees     1,537       300  
Loans receivable   $ 2,044     $ 400  

 

4. PROPERTY AND EQUIPMENT, NET

 

Property and equipment as of June 30, 2016 and December 31, 2015 consisted of the following:

 

    June 30,     December 31,  
    2016     2015  
Vehicles   $ 785     $ 777  
Computers and office equipment     927       905  
Equipment     764       605  
Software     186       171  
Total     2,662       2,458  
Less accumulated depreciation     (1,971 )     (1,799 )
                 
Property and equipment, net   $ 691     $ 659  

 

Depreciation expense for the three months ended June 30, 2016 and 2015 was $86 and $92, respectively. Depreciation expense for the six months ended June 30, 2016 and 2015 was $172 and $188, respectively.

 

  15  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

5. GOODWILL AND INTANGIBLE ASSETS

 

Goodwill

 

The following table summarizes the Company’s goodwill as of June 30, 2016 and December 31, 2015

 

    Applications and Infrastructure     Professional Services     Managed Services     Total  
Balance at December 31, 2015   $ 6,906     $ 9,257     $ 7,495     $ 23,658  
                                 
Acquisition     -       823       -       823  
                                 
Balance at June 30, 2016   $ 6,906     $ 10,080     $ 7,495     $ 24,481  

 

Intangible Assets

 

The following table summarizes the Company’s intangible assets as of June 30, 2016 and December 31, 2015:

 

        June 30, 2016     December 31, 2015  
                                                           
    Estimated   Gross                 Net     Gross                       Net  
    Useful   Carrying           Accumulated     Book     Carrying     Accumulated           Impairment     Book  
    Life   Amount     Additions     Amortization     Value     Amount     Amortization     Reclassification     Charge     Value  
Customer relationship and lists   7-10 yrs.   $ 14,451     $ 145     $ (5,352 )   $ 9,244     $ 14,451     $ (4,707 )   $ -     $ -     $ 9,744  
Non-compete agreements   2-3 yrs.     1,756       361       (1,785 )     332       2,455       (1,602 )     -       (699 )     154  
Purchased software   16 years     4,000       -       (483 )     3,517       -       (371 )     4,000       -       3,629  
In-process research and development         -       -       -       -       4,000       -       (4,000 )     -       -  
URL's   Indefinite     8       -       -       8       8       -       -       -       8  
Tradenames   1 year     -       -       -       -       59       (49 )     -       (10 )     -  
Tradenames   Indefinite     3,178       -       -       3,178       3,178       -       -       -       3,178  
Total intangible assets       $ 23,393     $ 506     $ (7,620 )   $ 16,279     $ 24,151     $ (6,729 )   $ -     $ (709 )   $ 16,713  

 

Amortization expense related to the identifiable intangible assets was $457 and $772 for the three months ended June 30, 2016 and 2015, respectively. Amortization expense related to the identifiable intangible assets was $940 and $1,684 for the six months ended June 30, 2016 and 2015, respectively. 

 

6. BANK DEBT

 

Bank debt as of June 30, 2016 and December 31, 2015 consisted of the following:

 

    June 30,     December 31,  
    2016     2015  
Installment note, monthly principal and interest of $1, interest 9.05%, secured by vehicle, maturing July 2016   $ -     $ 3  
                 
Four lines of credit, monthly principal and interest, ranging from $0 to $1, interest ranging from 5.5% to 9.75%, guaranteed personally by principal shareholders of acquired companies, maturing July 2016     124       128  
                 
Current portion of bank debt   $ 124     $ 131  

 

The interest expense associated with the bank debt during the three months ended June 30, 2016 and 2015 amounted to $3 and $3, respectively. The interest expense associated with the bank debt during the six months ended June 30, 2016 and 2015 amounted to $5 and $7, respectively. There are no financial covenants associated with the bank debt. 

 

  16  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

7. TERM LOANS

 

Term loans as of June 30, 2016 and December 31, 2015 consisted of the following:

 

    June 30,     December 31,  
    2016     2015  
Former owners of RM Leasing, unsecured, non-interest bearing, due on demand   $ 3     $ 3  
                 
Promissory note with company under common ownership by former owner of Tropical, 9.75% interest, monthly payments of interest only of $1, unsecured and personally guaranteed by officer, due November 2016     106       106  
                 
Term loan, White Oak Global Advisors, LLC, originally maturing in February 2019 and paid during February of 2016, interest of 12% with 2% paid-in-kind interest, net of debt discount $366     -       10,938  
                 
8% convertible promissory note, London Bay - VL Holding Company, LLC, unsecured, maturing October 2017     7,408       7,408  
                 
8% convertible promissory note, WV VL Holding Corp., unsecured, maturing October 2017     7,003       7,003  
                 
8% convertible promissory note, Tim Hannibal, unsecured, maturing October 2017     1,215       1,215  
                 
Promissory note, 12% interest, unsecured, matured in May 2016, net of debt discount of $0 and $9, respectively     -       748  
                 
12% senior convertible note, unsecured, maturing in January 2017, net of debt discount of $175 and $507, respectively     1,579       1,599  
                 
12% senior convertible note, unsecured, maturing in November 2016, net of debt discount of $43 and $173, respectively     482       352  
                 
12% senior convertible note tranche 1, unsecured, matured in January 2016, net of debt discount of $15     -       235  
                 
12% senior convertible note tranche 2, unsecured, matured in February 2016, net of debt discount of $80     -       253  
                 
12% senior convertible note tranche 3, unsecured, matured in March 2016, net of debt discount of $55     -       445  
                 
Senior secured convertible debenture, JGB (Cayman) Waltham Ltd., bearing interest of 4.67%, maturing in May 2019, net of debt discount of $1,976 and $4,179, respectively     4,124       3,321  
                 
12% convertible note, Richard Smithline, unsecured, maturing in January 2017, net of debt discount of $36 and $107, respectively     271       419  
                 
Senior secured convertible note, JGB (Cayman) Concord Ltd., bearing interest at 4.67%, maturing in May 2019, net of debt discount of $3,759     7,842       -  
                 
Senior secured note, JGB (Cayman) Waltham Ltd., bearing interest at 4.67%, maturing in May 2019     2,745       -  
                 
Senior secured note, JGB (Cayman) Concord Ltd., bearing interest at 4.67%, maturing in May 2019     5,220       -  
                 
      37,998       34,045  
Less: Current portion of term loans     (5,066 )     (3,787 )
                 
Long-term portion term loans, net of debt discount   $ 32,932     $ 30,258  

 

The interest expense, including amortization of debt discounts, associated with the term loans outstanding during the three months ended June 30, 2016 and 2015 amounted to $2,445 and $1,393, respectively. The interest expense, including amortization of debt discounts, associated with the term loans outstanding during the six months ended June 30, 2016 and 2015 amounted to $6,243 and $3,536, respectively.

 

Promissory Notes to the Mark Munro 1996 Charitable Remainder UniTrust

 

On February 10, 2015, the Mark Munro 1996 Charitable Remainder UniTrust converted $100 principal amount of its January 1, 2014 note into 42,553 shares of the Company’s common stock.

 

  17  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On February 25, 2015, the Company restructured the terms of certain related-party notes and the Mark Munro 1996 Charitable Remainder UniTrust in order to extend the maturity dates thereof and to reduce the interest rate accruing thereon. The following notes were restructured as follows:

 

  notes issued to the Mark Munro 1996 Charitable Remainder UniTrust in the aggregate principal amount of $300 had the interest rates reduced from 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018; and

 

  notes issued to the Mark Munro 1996 Charitable Remainder UniTrust in the aggregate principal amount of $175 had the interest rates reduced from 12% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018.

 

In consideration for such restructuring, the Company issued to the Mark Munro 1996 Charitable Remainder UniTrust 89,900 shares of common stock which resulted in a loss on extinguishment of debt of $220 in the unaudited condensed consolidated statement of operations for the three months ended March 31, 2015.

 

During June 2015, the Mark Munro 1996 Charitable Remainder UniTrust converted $25 of principal amount of notes payable and related accrued interest into 8,306 shares of the Company’s common stock.

 

On July 21, 2015, the Mark Munro 1996 Charitable Remainder UniTrust converted the remaining $450 principal amount and related accrued interest of $5 of its promissory note into 219,820 shares of the Company’s common stock.

 

Revolving Line of Credit

 

On July 3, 2014, the Company obtained an unsecured $3,000 interim revolving line of credit from the Mark Munro 1996 Charitable Remainder UniTrust to provide working capital as well as cash to make the Company’s upcoming amortization payments pursuant to the Company’s Convertible Debentures. The line bore interest at the rate of 1.5% per month on funds drawn and matured on March 31, 2016.

 

As of March 31, 2016 and December 31, 2015, there was no amount outstanding under the related party revolving line of credit.

 

Term Loan - White Oak Global Advisors, LLC

 

On October 9, 2014, the Company’s former wholly-owned subsidiary, VaultLogix, entered into a loan and security agreement with the lenders party thereto, White Oak Global Advisors, LLC, as Administrative Agent, Data Protection Services, LLC (“DPS”), U.S. Data Security Acquisition, LLC (“USDSA”) and U.S. Data Security Corporation (“USDSC”) as guarantors, pursuant to which, VaultLogix received a term loan in an aggregate principal amount of $13,261. Interest on the term loan accrues at a rate per annum equal to the sum of (a) the greater of (i) the LIBOR Index Rate (as defined), as adjusted as of each Libor Index Adjustment Date (as defined) and (ii) 1.00% per annum; plus (b) 1100 basis points per annum. The LIBOR Index Rate was 1.0896 as of December 31, 2015; however, this did not exceed the 12% stated rate as defined in item (ii) above.

 

The proceeds of the term loan were used to finance the Company’s acquisition of VaultLogix, DPS and USDSA, to repay certain outstanding indebtedness (including all indebtedness owed by VaultLogix to Hercules Technology II, L.P.) and to pay fees, costs and expenses.

  

In connection with the term loan, the Company entered into (i) a continuing guaranty in favor of the administrative agent, (ii) a pledge agreement, and (iii) a security agreement, pursuant to which the obligations of the Company in respect of the term loan are secured by a security interest in substantially all of the assets of VaultLogix, subject to certain customary exceptions.

 

The term loan was subject to certain affirmative and negative covenants that were tested at the end of each fiscal quarter. The Company was in compliance with all covenants as of December 31, 2015.

 

Principal of $11,305 remained outstanding as of December 31, 2015.

 

On February 17, 2016, the Company entered into a securities exchange agreement whereby the Company and VaultLogix exchanged the White Oak Global Advisors term loan and assigned the term loan to JGB (Cayman) Concord Ltd. Refer to the JGB (Cayman) Concord Ltd. Senior Secured Convertible Note section of this note for further explanation. As a result of this assignment, the Company and VaultLogix’s obligations to White Oak Global Advisors, LLC has been satisfied as of March 31, 2016. The Company recorded a $843 loss on extinguishment of debt in the unaudited condensed consolidated statement of operations for the three months ended March 31, 2016.

 

Term Loan – 8% Convertible Promissory Notes

 

Effective as of October 9, 2014, the Company consummated the acquisition of all of the outstanding membership interests of VaultLogix and its affiliated entities for an aggregate purchase price of $36,796. The purchase price for the acquisition was payable to the sellers as follows: (i) $16,385 in cash, (ii) 1,008,690 shares of the Company’s common stock and (iii) $15,627 in unsecured convertible promissory notes, as further described below. The closing payments were subject to customary working capital adjustments.

 

  18  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The promissory notes accrue interest at a rate of 8% per annum, and all principal and interest accrued under the promissory notes is payable on October 9, 2017. The promissory notes are convertible into shares of the Company’s common stock at a conversion price equal to $6.37 per share. A portion of the principal amount of the promissory notes equal to 20% of the principal amount on the closing date were not convertible until January 9, 2016.

 

On a date when (i) the shares issuable upon conversion of the promissory note are freely tradeable without restriction or volume limitations under Rule 144, and (ii) the average closing price of the Company’s common stock is 105% or higher of the conversion price on the three (3) trading days immediately prior to such date, the Company may deliver notice to the holders of the promissory notes electing to convert some or all of the outstanding amounts owed under the promissory notes into common stock at the applicable conversion price. Additionally, if on or after the maturity date, (i) the Company is restricted or otherwise unable to pay in cash all outstanding amounts under the promissory notes, (ii) the promissory notes have not otherwise been paid in full within ten business days following the maturity date, or (iii) the Company is not at such time entitled to effect a forced conversion, then, in the event that both (i) and (iii) above apply, the Company, and in the event that both (ii) and (iii) above apply, the holders of the promissory notes, shall have the right to convert all outstanding amounts owing under the promissory notes into shares of the Company’s common stock at a conversion price equal to the average closing price of the Company’s common stock on the three trading days immediately preceding the date of such conversion.

 

As of June 30, 2016, the Company had not forced any conversions.

  

Promissory Notes

 

The Company entered into a securities purchase agreement with an investor whereby the Company issued to the investor a demand promissory note, dated November 17, 2014, in the original principal amount of $1,000, with interest accruing at the rate of 12% per annum. The note matured on the earlier of: (x) November 10, 2015 or (y) upon demand by the investor, which such demand could be made any time after 150 days following the issuance of the note upon 30 days’ written notice to the Company; provided, that $60 of interest was guaranteed by the Company regardless of when the note was repaid. The Company could have redeemed the note at any time prior to the maturity date for an amount equal to (i) 100% of the outstanding principal amount, plus (ii) a redemption premium equal to an additional 10% of the outstanding principal amount, plus (iii) any accrued and unpaid interest on the note. The redemption premium could be paid in cash or common stock at the option of the Company. The holder demanded repayment of the demand promissory note by May 16, 2015 and such note was converted on May 14, 2015 into 348,164 shares of the Company’s common stock.

 

On May 14, 2015, the Company entered into a securities purchase agreement with the investor whereby the Company issued a term promissory note in the original principal amount of $1,000, with interest accruing at the rate of 12% per annum. The note matures at the earlier of: (x) May 14, 2016 or (y) upon demand by the investor, which such demand may be made any time after 170 days following the issuance of the note upon 10 days’ written notice to the Company; provided, that $60 of interest is guaranteed by the Company regardless of when the note is repaid. The Company may redeem the note at any time prior to the maturity date for an amount equal to (i) 100% of the outstanding principal amount, plus (ii) an additional 10% of the outstanding principal amount (the “Redemption Premium”), plus (iii) any accrued and unpaid interest on the note. The Redemption Premium can be paid in cash or common stock at the option of the Company. If common stock of the Company is used to pay the Redemption Premium, then such shares shall be delivered by the third business day following the maturity date, or date of demand, as applicable, at a mutually agreed upon conversion price by both parties.

 

On August 6, 2015, the Company amended the May 14, 2015 term promissory note to increase the principal amount of the note to $1,060 and modify the terms of the promissory note to allow for the investor to convert the note into shares of the Company’s common stock. The term promissory note is convertible into shares of the Company’s common stock at the election of the investor at a conversion price equal to $2.00 per share, subject to certain adjustments.

 

On August 6, 2015, the Company entered into a senior convertible note agreement with the investor whereby the Company issued a promissory note in the original principal amount of $2,105, with interest accruing at the rate of 12% per annum, which matures on January 6, 2017. At the election of the investor, the note is convertible into shares of the Company’s common stock at a conversion price equal to $2.00 per share, subject to adjustment as set forth in the agreement. The investor may elect to have the Company redeem the senior convertible note upon the occurrence of certain events, including the Company’s completion of a $10,000 underwritten offering of the Company’s common stock. Refer to Note 8, Derivative Instruments, for further detail on the derivative features associated with the August 6, 2015 convertible note.

 

  19  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On November 12, 2015, the Company entered into a securities purchase agreement with the investor whereby the Company issued a senior convertible note, for cash proceeds of $500, in the original principal amount of $525. The note has a term of one year, bears interest at the rate of 12% per annum and, at the election of the investor, the note is convertible into shares of the Company’s common stock at a conversion price equal to $1.75 per share, subject to adjustment as set forth in the note. The note began amortizing in twelve bi-weekly installments beginning on May 12, 2016. Amortization payments may be made, at the Company’s option, either in (i) cash, in which case the Company would also have to issue to the investor a number of shares of the Company’s common stock equal to 5% of such amortization payment or (ii) subject to the Company satisfying certain equity conditions, shares of the Company’s common stock, pursuant to the amortization conversion rate, which is equal to the lower of (x) $1.75 and (y) a 25% discount to lowest volume weighted average price of the Company’s common stock in the prior three trading days.

 

On November 12, 2015, the Company entered into an exchange agreement with the investor whereby the Company exchanged a portion of the senior secured note originally issued by the Company to GPB Life Science Holdings, LLC on December 3, 2014 and subsequently assigned to the investor, for new senior convertible notes, in three tranches of $500 for a total principal amount of $1,500. The notes bore interest at the rate of 12% per annum, were convertible into shares of the Company’s common stock at a conversion price equal to $1.25 per share, subject to adjustment as set forth in the notes, and were redeemable on a bi-weekly basis in an amount equal to one-sixth of the face amount of the senior convertible notes and guaranteed interest. The redemptions were made, at the Company’s option, either in (i) cash, in which case the Company would also have to issue to the investor a number of shares of the Company’s common stock equal to 5% of such redemption payment or (ii) subject to the Company satisfying certain equity conditions, shares of the Company’s common stock, pursuant to the redemption conversion rate, which was equal to the lower of (x) $1.25 and (y) a 25% discount to lowest volume weighted average price of the Company’s common stock in the prior three trading days.

 

The Company issued the three tranches of new senior convertible notes on the following dates:

 

  $500 issued on November 13, 2015 which matured on January 28, 2016 (“Tranche 1”),
     
  $500 issued on November 27, 2015 which matured on February 19, 2016 (“Tranche 2”) and
     
  $500 issued on December 11, 2015 which matured on March 4, 2016 (“Tranche 3”).

 

The investor who held the promissory note tranches issued on November 13, 2015, November 27, 2015, and December 11, 2015 converted the debt into shares of the Company’s common stock. Below is a summary of the transactions:

 

Tranche 1:

 

  During November 2015, the investor converted $83 principal amount of debt into 66,667 shares of the Company’s common stock.
     
  During December 2015, the investor converted $167 principal amount of debt into 133,334 shares of the Company’s common stock.
     
  During January 2016, the investor converted $167 principal amount of debt into 133,334 shares of the Company’s common stock.
     
  On February 3, 2016, the investor converted the remaining $83 principal amount of debt into 66,667 shares of the Company’s common stock. Tranche 1 of the promissory note debt was fully amortized as of this date.

 

Tranche 2:

 

  During December 2015, the investor converted $166 principal amount of debt into 133,334 shares of the Company’s common stock.
     
  During January 2016, the investor converted $167 principal amount of debt into 133,334 shares of the Company’s common stock.
     
  During February 2016, the investor converted $167 principal amount of debt into 133,334 shares of the Company’s common stock. Tranche 2 of the promissory note debt was fully amortized as of February 22, 2016.

 

  20  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Tranche 3:

 

  During January 2016, the investor converted $250 principal amount of debt into 200,001 shares of the Company’s common stock.
     
  During February 2016, the investor converted $167 principal amount of debt into 133,334 shares of the Company’s common stock.

 

  On March 2, 2016, the investor converted the remaining $83 principal amount into 66,667 shares of the Company’s common stock.

  

During March 2016, the Company paid $151 in cash related to the principal amount of notes outstanding related to the May 2015 term promissory notes.

 

During the six months ended June 30, 2016, the investor who holds the May 2015 term promissory notes converted $606 of principal amount outstanding into shares of the Company’s common stock. Refer to Note 10, Stockholders’ Deficit, for further information.

 

During April 2016, the Company paid $117 in cash related to the principal amount of notes outstanding related to the August 2015 term promissory notes.

 

During the six months ended June 30, 2016, the investor who holds the August 2015 term promissory notes converted $234 of principal amount outstanding into shares of the Company’s common stock. Refer to Note 10, Stockholders’ Deficit, for further information.

 

Principal of $2,279 and $4,471 on the notes remained outstanding as of June 30, 2016 and December 31, 2015, respectively. 

 

Bridge Financing - GPB Life Science Holdings, LLC

 

The Company entered into a bridge financing agreement, effective as of December 3, 2014, with GPB Life Science Holdings, LLC, whereby the Company issued to the investor for gross proceeds of $2,375 (i) a senior secured note, dated December 3, 2014, in the principal amount of $2,500 with interest accruing at the rate of 12% per annum and (ii) a four-year warrant, dated December 3, 2014, exercisable for up to 250,000 shares of the Company’s common stock at an exercise price of $5.00 per share, subject to adjustment as set forth therein. The note matured upon the earlier of: June 1, 2015 or (y) the date of a Major Transaction (as defined in the purchase agreement). In addition, upon maturity of the note, the Company was required to pay the investor additional interest in cash, which interest was to accrue over the term of the note at the rate of 4% per annum. The note was secured by (i) a first priority security interest in and to all Accounts Receivable (as defined in the purchase agreement) of the Company and its subsidiaries, except those of VaultLogix, and (ii) a first priority security interest and lien on all Collateral (as defined in the purchase agreement) of the Company and its subsidiaries, which lien and security interest was to go into effect at such time as White Oak Global Advisors, LLC (“White Oak”) released (or was deemed to have released pursuant to the applicable documents between it and the Company), its liens and security interest on any collateral of the Company and the Company’s obligation to grant, pledge or otherwise assign a lien in favor of White Oak was terminated (pursuant to the applicable documents between White Oak and the Company). Refer to Note 8, Derivative Instruments, for further detail on the warrant to purchase 250,000 shares of common stock.

 

On December 31, 2014, pursuant to the bridge financing agreement, the Company issued to the investor an additional note in the principal amount of $1,500 for a purchase price of $1,425 with interest accruing at the rate of 12% per annum. The Company used the proceeds of this additional financing to repay the convertible note payable to 31 Group, LLC. Pursuant to the second agreement, the Company issued a warrant entitling the lender to purchase 150,000 shares of common stock. The warrant is exercisable at a fixed price of $5.00 and expired 180 days from the original issue date. Refer to Note 8, Derivative Instruments, for further detail on the warrant to purchase 150,000 shares of common stock.

 

On May 15, 2015, the Company and GPB Life Science Holdings, LLC entered into a securities purchase agreement and Amendment No. 1 to the bridge financing agreement whereby the Company (i) issued and sold to the investor a senior secured convertible note in the principal amount of $2,000, having substantially the same terms and conditions as the outstanding notes, (ii) issued to the investor a four-year warrant, exercisable for up to 200,000 shares of the Company’s common stock, with an exercise price of $3.75, subject to adjustment as set forth therein, (iii) issued to the investor a four-year warrant, exercisable for up to 50,000 shares of the common stock, with an exercise price of $3.93, subject to adjustment as set forth therein, (iv) amended the exercise price of the outstanding warrants held by the investor to $3.75, subject to adjustment as set forth in such warrants, (v) extended the maturity date of the outstanding notes held by such investor, such that the maturity date of all three notes, subject to certain exceptions as provided in the Agreement, was May 15, 2016, (vi) amended the outstanding notes held by such investor to make them convertible into shares of the Company’s common stock at an exercise price of $3.75 per share, and (vii) added the same amortization provision to the outstanding notes held by such investor as is in the new note requiring the Company to make three amortization payments to the investor of $1,125 each on each of September 1, 2015, December 1, 2015 and March 1, 2016, so that each of the three notes receives its pro-rata portion of each $1,250 amortization payment. In addition, the Company and the investor have agreed that all or any portion of the $6,000 aggregate principal amount of the Notes may, by mutual agreement of the Company and the investor, be paid by the Company at any time and from time to time by the issuance to the investor of no more than 1,600,000 shares of the Company’s common stock.

 

  21  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

In conjunction with Amendment No. 1 to the bridge financing agreement, the Company incurred legal and placement fees of $209 and recorded this amount as a debt discount that will be amortized to interest expense on the unaudited condensed consolidated statement of operations.

 

The Company accounted for Amendment No. 1 to the bridge financing agreement in accordance with ASC 470-50, Debt – Modifications and Extinguishments (“ASC Topic 470-50”). In accordance with ASC Topic 470-50, the Company extinguished the December 3, 2014 and December 31, 2014 bridge financing senior secured convertible notes in the amounts of $2,500 and $1,500, respectively, and recorded a new bridge financing senior secured convertible note in the amount of $6,020 on the balance sheet as of May 15, 2015. The fair value of the Amendment No. 1 senior secured convertible note was $6,020, which was an amount in excess of the face value of the $6,000 senior secured convertible note and as such, the Company recorded the fair value of the lender’s conversion feature of the note of $827 to additional paid-in capital on the balance sheet and a related loss on debt extinguishment of $847 on the consolidated statement of operations. In addition, the Company used a Monte-Carlo simulation to fair-value the lender’s default premium option and recorded a derivative liability of $22 to debt discount on the consolidated balance sheet as of May 15, 2015.

 

On August 12, 2015, the Company and GPB Life Science Holdings, LLC entered into Amendment No. 2 to the original bridge financing agreement, dated December 3, 2014, whereby the Company and GPB Life Science Holdings, LLC agreed to (i) reduce the conversion price of the notes from $3.75 to $2.00 per common share, (ii) amend and restate the prior warrants and additional warrants to reduce the exercise price from $3.75 to $2.00 per warrant share, (iii) increase the number of amortization payment dates and reduce the amortization payments to $563, and (iv) permit the Company to make the amortization payments in shares of the Company common stock converted from any of the prior notes or the new notes. The conversion price for the shares of the Company’s common stock used to make an amortization payment shall be the lesser of (i) $2.00 and (ii) 75% of the average of the volume weighted average price for the five consecutive trading days ending on, and including, the trading day immediately preceding the date of the amortization payment. Refer to Note 8, Derivative Instruments, for further detail on the reduction of the conversion price, amendment and restatement of the warrants.

 

The Company accounted for Amendment No. 2 in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company modified the May 15, 2015 Amendment No. 1 bridge financing senior secured convertible note in the amount $6,020. In conjunction with this transaction, the Company modified the terms of the equity warrants to reduce the conversion price from $3.75 to $2.00 per share of the Company’s common stock. Refer to Note 8, Derivative Instruments, for further detail on the reduction of the conversion price of the warrants.

 

On November 12, 2015, the Company entered into an exchange agreement with the investor (as noted above in the Promissory Notes section of this footnote) whereby the Company exchanged a portion of the senior secured note originally issued by the Company to GPB Life Science Holdings, LLC on December 3, 2014 and subsequently assigned to the investor, for new senior convertible notes, in three tranches of $500 for a total principal amount of $1,500.

 

GPB Life Science Holdings, LLC exchanged the following senior secured notes to the investor in the following three tranches:

 

  $500 exchanged on November 13, 2015 which matured on January 28, 2016 (Tranche 1),
     
  $500 exchanged on November 27, 2015 which matured on February 19, 2016 (Tranche 2), and
     
  $500 exchanged on December 11, 2015 which matured on March 4, 2016 (Tranche 3).

 

  22  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The Company accounted for the exchange in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company extinguished each tranche exchanged and recorded a new note to the investor. For Tranche 1, the Company fair valued the investors’ conversion features and removed the existing debt discount on Tranche 1 and recorded a loss on extinguishment of $8 on the consolidated statement of operations as of November 13, 2015. For Tranche 2, the Company fair valued the investors’ conversion features and removed the existing debt discount on Tranche 2 and recorded a loss on debt extinguishment of $92 on the consolidated statement of operations as of November 27, 2015. For Tranche 3, the Company fair valued the investors’ conversion features and removed the existing debt discount on Tranche 3.

 

On December 29, 2015, the Company entered into a conversion agreement with GPB Life Science Holdings, LLC pursuant to which, among other things, (i) the Company used $2,300 of the proceeds of the JGB (Cayman) Waltham Ltd. senior secured convertible debentures (as described later within this footnote) to reduce the total amount owed by the Company to GPB Life Science Holdings, LLC to $1,500, (ii) the Company agreed that, if the closing price per share of the Company’s common stock 90 days after December 29, 2015 was less than the remaining balance conversion price, as adjusted, then the Company would issue to GPB Life Science Holdings, LLC additional unregistered shares of the Company’s common stock in an aggregate amount equal to the amount set forth in the conversion agreement, (iii) GPB Life Science Holdings, LLC and the Company agreed to convert the remaining balance of $1,500 into shares of the Company’s common stock at a conversion price per share equal to 75% multiplied by the lower of (x) the average volume weighted average price per share of the Company’s common stock for the five prior trading days and (y) the one day volume weighted price for a share of the Company’s common stock on December 29, 2015, (iv) GPB Life Science Holdings, LLC agreed to reduce the exercise price of those certain outstanding warrants originally issued by the Company on May 14, 2015 to $1.75, and (v) GPB Life Science Holdings, LLC released all of its remaining security interest in the assets of the Company. On January 22, 2016, the Company issued 500,000 shares of common stock in full settlement of this provision and GPB Life Science Holdings, LLC released its remaining security interest in the assets of the Company (refer to Note 10, Stockholders’ Deficit, for additional detail).

 

The Company accounted for the payment of $2,300 principal amount outstanding (as noted in item (i) above) to GPB Life Science Holdings, LLC in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company extinguished $2,300 of the note payable to GPB Life Science Holdings, LLC, removed the existing derivative liability related to the maturity date feature of $31, reduced the beneficial conversion feature of $139 which was recorded in additional paid in capital, reduced accrued interest on the notes of $199, paid $25 in legal fees, and paid interest of $419. In addition, the Company amended the warrants attached to the GPB Life Science Holdings, LLC convertible debentures (refer to Note 8, Derivative Instruments, for additional detail).

 

On December 29, 2015, GPB Life Science Holdings, LLC converted $1,500 of principal amount outstanding into 1,918,649 shares of the Company’s common stock.

 

Richard Smithline Senior Convertible Note

 

On August 6, 2015, the Company issued to Richard Smithline a senior convertible note in the principal amount of $526, with interest accruing at the rate of 12% per annum, which matures on January 11, 2017. The note is convertible into shares of the Company’s common stock at a conversion price equal to $2.00 per share, subject to adjustment as set forth in the agreement. Refer to Note 8, Derivative Instruments, for further detail on the derivative features associated with the Richard Smithline Senior Convertible Note.

 

During the six months ended June 30, 2016, Richard Smithline converted $218 of principal amount of senior convertible notes outstanding into shares of the Company’s common stock. Refer to Note 10, Stockholders’ Deficit, for further information.

 

Principal of $307 and $526 remained outstanding as of June 30, 2016 and December 31, 2015, respectively.

 

  23  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

JGB (Cayman) Waltham Ltd. Senior Secured Convertible Debenture

 

On December 29, 2015, the Company entered into a securities purchase agreement with JGB (Cayman) Waltham Ltd. (“JGB Waltham”) whereby the Company issued to JGB Waltham, for gross proceeds of $7,500, a $500 original issue discount senior secured convertible debenture in the principal amount of $7,500. The debenture had a maturity date of June 30, 2017, bore interest at 10% per annum, and was convertible into shares of the Company’s common stock at a conversion price equal to $1.33 per share, subject to adjustment as set forth in the debenture. The Company was to pay interest to JGB Waltham on the aggregate unconverted and then outstanding principal amount of the debenture in arrears each calendar month and on the maturity date in cash, or, at the Company’s option and subject to the Company satisfying certain equity conditions, in shares of the Company’s common stock. In addition, December 29, 2016 was an interest payment date on which the Company was to pay to JGB Waltham a fixed amount, as additional interest under the debenture an amount equal to $350 in cash, shares of the Company’s common stock or a combination thereof. Commencing on February 29, 2016, JGB Waltham had the right, at its option, to require the Company to redeem up to $350 of the outstanding principal amount of the debenture per calendar month, which redemption could have been made in cash or, at the Company’s option and subject to satisfying certain equity conditions, in shares of the Company’s common stock. The debenture was guaranteed to by the Company and certain of its subsidiaries and was secured by all assets of the Company. The total cash received by the Company as a result of this agreement was $3,730.

 

The Company used a portion of the proceeds from the debenture to pay $2,300 remaining under the senior secured notes the Company originally issued to GPB Life Science Holdings, LLC. Refer to the Bridge Financing – GPB Life Science Holdings, LLC section of this note for further detail.

 

On May 17, 2016, the Company entered into a Forbearance and Amendment Agreement (the “Debenture Forbearance Agreement”) with JGB Waltham pursuant to which JGB Waltham agreed to forbear action with respect to certain existing defaults in accordance with the terms of the Debenture Forbearance Agreement. The defaults, which were not monetary in nature, related to the Company’s inability to timely file its Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

 

In connection with the execution of the Debenture Forbearance Agreement, the Company issued to JGB Waltham an amended and restated senior secured convertible debenture (the “Amended and Restated Debenture”) which amended the original 10% senior secured convertible debenture issued to JGB Waltham on December 29, 2015 by: (i) reducing the conversion price at which the Amended and Restated Debenture converts into shares of the Company’s common stock; and (ii) eliminating the provisions that provided for (A) the issuance of common stock at a discount to the market price of the common stock and (B) certain anti-dilution protections.

 

The Amended and Restated Debenture was issued in the principal amount of $7,500, has a maturity date of May 31, 2019, bears interest at 0.67% per annum, and is convertible into shares of the Company’s common stock at a fixed conversion price equal to $0.80 per share, subject to equitable adjustments as set forth in the Amended and Restated Debenture. The Company shall pay interest to JGB Waltham on the aggregate unconverted and then outstanding principal amount of the Amended and Restated Debenture, payable monthly in arrears as of the last trading day of each calendar month and on May 31, 2019, in cash. In addition, the Company shall pay JGB Waltham an additional amount equal to 7.5% of the outstanding principal amount on the Amended and Restated Debenture on each of May 31, 2017, May 31, 2018 and May 31, 2019, subject to certain exceptions set forth in the Amended and Restated Debenture. JGB Waltham has the right, at its option, to require the Company to redeem up to $169 of the outstanding principal amount of the Amended and Restated Debenture plus the then-accrued and unpaid interest thereon each calendar month, in cash. The Amended and Restated Debenture contains standard events of default.

 

In connection with the execution of the Debenture Forbearance Agreement, the Company issued to JGB Waltham a senior secured note (the “2.7 Note”), dated May 17, 2016, in the principal amount of $2,745 that matures on May 31, 2019, bears interest at 0.67% per annum and contains standard events of default.

 

The Company accounted for the Debenture Forbearance Agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company extinguished the December 29, 2015 senior secured convertible debenture in the then-current principal amount of $6,100 and recorded a new senior secured convertible debenture at its new fair value of $3,529 on the balance sheet as of May 17, 2016. As a result of the extinguishment, the Company recorded a loss on extinguishment of debt of $1,457 on the consolidated statement of operations as of May 17, 2016. In addition, the Company re-valued the derivative features associated with the December 29, 2015 senior secured convertible debenture. Refer to Note 8, Derivative Instruments, for additional information on this transaction.

 

  24  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On May 23, 2016, the Company entered into an amended agreement with JGB Concord, JGB Waltham, White Oak Global Advisors, LLC, VaultLogix, and the Guarantors thereto (the “Amended Agreement”) pursuant to which (i) JGB Concord permitted the Company to withdraw $172 from the Blocked Account (as defined in the original debenture), and (ii) JGB Concord permitted the Company to withdraw $328 from the Deposit Account (as defined in the original note) and, in exchange for the foregoing, (i) VaultLogix guaranteed the obligations of, and provide security for, the Amended and Restated Debenture and the 2.7 Note, (ii) the Company’s subsidiaries guaranteed all indebtedness due to JGB Concord under the Amended and Restated Note and 5.2 Note, and (iii) the Company and its subsidiaries pledged their assets as security for all obligations owed to JGB Concord under the Amended and Restated Note and the 5.2 Note in accordance with the terms of an Additional Debtor Joinder, dated May 23, 2016, pursuant to which the Company and each additional party thereto agreed to be bound by the terms of that certain Security Agreement, dated as of February 18, 2016, made by VaultLogix in favor of the secured party thereto (the “February Security Agreement”). In addition, the interest rates on the Amended and Restated Note and the 5.2 Note were amended from 0.67% to 1.67%.

 

The Company accounted for this Amended Agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company accounted for the Amended Agreement as a debt modification and adjusted the fair value of the associated derivative liabilities to its fair value as of May 23, 2016. Refer to Note 8, Derivative Instruments, for additional information on this transaction.

 

On June 23, 2016, the Company entered into an amendment agreement with JGB Concord and JGB Waltham pursuant to which, (i) JGB Waltham, and JGB Concord released to the Company an aggregate of $1,500 from the Deposit Account (as defined in the original note). Upon the release of the funds (i) the JGB Waltham senior secured convertible debenture (the “December Debenture”) was amended to increase the Applicable Interest Rate (as defined in the original note) by 3.0% to take effect on July 1, 2016; (ii) the December Debenture was amended to increase the annual rate of interest by 3.0% to take effect on July 1, 2016; (iii) the JGB Concord senior secured convertible note (the “February Convertible Note”) was amended to increase the Applicable Interest Rate (as defined in the original February Convertible Note) by 3.0%, to take effect on July 1, 2016; and (iv) the February Note was amended to increase the annual rate of interest by 3.0%, to take effect on July 1, 2016. After giving effect to the foregoing annual rate of interest on each December Debenture and February Convertible Note as of July 1, 2016, was 4.67%. As additional consideration for the release of the funds, the Company issued 900,000 shares of the Company’s common stock on June 23, 2016 to JGB Concord.

 

The Company accounted for the June 23, 2016 amendment agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company extinguished the May 17, 2016 Debenture Forbearance Agreement in the principal amount of $6,100 and recorded a new senior secured convertible debenture at its new fair value of $4,094 on the balance sheet as of June 23, 2016. As a result of the extinguishment, the Company recorded a loss on extinguishment of debt of $483 on the consolidated statement of operations as of June 23, 2016. In addition, the Company re-valued the derivative features associated with the May 17, 2016 Debenture Forbearance Agreement. Refer to Note 8, Derivative Instruments, for additional information on this transaction.

 

Principal of $6,100 and $7,500 related to the June 23, 2016 amended Debenture Forbearance Agreement remained outstanding as of June 30, 2016 and December 31, 2015, respectively. Principal of $2,745 related to the 2.7 Note remained outstanding as of June 30, 2016.

 

JGB (Cayman) Concord Ltd. Senior Secured Convertible Note

 

On February 17, 2016, the Company entered into a securities exchange agreement by and among the Company, VaultLogix, and JGB (Cayman) Concord Ltd. (“JGB Concord”), whereby the Company exchanged the White Oak Global Advisors, LLC promissory note and subsequently assigned to JGB Concord a new 8.25% senior secured convertible note dated February 18, 2016 in the principal amount of $11,601. As a result of the assignment, the obligations of the Company and VaultLogix to White Oak Global Advisors, LLC were satisfied.

 

The note issued to JGB Concord had a maturity date of February 18, 2019, bore interest at 8.25% per annum, and was convertible into shares of the Company’s common stock at a conversion price equal to the lowest of: (a) $2.00 per share, (b) 80% of the average of the volume weighted average prices for each of the five consecutive trading days immediately prior to the applicable conversion date, and (c) 85% of the volume weighted average price for the trading day immediately preceding the applicable conversion date, subject to adjustment as set forth in the note. Interest on the senior secured convertible note was due in arrears each calendar month in cash, or, at the Company’s option and subject to stockholder approval, in shares of the Company’s common stock. Commencing on the stockholder approval date, JGB Concord had the right, at its option, to convert the senior secured convertible note, in whole or in part, into shares of the Company’s common stock, subject to certain beneficial ownership limitations. The senior secured convertible note was secured by all assets of VaultLogix as well as a cash collateral blocked deposit account.

 

  25  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On May 17, 2016, the Company entered into a forbearance and amendment agreement (the “Note Forbearance Agreement”) with VaultLogix and JGB Concord, pursuant to which JGB Concord agreed to forbear action with respect to certain existing default in accordance with the terms of the Note Forbearance Agreement. The defaults, which were not monetary in nature, related to the Company’s inability to timely file its annual report on form 10-K for the fiscal year ended December 31, 2015.

 

In connection with the execution of the Note Forbearance Agreement, the Company executed and issued to JGB Concord an amended and restated senior secured convertible note (the “Amended and Restated Note”) in order to amend the original note to JGB Concord by: (i) reducing the conversion price at which the Amended and Restated Note converts into shares of the Company’s common; and (ii) eliminating provisions that provided for (A) the issuance of common stock at a discount to the market price of the common stock and (B) certain anti-dilution protections.

 

The Amended and Restated Note was issued in the aggregate principal amount of $11,601, has a maturity date of May 31, 2019, bears interest at 0.67% per annum, and is convertible into shares of the Company’s common stock at a fixed conversion price of $0.80 per share, subject to equitable adjustments as set forth in the Amended and Restated Note. The Company and VaultLogix shall pay interest to JGB Concord on the aggregate unconverted and then outstanding principal amount of the Amended and Restated Note, payable monthly in arrears as of the last trading day of each calendar month and on May 31, 2019, in cash. In addition, the Company shall pay to JGB Concord an additional amount equal to 7.5% of the outstanding principal amount on the Amended and Restated Note on each of May 31, 2017, May 31, 2018, and May 31, 2019, subject to certain exceptions set forth in the Amended and Restated Note. JGB Concord has the right, at its option, to require the Company to redeem up to $322 of the outstanding principal amount of the Amended and Restated Note plus the then accrued and unpaid interest thereon each calendar month in cash. The Amended and Restated Note contains standard events of default.

 

The Company accounted for the Note Forbearance Agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company extinguished the February 17, 2016 senior secured convertible note in the principal amount of $11,601 and recorded a new senior secured convertible debenture at its new fair value of $6,711 on the balance sheet as of May 17, 2016. As a result of the extinguishment, the Company recorded a loss on extinguishment of debt of $2,772 on the consolidated statement of operations as of May 17, 2016. In addition, the Company re-valued the derivative features associated with the February 17, 2016 senior secured convertible note. Refer to Note 8, Derivative Instruments, for additional information on this transaction.

 

In connection with the execution of the Note Forbearance Agreement, the Company executed and issued to JGB Concord a senior secured note (the “5.2 Note”), dated May 17, 2016, in the principal amount of $5,220 that matures on May 31, 2019, bears interest at 0.67% per annum, and contains standard events of default.

 

On May 23, 2016, the Company entered into an amended agreement with JGB Concord, JGB Waltham, White Oak Global Advisors, LLC, VaultLogix, and the Guarantors thereto (the “Amended Agreement”) pursuant to which (i) JGB Concord permitted the Company to withdraw $172 from the Blocked Account (as defined in the original debenture), and (ii) JGB Concord permitted the Company to withdraw $328 from the Deposit Account (as defined in the original note) and, in exchange for the foregoing, (i) VaultLogix guaranteed the obligations of, and provide security for, the Amended and Restated Debenture and the 2.7 Note, (ii) the Company’s subsidiaries guaranteed all indebtedness due to JGB Concord under the Amended and Restated Note and 5.2 Note, and (iii) the Company and its subsidiaries pledged their assets as security for all obligations owed to JGB Concord under the Amended and Restated Note and the 5.2 Note in accordance with the terms of an Additional Debtor Joinder, dated May 23, 2016, pursuant to which the Company and each additional party thereto agreed to be bound by the terms of that certain Security Agreement, dated as of February 18, 2016, made by VaultLogix in favor of the secured party thereto (the “February Security Agreement”). In addition, the interest rates on the Amended and Restated Note and the 5.2 Note were amended from 0.67% to 1.67%.

 

  26  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The Company accounted for this Amended Agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company accounted for the Amended Agreement as a debt modification and adjusted the fair value of the associated derivative liabilities to its fair value as of May 23, 2016. Refer to Note 8, Derivative Instruments, for additional information on this transaction.

 

On June 23, 2016, the Company entered into an amendment agreement with JGB Concord and JGB Waltham pursuant to which, (i) JGB Waltham, and JGB Concord released to the Company an aggregate of $1,500 from the Deposit Account (as defined in the original note). Upon the release of the funds (i) the JGB Waltham senior secured convertible debenture (the “December Debenture”) was amended to increase the Applicable Interest Rate (as defined in the original note) by 3.0% to take effect on July 1, 2016; (ii) the December Debenture was amended to increase the annual rate of interest by 3.0% to take effect on July 1, 2016; (iii) the JGB Concord senior secured convertible note (the “February Convertible Note”) was amended to increase the Applicable Interest Rate (as defined in the original February Convertible Note) by 3.0%, to take effect on July 1, 2016; and (iv) the February Note was amended to increase the annual rate of interest by 3.0%, to take effect on July 1, 2016. After giving effect to the foregoing annual rate of interest on each December Debenture and February Convertible Note as of July 1, 2016, was 4.67%. As additional consideration for the release of the funds, the Company issued 900,000 shares of the Company’s common stock on June 23, 2016 to JGB Concord, and agreed to a make-whole provision whereby the Company will pay JGB Concord in cash the difference between $0.94 per share of the Company’s common stock and the average volume weighted average price of the Company’s common stock sixty days after the shares of the Company’s common stock are freely tradable. Refer to Note 8, Derivative Instruments, for further detail on the Company’s accounting for the JGB Concord make-whole provision.

 

The Company accounted for the June 23, 2016 amendment agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company extinguished the May 17, 2016 Debenture Forbearance Note in the principal amount of $11,601 and recorded a new senior secured convertible note at its new fair value of $7,786 on the balance sheet as of June 23, 2016. As a result of the extinguishment, the Company recorded a loss on extinguishment of debt of $1,150 on the consolidated statement of operations as of June 23, 2016. In addition, the Company re-valued the derivative features associated with the May 17, 2016 Debenture Forbearance Note. Refer to Note 8, Derivative Instruments, for additional information on this transaction.

 

Principal of $11,601 related to the June 23, 2016 amended Note Forbearance Agreement remained outstanding as of June 30, 2016. Principal of $5,220 related to the 5.2 Note remained outstanding as of June 30, 2016.

 

  27  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

8. DERIVATIVE INSTRUMENTS

 

The Company evaluates and accounts for conversion options embedded in its convertible debt and freestanding instruments in accordance with ASC 815, Accounting for Derivative Instruments and Hedging Activities (“ASC Topic 815”).

 

MidMarket Warrants

 

The Company issued warrants to the lenders under the MidMarket Loan Agreement in 2012. These warrants were outstanding as of June 30, 2016 and December 31, 2015.

 

The terms of the warrants issued in September 2012 originally provided, among other things, that the number of shares of common stock issuable upon exercise of such warrants amounted to 11.5% of the Company’s fully-diluted outstanding common stock and common stock equivalents, whether the common stock equivalents were fully vested and exercisable or not, and that the initial exercise price of such warrants was $5.00 per share of common stock, subject to adjustment. Pursuant to an amendment to the loan agreement, on March 22, 2013, the number of shares for which the warrants are exercisable was fixed at 234,233 shares. On September 17, 2012, when the warrants were issued, the Company recorded a derivative liability in the amount of $194. The amount was recorded as a debt discount and is being amortized over the original life of the related loans. The amount of the derivative liability was computed by using the Black-Scholes pricing model, which is not materially different from a binomial lattice valuation methodology, to determine the value of the warrants issued.

 

On September 17, 2015, the third anniversary date of the warrants, the Company failed to comply with the Minimum Adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) provisions set forth within the original warrant agreement. As such, the expiration date of the warrants was extended to September 17, 2017.

 

On June 30, 2016 and December 31, 2015, the Company used a binomial lattice pricing model to determine the fair value of the derivative liability of the warrants on that date, and determined the fair value was $11 and $21, respectively. The Company recorded the change in the fair value of the derivative liability for the three months ended June 30, 2016 and 2015 as a gain of $23 and loss of $31, respectively, and a gain of $10 and $76 for the six months ended June 30, 2016 and 2015, respectively.

  

The fair value of the warrant derivative liability as of June 30, 2016 and December 31, 2015 was calculated using a binomial lattice pricing model with the following factors, assumptions and methodologies:

 

    June 30,     December 31,  
    2016     2015  
             
Fair value of Company’s common stock   $ 0.70     $ 1.00  
Volatility (for June 30, 2016, based on the Company's historical volatility; for December 31, 2015, based on the closing prices of 3-4 comparable public companies)     105 %     80 %
Exercise price   $ 4.00 - $5.00     $ 4.00 - $5.00  
Estimated life     1.2 years       1.7 years  
Risk free interest rate (based on 1-year treasury rate)     0.515 %     0.86 %

 

As of March 12, 2014, the lenders under the loan agreement assigned their loans to 31 Group, LLC and Dominion Capital LLC and such assignees agreed to convert the outstanding principal amount of the loans into shares of the Company’s common stock at a conversion price of $10.50 per share. In connection with that agreement, the Company agreed that if 85% of the volume weighted average price of the Company’s common stock on April 14, 2014 was less than $10.50, the Company would issue an additional number of shares of the Company’s common stock such that the average conversion price of the loans was such lower price.

 

On April 15, 2014, the Company entered into an amendment to that agreement, due to the decline in the trading price of the Company’s common stock, pursuant to which the Company amended the provision requiring it to issue additional shares of common stock by issuing (i) 363,853 shares of common stock and warrants to purchase 100,000 shares of common stock to Dominion Capital LLC, and (ii) 401,996 shares of common stock and warrants to purchase 125,000 shares of common stock to 31 Group, LLC. The warrants are exercisable at a price of $7.25 per share for a three-year period, provided that if the shares of common stock underlying the warrants are registered under the Securities Act, the exercise period of the warrants will be reduced to two years. On April 15, 2014, the day the warrants were issued, the Company recorded a derivative liability in the amount of $416. The amount was recorded as a loss on extinguishment of debt on the unaudited condensed consolidated statement of operations. The amount of the derivative liability was computed by using the Black-Scholes pricing model, which is not materially different from a binomial lattice valuation methodology, to determine the value of the warrants issued.

 

  28  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On April 7, 2015, the Company entered into an Exchange Agreement (“31 Exchange Agreement”) with 31 Group, LLC, whereby the Company exchanged the April 15, 2014 warrants for a new warrant. Please refer to the 31 Group, LLC April 2015 Warrants section of this footnote for further detail on the new warrant.

 

On June 30, 2016 and December 31, 2015, the Company used a binomial lattice pricing model to determine the fair value of the derivative liability relating to the April 15, 2014 warrants on that date, and determined the fair value was nominal and as such, no amount was recorded with the Company’s unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2016.

 

The fair value of the April 15, 2014 warrants derivative at December 31, 2015 was calculated using a binomial lattice pricing model with the following factors, assumptions and methodologies:

 

    December 31,  
    2015  
       
Fair value of Company’s common stock   $ 1.00  
Volatility (for March 31, 2016, based on the Company's historical volatility; for December 31, 2015, based on the closing prices of 3-4 comparable public companies)     80 %
Exercise price   $ 7.25  
Estimated life     3.5 months   
Risk free interest rate (based on 1-year treasury rate)     0.33 %

 

12% Convertible Debentures Convertible Feature

 

The Company recorded a debt discount in the amount of $382 in connection with the 36,567 shares of the Company’s common stock issued to the original purchasers of the Convertible Debentures, which amount was amortized over the life of the Convertible Debentures. The Company also recorded a debt discount in the amount of $6,620, which amount was amortized over the life of the Convertible Debentures. The Company used a Monte Carlo simulation on the date of issuance to determine the fair value of the embedded conversion feature. The Company recorded interest expense of $210 related to the amortization of the debt discount for the three months ended March 31, 2015.

 

During the quarter ended March 30, 2015, the Company used a Monte Carlo simulation to determine the fair value of the embedded conversion feature of the Convertible Debentures and determined the fair value of the embedded conversion feature to be de minimis. The Company recorded the change in fair value of the derivative liability as a gain in the unaudited condensed consolidated statement of operations of $180 for the three months ended March 31, 2015.

 

During June 2015, the Company issued shares of common stock for the required amortization payments of the Convertible Debentures. The final amortization payment was made in shares of common stock in June 2015 which repaid the final amount due under the Convertible Debentures.

 

Forward Investments, LLC Convertible Feature

 

On February 4, 2014 and March 28, 2014, Forward Investments, LLC made convertible loans to the Company for working capital purposes in the amounts of $1,800 and $1,200, respectively. Such loans are evidenced by convertible promissory notes that bear interest at the rate of 2% and 10% per annum, were to mature on June 30, 2015 and are convertible into shares of the Company’s common stock at an initial conversion price of $6.36 per share.

 

The fair value of the embedded conversion feature at the date of issuance was $8,860. The Company recorded a debt discount of $6,475 and a loss on debt discount of $2,385. The debt discount is being amortized over the life of the loans. The Company used a Monte Carlo simulation on the date of issuance to determine the fair value of the embedded conversion feature.

 

On October 22, 2014, the two convertible loan agreements were modified to reduce the initial conversion price of $6.36 to $3.93. As a result, the Company used a Monte Carlo simulation to determine the fair value on the date of modification. The fair value of the conversion feature of the Forward Investments, LLC loan on the date of modification was $910. The Company recorded the change in the fair value of the derivative liability as a loss on fair value of derivative instruments of $310.

 

On March 4, 2015, the Company and Forward Investments, LLC restructured certain promissory notes in order to extend the maturity dates thereof, reduce the seniority and reduce the interest rate accruing thereon (refer to Note 12, Related Parties, for further detail). The Company accounted for this restructuring of the promissory notes as a debt modification under ASC Topic 470-50. As part of the modification, the Company analyzed the embedded conversion feature and recorded a loss on fair value of derivative instruments of $2,600 on the unaudited condensed consolidated statement of operations.

 

  29  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

In conjunction with the issuance of the 6.5% and 3% convertible notes issued on March 4, 2015, the Company recorded an additional derivative liability as a debt discount in the amount of $260 and $1,970, respectively, on the date of the issuance of the notes.

 

The debt discounts are being amortized over the life of the loans. The Company used a Monte Carlo simulation on the date of issuance to determine the fair value of the embedded conversion features.

 

On August 3, 2015, the Company and Forward Investments, LLC agreed to reset the conversion price of the convertible notes to $1.58 per share of the Company’s common stock. As a result, the Company used a Monte Carlo simulation to determine the fair value of the conversion features on the date of the agreement. On the date of the transaction, the fair value of the Forward Investments convertible notes conversion feature did not change and as such, no change in fair value of derivative instruments was recorded on the unaudited condensed consolidated statement of operations.

  

On October 26, 2015, the ratchet-down feature within the original agreement was triggered and the conversion price of the convertible notes was reset to $1.25 per share of the Company’s common stock. Prior to the triggering of the ratchet-down feature, the Company revalued the derivative and recorded a gain on fair value of derivative liabilities of $120 on the consolidated statement of operations. The Company then reduced the existing derivative liability related to the reset provision and recorded the change of $2,310 in the derivative liability value as a loss on change in fair value of derivative instruments on the consolidated statement of operations. On the date of the transaction, the fair value of the Forward Investments convertible notes conversion feature was $7,640, which was the value of the derivative liability as of October 26, 2015.

 

On December 29, 2015, the ratchet-down feature within the original agreement was triggered and the conversion price of the convertible notes was reset to $0.78 per share of the Company’s common stock. Prior to the triggering of the ratchet-down feature, the Company revalued the derivative and recorded a gain on fair value of derivative liabilities of $3,380 on the consolidated statement of operations. The Company then reduced the existing derivative liability related to the reset provision and recorded the change of $4,140 in the derivative liability value as a loss on change in fair value of derivative instruments on the consolidated statement of operations. On the date of the transaction, the fair value of the Forward Investments convertible notes conversion feature was $8,400, which was the value of the derivative liability as of December 29, 2015.

 

On June 30, 2016 and December 31, 2015 the fair value of the conversion feature of the Forward Investments, LLC loans was $7,386 and $13,534, respectively, which is included in derivative financial instruments on the unaudited condensed consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability for the three months ended June 30, 2016 and 2015 as a gain of $4,156 and a loss of $1,400, respectively, and a gain of $6,148 and a loss of $580 for the six months ended June 30, 2016 and 2015, respectively. 

 

The fair value of the Forward Investments, LLC derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    June 30,  
    2016  
                         
Principal amount   $ 3,650     $ 390     $ 2,825     $ 4,373  
Conversion trigger price per share   $ 0.78     $ 0.78     $ 0.78     $ 0.78  
Risk free rate     1.08 %     1.08 %     0.20 %     0.52 %
Life of conversion feature (in years)     5.5       5.5       -       1.5  
Volatility     100 %     100 %     100 %     100 %

 

    December 31,  
    2015  
                         
Principal amount   $ 3,650     $ 390     $ 2,825     $ 4,373  
Conversion trigger price per share   $ 0.78     $ 0.78     $ 0.78     $ 0.78  
Risk free rate     1.93 %     1.93 %     0.49 %     1.06 %
Life of conversion feature (in years)     6.0       6.0       0.5       2.0  
Volatility     105 %     105 %     105 %     105 %

 

August 6, 2015 Demand Promissory Note – Senior Convertible Note Embedded Features

 

On August 6, 2015, the Company entered into a senior convertible note agreement with the investor whereby the Company issued a promissory note in the original principal amount of $2,105, with interest accruing at the rate of 12% per annum, which matures on January 6, 2017. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815, Derivatives and Hedging and ASC 480, Distinguishing Liabilities from Equity . On August 6, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $524 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

  30  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On June 30, 2016 and December 31, 2015, the Company used a Monte Carlo simulation to value the settlement features of the senior convertible note and determined the fair value to be $0 and $339, respectively. The Company recorded a gain on fair value of derivative instruments of $78 and $339 on the unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2016 and 2015, respectively.

 

The fair value of the demand promissory note derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    June 30,     December 31,  
    2016     2015  
             
Principal amount   $ 1,754     $ 2,105  
Conversion price per share   $ 1.25     $ 1.25  
Conversion trigger price per share      None        None  
Risk free rate     0.38 %     0.69 %
Life of conversion feature (in years)     0.61       1.10  
Volatility     100 %     105 %

 

November 12, 2015 Demand Promissory Note – Senior Convertible Note Embedded Features

 

On November 12, 2015, the Company entered into a securities purchase agreement with an investor whereby the Company issued a senior convertible note, for cash proceeds of $500, in the original principal amount of $525. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815, Derivatives and Hedging and ASC 480, Distinguishing Liabilities from Equity . On November 12, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $149 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

On June 30, 2016 and December 31, 2015, the Company used a Monte Carlo simulation to value the settlement features of the senior convertible note and determined the fair value to be $43 and $155, respectively, and recorded a gain on fair value of derivative instruments of $52 and $112 on the unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2016, respectively.

 

The fair value of the demand promissory note derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    June 30,     December 31,  
    2016     2015  
             
Principal amount   $ 525     $ 525  
Conversion price per share   $ 1.75     $ 1.75  
Conversion trigger price per share      None        None  
Risk free rate     0.23 %     0.61 %
Life of conversion feature (in years)     0.37       0.87  
Volatility     100 %     105 %

 

November 12, 2015 Exchange Agreement Tranches – Senior Convertible Note Embedded Features

 

On November 12, 2015, the Company entered into an exchange agreement with an investor whereby the Company exchanged a portion of the senior secured note originally issued by the Company to GPB Life Science Holdings, LLC on December 3, 2014 and subsequently assigned to the investor, for new senior convertible notes issued in three tranches of $500 for a total principal amount of $1,500. The notes have a term of one year, bear interest at 12% per annum, and are convertible into shares of the Company’s common stock at a conversion price equal to $1.25 per share, subject to adjustment as set forth in the notes.

 

On November 13, 2015, the Company issued to the investor the first tranche of senior secured notes in the principal amount of $500. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815,  Derivatives and Hedging  and ASC 480,  Distinguishing Liabilities from Equity . On November 13, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $164 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

  31  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

On November 27, 2015, the Company issued to the investor the second tranche of senior secured notes in the principal amount of $500. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815,  Derivatives and Hedging  and ASC 480,  Distinguishing Liabilities from Equity . On November 27, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $205 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

On December 11, 2015, the Company issued to the investor the third tranche of senior secured notes in the principal amount of $500. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815,  Derivatives and Hedging  and ASC 480,  Distinguishing Liabilities from Equity . On December 11, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $109 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

On December 31, 2015, the Company used a Monte Carlo simulation to value the settlement features of the three tranches of senior convertible notes and determined the fair value to be $57 related to tranche one, $78 related to tranche two, and $118 related to tranche three. The Company recorded the change in the fair value of the derivative liability for the three months ended March 31, 2016 as a gain in the unaudited condensed consolidated statements of operations of $252 as the three tranches of senior convertible notes were converted into shares of the Company’s common stock during the three months ended March 31, 2016.

 

The fair value of the senor convertible note derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    December 31, 2015  
Principal amount   $ 250     $ 333     $ 500  
Conversion price per share   $ 1.25     $ 1.25     $ 1.25  
Conversion trigger price per share     None       None       None  
Risk free rate     0.14 %     0.14 %     0.15 %
Life of conversion feature (in years)     0.08       0.12       0.16  
Volatility     105 %     105 %     105 %

 

31 Group, LLC April 2015 Warrants

 

In April 2015, the Company exchanged two warrants previously issued to 31 Group, LLC on April 15, 2014 and July 1, 2014 for two new warrants, each of which is identical to the previous warrants issued, except that the exercise price of such new warrants is $5.00 per share, subject to adjustments noted within the 31 Exchange Agreement. Pursuant to the 31 Exchange Agreement, on July 1, 2015, the Company was obligated to pay 31 Group, LLC a cash make-whole amount equal to the greater of (a) zero (0) and (b) the difference of (i) $5,175 less (ii) the product of (x) the Exchange Share Amount (as defined in the 31 Exchange Agreement) and (y) the quotient of (A) the sum of each of the 30 lowest daily volume weighted average prices of the Company’s common stock during the period commencing on, and including, April 8, 2015 and ending on, and including, June 30, 2015, divided by (B) 30. As part of the 31 Exchange Agreement, the registration rights agreement previously entered into between the Company and 31 Group, LLC in October 2014 was terminated.

 

On the date of issuance, the Company used the Black-Scholes pricing method, which is not materially different from a binomial lattice valuation methodology, to determine the fair value of the derivative liability of the warrants on those dates, and determined the fair value was $15 and $11, respectively.

 

On May 14, 2015, the Company and 31 Group, LLC entered into an amended agreement whereby the Company issued 100,000 shares of unregistered common stock of the Company to 31 Group, LLC in exchange for the termination of any obligation of the Company to pay the make-whole payment, as described in the 31 Group, Exchange Agreement.

 

On June 30, 2016 and December 31, 2015, the Company used a binomial lattice pricing model to determine the fair value of the warrants and derived an implied fair value of $1 and $2, respectively, which is included in derivative financial instruments at estimated fair value on the unaudited condensed consolidated balance sheets. The Company recorded the change in the fair value of the derivative liability for the three months ended June 30, 2016 and 2015 as a gain in the unaudited condensed consolidated statements of operations of $4 and $13, respectively, and a gain of $1 and a loss of $13 for the six months ended June 30, 2016 and 2015, respectively.

 

  32  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The fair value of the 31 Group, LLC April 2015 exchange agreement warrants derivative as of June 30, 2016 and December 31, 2015 was calculated using a binomial lattice pricing model with the following factors, assumptions and methodologies:

 

    June 30,     December 31,  
    2016     2015  
    July 1,     April 15,     July 1,  
    2014     2014     2014  
    Warrant     Warrant     Warrant  
Fair value of Company's common stock   $ 0.70     $ 1.00     $ 1.00  
Volatility (for June 30, 2016, based on the Company's historical volatility; for December 31, 2015, based on the closing prices of 3-4 comparable public companies)     105 %     80 %     80 %
Exercise price per share   $ 5.00     $ 5.00     $ 5.00  
Estimated life     1 year       3.5 months       1.5 years  
Risk free interest rate (based on 1-year treasury rate)     0.45 %     0.33 %     0.86 %

 

Bridge Financing Agreement Warrants

 

On December 29, 2015, the Company entered into an agreement with the JGB (Cayman) Waltham Ltd. whereby the Company issued to JGB (Cayman) Waltham Ltd. a senior secured convertible debenture (as noted in Note 7, Term Loans) and, among other things, a portion of the JGB (Cayman) Waltham Ltd. proceeds were used to repay the GPB Life Science Holdings, LLC bridge notes. On this date, the Company evaluated the payoff of the GPB Life Science Holdings, LLC bridge notes and determined that the repayment of the bridge notes qualified for debt extinguishment accounting under ASC-470-50,  Debt – Modifications and Extinguishments  (“ASC-470-50”). In accordance with ASC-470-50, the Company evaluated the tranche warrants and revalued the warrants at the $1.75 conversion price and determined that the fair value of the warrants was $258, which is included in common stock warrants within the stockholders’ deficit section on the condensed consolidated balance sheet as of December 31, 2015.

 

Bridge Financing Amendment No. 2 Feature

 

On December 29, 2015, the Company entered into an agreement with the JGB (Cayman) Waltham Ltd. whereby the Company issued to JGB (Cayman) Waltham Ltd. a senior secured convertible debenture (as noted in Note 7, Term Loans) and, among other things, a portion of the JGB (Cayman) Waltham Ltd. proceeds were used to repay the GPB Life Science Holdings, LLC bridge notes. On this date, the Company evaluated the payoff of the GPB Life Science Holdings, LLC bridge notes and determined that the repayment of the bridge notes qualified for debt extinguishment accounting under ASC-470-50, Debt – Modifications and Extinguishments (“ASC-470-50”). In accordance with ASC-470-50, the Company evaluated the maturity date feature prior to the payoff transaction and determined that the feature had a fair value of $31 as of December 31, 2015. In conjunction with the payoff, the Company re-evaluated the maturity date feature and determined that the derivative was extinguished along with the related bridge financing debt.

 

Richard Smithline Senior Convertible Note Embedded Features

 

On August 6, 2015, the Company issued to Richard Smithline a senior convertible note in the principal amount of $526, with interest accruing at the rate of 12% per annum, which matures on January 11, 2017. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815, Derivatives and Hedging and ASC 480, Distinguishing Liabilities from Equity . On August 6, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $131 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

On June 30, 2016 and December 31, 2015, the Company used a Monte Carlo simulation to value the settlement features of the senior convertible noted and determined the fair value to be $0 and $85, respectively. The Company recorded the change in the fair value of the derivative liability for the three months ended June 30, 2016 as a gain of $18 and a gain of $85 for the six months ended June 30, 2016 in the unaudited condensed consolidated statements of operations.

 

  33  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The fair value of the Smithline derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    June 30,     December 31,  
    2016     2015  
             
Principal amount   $ 307     $ 526  
Conversion price per share   $ 1.25     $ 1.25  
Conversion trigger price per share      None        None  
Risk free rate     0.38 %     0.69 %
Life of conversion feature (in years)     0.61       1.10  
Volatility     100 %     105 %

 

JGB (Cayman) Waltham Ltd. Senior Secured Convertible Debenture Features

 

On December 29, 2015, the Company entered into a securities purchase agreement with JGB Waltham whereby the Company issued to JGB Waltham, for gross proceeds of $7,500, a 10% original issue discount senior secured convertible debenture in the aggregate principal amount of $7,500. The Company evaluated the senior convertible note’s settlement provisions and determined that the voluntary conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815, Derivatives and Hedging and ASC 480, Distinguishing Liabilities from Equity . On December 29, 2015, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $1,479 related to the voluntary conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a debt discount and related derivative liability. The debt discounts are being amortized over the life of the loan.

 

On May 17, 2016, the Company entered into the Debenture Forbearance Agreement with JGB Waltham pursuant to which JGB Waltham agreed to forbear action with respect to certain existing defaults in accordance with the terms of the Debenture Forbearance Agreement (Refer to Note 7, Term Loans, for further details). The Company evaluated the Debenture Forbearance Agreement and accounted for the transaction as a debt extinguishment in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company used a Monte Carlo simulation to revalue the settlement features associated with the Debenture Forbearance Agreement and determined that the fair value of the features was $2,612. The Company recorded the change in the settlement features as a loss to change in fair value of derivative instruments of $1,154 to its consolidated statement of operations on May 17, 2016.

 

On May 23, 2016, the Company entered into the Amended Agreement with JGB Concord, JGB Waltham, White Oak Global Advisors, LLC, VaultLogix, and the Guarantors. The Company accounted for this Amended Agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company accounted for the Amended Agreement as a debt modification and utilized a Monte Carlo simulation to determine the fair value of the settlement features to be $2,654 as of May 23, 2016. The Company recorded a loss on the fair value of the settlement features to change in fair value of derivative instruments of $41 on the consolidated statement of operations as of May 23, 2016.

 

On June 23, 2016, the Company entered into an amended agreement with JGB Concord and JGB Waltham (refer to Note 7, Term Loans, for further detail). The Company accounted for the amended agreement as a debt extinguishment in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company used a Monte Carlo simulation to revalue the settlement features associated with the Amended Agreement and determined that the fair value of the features was $3,139 as of June 23, 2016. The Company recorded the change in the settlement features as a loss to change in fair value of derivative instruments of $486 to its consolidated statement of operations on June 23, 2016.

 

On June 30, 2016 and December 31, 2015, the Company used a Monte Carlo simulation to value the settlement features of the senior convertible notes issued to JGB Waltham and JGB Concord and determined the fair value to be $2,261 and $3,150, respectively. The Company recorded the change in the fair value of the derivative liability for the three months ended June 30, 2016 as a gain of $486 and a gain of $1,436 for the six months ended June 30, 2016 in the unaudited condensed consolidated statements of operations.

 

The fair value of the JGB Waltham derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    June 30,     December 31,  
    2016     2015  
             
Principal amount   $ 6,100     $ 7,500  
Conversion price per share   $ 0.80     $ 1.33  
Conversion trigger price per share   $ 1.60     $ 4.00  
Risk free rate     0.7 %     0.86 %
Life of conversion feature (in years)     2.92       1.50  
Volatility     100 %     105 %

 

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INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

JGB (Cayman) Concord Ltd. Senior Secured Convertible Note

 

On February 17, 2016, the Company entered into a securities exchange agreement by and among the Company, VaultLogix, and JGB Concord, whereby the Company exchanged the White Oak Global Advisors, LLC promissory note and subsequently assigned to the lender party a new 8.25% senior secured convertible note dated February 18, 2016 in the aggregate principal amount of $11,601 (refer to Note 6, Term Loans, for further details).

 

The Company evaluated the senior secured convertible note’s settlement provisions and determined that the conversion feature and fundamental transaction clauses met the criteria to be classified as embedded derivatives as set forth in ASC 815,  Derivatives and Hedging  and ASC 480,  Distinguishing Liabilities from Equity . On February 18, 2016, the Company used a Monte Carlo simulation to value the settlement features and ascribed a value of $1,350 related to the conversion feature and fundamental transaction clauses and recorded these items on the unaudited condensed consolidated balance sheets as a derivative liability. The debt discounts are being amortized over the life of the loan.

 

On May 17, 2016, the Company entered into the Note Forbearance Agreement with JGB Concord pursuant to which JGB Concord agreed to forbear action with respect to certain existing defaults in accordance with the terms of the Note Forbearance Agreement (Refer to Note 7, Term Loans, for further details). The Company evaluated the Note Forbearance Agreement and accounted for the transaction as a debt extinguishment in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company used a Monte Carlo simulation to revalue the settlement features associated with the Note Forbearance Agreement and determined that the fair value of the features was $4,968. The Company recorded the change in the settlement features as a loss to change in fair value of derivative instruments of $2,196 to its consolidated statement of operations on May 17, 2016.

 

On May 23, 2016, the Company entered into the Amended Agreement with JGB Concord, JGB Waltham, White Oak Global Advisors, LLC, VaultLogix, and the Guarantors. The Company accounted for this Amended Agreement in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company accounted for the Amended Agreement as a debt modification and utilized a Monte Carlo simulation to determine the fair value of the settlement features to be $5,046 as of May 23, 2016. The Company recorded a loss on the fair value of the settlement features to change in fair value of derivative instruments of $79 on the consolidated statement of operations as of May 23, 2016.

 

On June 23, 2016, the Company entered into an amended agreement with JGB Concord and JGB Waltham (refer to Note 7, Term Loans, for further detail). The Company accounted for the amended agreement as a debt extinguishment in accordance with ASC Topic 470-50. In accordance with ASC Topic 470-50, the Company used a Monte Carlo simulation to revalue the settlement features associated with the Amended Agreement and determined that the fair value of the features was $5,971 as of June 23, 2016. The Company recorded the change in the settlement features as a loss to change in fair value of derivative instruments of $924 to its consolidated statement of operations on June 23, 2016.

 

As part of the June 23, 2016 amended agreement with JGB Concord, the Company issued 900,000 shares of the Company’s common stock on June 23, 2016 to JGB Concord (Refer to Note 10, Stockholders’ Deficit, for further detail), which includes a make-whole provision whereby the Company will pay JGB Concord in cash the difference between $0.94 per share of the Company’s common stock and the average volume weighted average price per share of the Company’s common stock sixty days after shares of the Company’s common stock are freely tradable. The Company accounted for the make-whole provision within the June 23, 2016 amendment agreement as a derivative liability and utilized a binomial lattice model to ascribe a value of $280, which was recorded as a derivative liability on the Company’s consolidated balance sheet and as a loss on extinguishment of debt on the Company’s consolidated statement of operations on June 23, 2016.

 

On June 30, 2016, the Company used a Monte Carlo simulation to value the settlement features of the senior secured convertible notes and determined the fair value to be $4,299 and recorded a loss on fair value of derivative instruments of $1,671 for the three months ended June 30, 2016 and a loss of $2,949 for the six months ended June 30, 2016 on the unaudited condensed consolidated statement of operations.

 

The fair value of the JGB Concord derivative at the measurement date was calculated using the Monte Carlo simulation with the following factors, assumptions and methodologies:

 

    June 30,  
    2016  
       
Principal amount   $ 11,601  
Conversion price per share   $ 0.80  
Conversion trigger price per share   $ 1.60  
Risk free rate     0.7 %
Life of conversion feature (in years)     2.92  
Volatility     100 %

 

On June 30, 2016, the Company used a binomial lattice model to value the make-whole provision and determined the fair value to be $372 and recorded a loss on fair value of derivative instruments of $92 for the three and six months ended June 30, 2016 on the unaudited condensed consolidated statement of operations. 

 

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INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The fair value of the JGB Concord make-whole provision at the measurement date was calculated using a binomial lattice model with the following factors, assumptions and methodologies:

 

    June 30,  
    2016  
       
Fair value of Company’s common stock   $ 0.70  
Volatility (for June 30, 2016, based on the Company's historical volatility; for December 31, 2015, based on the closing prices of 3-4 comparable public companies)     105 %
Exercise price   $ 0.94  
Estimated life     7.9 months  
Risk free interest rate (based on 1-year treasury rate)     0.405 %

 

Option Shares

 

On October 15, 2014, the Company granted to an employee pursuant to the InterCloud Systems, Inc. 2012 Performance Incentive Plan an option to purchase 150,000 shares of common stock at an exercise price of $3.72 per share. The option vested immediately and expires on the tenth anniversary of the grant date.

 

On October 15, 2014, the Company granted to an employee pursuant to the InterCloud Systems, Inc. 2012 Performance Incentive Plan an option to purchase 25,000 shares of common stock at an exercise price of $3.72 per share. The option vests over three years with 33 1/3 percent vesting on the first anniversary of the grant date and on each of the next two anniversaries of the grant date. This option expires on the fifth anniversary of the grant date.

 

During the quarter ended March 31, 2015, the Company re-evaluated the options issued on October 15, 2014 and reclassified the options to additional paid-in capital within the unaudited condensed consolidated balance sheet.

 

Net Settlement of Accounts Payable

 

On March 25, 2015, the Company issued 300,000 shares of common stock and a warrant to purchase 80,000 shares of common stock to a third-party vendor to settle various accounts payable. The shares of common stock were issued with a six-month restrictive legend and as such, the fair value of the accounts payable to be paid with the common stock has not yet been determined. The Company recorded the common stock at a fair value of $648 and the warrant with a fair value of $106, which reduced the accounts payable to the third party in the amount of $1,475. The Company recorded a derivative liability of $721 at the time the shares were issued. The Company used a Black-Scholes pricing model to determine the fair value of the warrant on the date it was issued.

  

On April 1, 2015, the Company cancelled the warrants to purchase 80,000 shares of common stock issued to the third party and the third party returned the 300,000 shares of common stock previously issued on March 25, 2015 to treasury stock. The Company then issued a new one-year warrant for 425,000 shares of common stock with an exercise price of $0.55 per share. The Company recorded the warrant with a fair value of $674, which reduced the accounts payable to the third party in the amount of $1,417. The Company recorded a derivative liability of $743 at the time the warrants were issued. The derivative liability relates to the difference between the accounts payable due to the third party and the fair value of the warrants on April 1, 2015. The Company used a Black-Scholes pricing model, which is not materially different from a binomial lattice valuation methodology, to determine the fair value of the warrant on the date it was issued.

 

During the quarter ended June 30, 2015, the Company revalued the accounts payable derivative and recorded a gain on fair value of derivative instruments of $224 and $230 for the three and six months ended June 30, 2015, respectively, on the unaudited condensed consolidated statement of operations.

 

Beginning on October 9, 2015 and continuing through November 12, 2015, the third-party began exercising the warrants to purchase shares of the Company’s common stock. During this time, the third-party exercised all of the 425,000 warrants issued on April 1, 2015 to purchase 287,001 shares of the Company’s common stock. The third-party applied the proceeds from the warrant exercise to reduce outstanding accounts payable of $452. The Company recorded a reduction in accounts payable of $452, a reduction in the derivative balance of $743, and recorded a loss on fair value of derivative of $30. As of November 12, 2015, there are no remaining warrants issued for settlement of accounts payable or any related derivative liabilities.

 

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INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

9. INCOME TAXES

 

As of June 30, 2016 and December 31, 2015, the Company had federal net operating loss carry forwards (“NOL’s”) of approximately $103,364 and $64,489, respectively, and state NOL’s of approximately $98,547 and $60,617, respectively, that will be available to reduce future taxable income, if any. These NOL’s begin to expire in 2025. In addition, as of June 30, 2016 and December 31, 2015, the Company had federal tax credit carry forwards of $692 and $690, respectively, available to reduce future taxes. These credits begin to expire in 2022.

 

Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, provide for annual limitations on the utilization of net operating loss and credit carryforwards if the Company were to undergo an ownership change, as defined in Section 382 of the Code. In general, an ownership change occurs whenever the percentage of the shares of a corporation owned, directly or indirectly, by 5-percent shareholders, as defined in Section 382 of the Code, increases by more than 50 percent over the lowest percentage of the shares of such corporation owned, directly or indirectly, by such 5-percent shareholders at any time over the preceding three years. In the event such ownership change occurs, the annual limitation may result in the expiration of the net operating losses prior to full utilization. The Company has completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since the Company became a “loss corporation” under the Code. As disclosed, the Company has taken these limitations into account in determining its available NOL’s.

 

During 2012, the Company acquired ownership of three entities that had historically used the cash method of accounting for tax purposes. Section 446 of the Internal Revenue Code of 1986, as amended, requires that the Company prepare its tax returns using the accrual method of accounting. As a result of this change from cash to accrual accounting for income tax purposes, the Company recognized $1,193 of income during 2015.

 

During 2012 and 2013, the Company acquired 100% of a Puerto Rican limited liability company, thereby subjecting the Company to Puerto Rico income taxes on any Puerto Rico-sourced taxable income. Such taxes paid are considered foreign taxes that may be credited against federal income taxes payable in future years.

 

The Company’s 2013 U.S. corporation income tax return is currently under examination. The Internal Revenue Service has questioned the Company’s classification of certain individuals as independent contractors rather than employees, and the year of income tax reporting of restricted stock issuances. The Company estimates its potential liability to be $500, but the liability, if any, upon final disposition of these matters is uncertain. 

 

10. STOCKHOLDERS’ DEFICIT

 

Common Stock:

 

Issuance of shares of common stock to third parties for services and non-employees

 

During February 2016, the Company issued 180,852 shares of its common stock to consultants in exchange for consulting services relating to corporate matters. The shares were valued at fair value at $0.52 per share and were immediately vested. The Company recorded $9 to salaries and wages expense as $85 was accrued as of December 31, 2015.

 

During March 2016, the Company issued 90,909 shares of its common stock to consultants in exchange for consulting services relating to corporate matters. The shares were valued at fair value at $0.68 per share and were immediately vested. The Company recorded $62 to salaries and wages expense.

 

Issuance of shares pursuant to promissory notes

 

In January 2016, the Company issued an aggregate of 466,669 shares of common stock to a third-party lender in satisfaction of notes payable aggregating $583. The shares were issued at $1.25, per the terms of the notes payable.

 

In February 2016, the Company issued an aggregate of 649,098 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $590. The shares were issued at $1.25, per the terms of the notes payable.

 

In March 2016, the Company issued an aggregate of 402,520 shares of common stock to a third-party lender in satisfaction of notes payable aggregating $289. The shares were issued at $1.25, per the terms of the notes payable.

 

In June 2016, the Company issued an aggregate of 284,406 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $156. The shares were issued at $0.55, per the terms of the notes payable.

 

  37  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Issuance of shares pursuant to Smithline Senior Convertible Note

 

In February 2016, the Company issued an aggregate of 199,573 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $75. The shares were issued at $0.38, per the terms of the note payable.

 

In March 2016, the Company issued an aggregate of 105,835 shares of common stock to a third-party lender in satisfaction of notes payable aggregating $49. The shares were issued at $0.46, per the terms of the note payable.

 

In April 2016, the Company issued an aggregate of 73,996 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $48. The shares were issued at $0.65, per the terms of the note payable.

 

In May 2016, the Company issued an aggregate of 88,532 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $48. The shares were issued at $0.54, per the terms of the note payable.

 

In June 2016, the Company issued an aggregate of 68,254 shares of common stock to a third-party lender in satisfaction of notes payable and accrued interest aggregating $47. The shares were issued at $0.69, per the terms of the note payable.

 

Issuance of shares pursuant to Bridge Financing Provision

 

In January 2016, the Company issued an aggregate of 500,000 shares of common stock to a third-party lender in satisfaction of notes payable aggregating $320. The shares were valued at fair value at $0.64 per share.

 

Issuance of shares pursuant to acquisition of assets of SDN Essentials, LLC

 

In January 2016, the Company issued 1,000,000 shares of common stock valued at $1.00 per share in connection with the acquisition of assets of SDN. In addition to the aforementioned shares, the Company paid $50 in cash and an earn out provision of $515, subject to SDN meeting certain revenue targets. The Company will also issue a pool of 50,000 shares of the Company’s common stock which will be allocated among all employees of SDN.

 

Issuance of shares to JGB Concord

 

In June 2016, the Company issued 900,000 shares of common stock valued at $0.92 per share as a concession for restructuring certain debt agreements. The Company recorded these shares as a loss on fair value of debt extinguishment of $828 on the unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2016.

 

Purchase of Treasury Shares

 

During March 2016, the Company repurchased 1,961 shares from the Ian Gist Cancer Research Fund. The shares were valued at fair value at $0.54 per share.

 

During March 2016, the Company repurchased 141,322 shares at par value of $0.0001 per share from twenty employees who terminated employment.

 

During June 2016, the Company repurchased 55,167 shares at par value of $0.0001 per share from twelve employees who terminated employment.

 

  38  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

11. STOCK-BASED COMPENSATION

 

Restricted Stock

 

The following table summarizes the Company’s restricted stock activity during the six months ended June 30, 2016:

 

    Number of Shares     Weighted Average Grant Date Fair Value  
Outstanding at January 1, 2016     2,023,116     $ 3.50  
Vested     (44,666 )   $ 2.68  
Forfeited/Cancelled     (141,322 )   $ 2.93  
Outstanding at March 31, 2016     1,837,128     $ 3.57  
                 
Vested     (271,490 )   $ 2.33  
Forfeited/Cancelled     (55,167 )   $ 2.78  
Outstanding at June 30, 2016     1,510,471     $ 3.82  

 

For the three months ended June 30, 2016 and 2015, the Company incurred $0 and $5,160, respectively, in stock compensation expense from the issuance of common stock to employees and consultants. For the six months ended June 30, 2016 and 2015, the Company incurred $71 and $6,483, respectively, in stock compensation expense from the issuance of common stock to employees and consultants. 

 

The Company recorded an additional $632 and $733 in stock compensation expense on shares subject to vesting terms in previous periods during the three months ended June 30, 2016 and 2015, respectively. The Company recorded an additional $1,309 and $1,582 in stock compensation expense on shares subject to vesting terms in previous periods during the six months ended June 30, 2016 and 2015, respectively.

 

Issuance of shares of common stock to employee for incentive earned

 

During March 2016, the Company issued an aggregate of 73,519 shares to an employee in settlement of incentives earned. The shares were valued at fair value at $0.68 per share. The Company had accrued for $50 of the expense in 2015.

 

Options

 

There were no options granted during the six months ended June 30, 2016 or 2015.

 

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INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

The following table summarizes the Company’s stock option activity and related information for the six months ended June 30, 2016:

 

          Weighted Average        
    Shares Underlying Options     Exercise
Price
    Remaining Contractual Term (in years)     Aggregate Intrinsic Value (in thousands)  
Outstanding at January 1, 2016     175,000     $ 3.72       6.29     $ 476  
Granted     -       -       -       -  
Forfeited and expired     -       -       -       -  
Exercised     -       -       -       -  
Outstanding at June 30, 2016     175,000     $ 3.72       5.80     $ 529  
Exercisable at June 30, 2016     158,333     $ 3.72       5.80     $ 478  

 

The aggregate intrinsic value for outstanding options is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock as of June 30, 2016 and December 31, 2015 of $0.70 and $1.00, respectively.

 

12. RELATED PARTIES

 

At June 30, 2016 and December 31, 2015, the Company had outstanding the following loans due to related parties:

 

    June 30,     December 31,  
    2016     2015  
             
Promissory note issued to CamaPlan FBO Mark Munro IRA, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $56 and $72, respectively   $ 541     $ 525  
Promissory note issued to 1112 Third Avenue Corp, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $53 and $68, respectively     322       307  
Promissory note issued to Mark Munro, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $90 and $116, respectively     1,247       1,221  
Promissory note issued to Pasack Road, LLC, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $221 and $286, respectively     2,429       2,364  
Promissory notes issued to Forward Investments, LLC, between 2% and 10% interest, maturing on July 1, 2016, unsecured, net of debt discount of $115 and $749, respectively     6,360       5,727  
Promissory notes issued to Forward Investments, LLC, 3% interest, maturing on January 1, 2018, unsecured, net of debt discount of $1,215 and $1,528, respectively     3,159       2,844  
Promissory notes issued to Forward Investments, LLC, 6.5% interest, maturing on July 1, 2016, unsecured, net of debt discount of $26 and $147, respectively     364       243  
Former owner of IPC, unsecured, 8% interest, matured on May 30, 2016     5,755       5,755  
Former owner of IPC, unsecured, 15% interest, due on demand     75       75  
Former owner of Nottingham, unsecured, 8% interest, matured on May 30, 2016     225       225  
      20,477       19,286  
Less: current portion of debt     (11,751 )     (11,103 )
Long-term portion of notes payable, related parties   $ 8,726     $ 8,183  

 

The interest expense, including amortization of debt discounts, associated with the related-party notes payable in the three months ended June 30, 2016 and 2015 was $946 and $1,011, respectively. The interest expense, including amortization of debt discounts, associated with the related-party notes payable in the six months ended June 30, 2016 and 2015 was $1,848 and $2,521, respectively. 

 

Restructuring of Related Party Promissory Notes Issued in 2014

 

On February 25, 2015, the Company restructured the terms of certain related-party promissory notes and term loans issued to Mark Munro, CamaPlan FBO Mark Munro IRA, 1112 Third Ave. Corp., the Mark Munro 1996 Charitable Remainder Trust and Pascack Road, LLC in order to extend the maturity dates thereof and to reduce the interest rate accruing thereon. The following notes were restructured as follows:

 

  notes issued to Mark Munro in the aggregate principal amount of $637 had the interest rates reduced from 12% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;

 

  notes issued to CamaPlan FBO Mark Munro IRA in the aggregate principal amount of $397 had the interest rates reduced from 12% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;

 

  40  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

  a note issued to 1112 Third Avenue Corp. in the principal amount of $375 had the interest rate reduced from 12% to 3% per annum and the maturity date extended from March 31, 2016 to January 1, 2018;
     
  notes issued to Pascack Road, LLC in the aggregate principal amount of $1,575 had the interest rate reduced from 12% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018.

 

In consideration for such restructuring, the Company issued to Mark Munro 63,700 shares of unregistered common stock, the CamaPlan FBO Mark Munro IRA 39,690 shares of unregistered common stock, 1112 Third Avenue Corp. 87,500 shares of unregistered common stock, the Mark Munro 1996 Charitable Remainder UniTrust 27,500 shares of unregistered common stock and Pascack Road, LLC 157,500 shares of unregistered common stock. The Company recorded a loss on modification of debt of $798 on the unaudited condensed consolidated statement of operations as of March 31, 2015 related to the consideration given to the debt holders.

 

Restructuring of Related Party Promissory Notes Issued in 2014

 

On February 25, 2015, the Company restructured the terms of certain related-party promissory notes and term loans issued to Mark Munro, Cama Plan FBO Mark Munro IRA, 1112 Third Ave. Corp., the Mark Munro 1996 Charitable Remainder Trust and Pascack Road, LLC in order to extend the maturity dates thereof and to reduce the interest rate accruing thereon. The following notes were restructured as follows:

 

  notes issued to Mark Munro in the aggregate principal amount of $700 had the interest rates reduced from 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;
     
  notes issued to CamaPlan FBO Mark Munro IRA in the aggregate principal amount of $200 had the interest rates reduced from 12% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018;
     
  notes issued to Pascack Road, LLC in the aggregate principal amount of $1,075 had the interest rate reduced from 18% to 3% per annum and the maturity dates extended from March 31, 2016 to January 1, 2018.

 

In consideration for such restructuring, the Company issued to Mark Munro 95,600 shares of unregistered common stock, the CamaPlan FBO Mark Munro IRA 41,600 shares of unregistered common stock, the Mark Munro 1996 Charitable Remainder UniTrust 62,400 shares of unregistered common stock and Pascack Road, LLC 223,600 shares of unregistered common stock. The Company recorded a loss on extinguishment of debt of $1,159 on the unaudited condensed consolidated statement of operations as of March 31, 2015 related to the consideration given to the debt holders.

 

Restructuring of Forward Investments, LLC Promissory Notes and Working Capital Loan

 

On March 4, 2015, the Company restructured the terms of certain promissory notes issued by it to a related party investor, Forward Investments, LLC, in order to extend the maturity dates thereof, reduce the seniority and reduce the interest rate accruing thereon. The following notes were restructured as follows:

 

  notes issued to Forward Investments, LLC in the aggregate principal amount of $3,650 that bear interest at the rate of 10% per annum, had the maturity date extended from June 30, 2015 to July 1, 2016;

 

  notes issued to Forward Investments, LLC in the principal amount of $2,825 that bear interest at the rate of 2% per annum, had the maturity date extended from June 30, 2015 to July 1, 2016; and
     
  notes issued to Forward Investments, LLC in the aggregate principal amount of $2,645 were converted from senior notes to junior notes, had the interest rate reduced from 18% to 3% per annum, had the maturity date extended by approximately three years to January 1, 2018, and originally were convertible at a conversion price of $6.36 per share until the Convertible Debentures were repaid in full and thereafter $2.35 per share, subject to further adjustment as set forth therein.

 

In connection with such restructuring, Forward Investments, LLC agreed to lend to the Company an amount substantially similar to the accrued interest the Company owed to Forward Investments, LLC on the restructured notes. In consideration for such restructuring and additional payments made by Forward Investments, LLC to the Company, the Company issued to Forward Investments, LLC an additional convertible note in the original principal amount of $1,730 with an interest rate of 3% per annum, a maturity date of January 1, 2018, and an initial conversion price of $6.36 per share until the Convertible Debentures were repaid in full and thereafter $2.35 per share, subject to further adjustment as set forth therein, and provided Forward Investments, LLC the option to lend the Company an additional $8,000 in the form of convertible notes similar to the existing convertible notes of the Company issued to Forward Investments, LLC. The convertible note was issued to Forward Investments, LLC as an incentive to restructure the above-mentioned notes and resulted in the Company recording a loss on modification of debt of $1,508 on the unaudited condensed consolidated statement of operations as of March 31, 2015.

 

  41  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

As part of the restructuring, Forward Investments, LLC agreed to convert $390 of accrued interest on the above-mentioned loans to a new note bearing interest at the rate of 6.5% per annum that matures on July 1, 2016.

 

In conjunction with the extension of the 2% and 10% convertible notes, the Company recorded an additional $1,916 of debt discount at the date of the restructuring.

 

Revolving Line of Credit

 

On July 3, 2014, the Company obtained an unsecured $3,000 interim revolving line of credit from the Mark Munro 1996 Charitable Remainder UniTrust to provide working capital as well as cash to make the Company’s upcoming amortization payments pursuant to the Company’s Convertible Debentures. The line bore interest at the rate of 1.5% per month on funds drawn and matured on March 31, 2016.

 

As of June 30, 2016 and December 31, 2015, there was no amount outstanding under the related party revolving line of credit.

 

Convertible Promissory Note to Frank Jadevaia

 

On January 1, 2014, the Company acquired all of the outstanding capital stock of IPC. As part of the purchase price for the acquisition, the Company issued a convertible promissory note to Frank Jadevaia, the current President of the Company, in the original principal amount of $6,255. The convertible promissory note accrues interest at the rate of 8% per annum, and all principal and interest accruing thereunder was originally due and payable on December 31, 2014. At the election of Mr. Jadevaia, the convertible promissory note is convertible into shares of the Company's common stock at a conversion price of $16.99 per share (subject to equitable adjustments for stock dividends, stock splits, recapitalizations and other similar events). The Company can elect to force the conversion of the convertible promissory note if the Company’s common stock is trading at a price greater than or equal to $16.99 for ten consecutive trading days.

 

On December 31, 2014, the Company and Mr. Jadevaia agreed to a modification of the convertible promissory note. The term of the convertible promissory note was extended to May 30, 2016 and, in consideration for this modification, the Company issued to Mr. Jadevaia 100,000 shares of common stock.

 

On May 19, 2015, Mr. Jadevaia assigned $500 of principal related to the convertible promissory note and the assignees converted all $500 principal amount of such note into 232,182 shares of the Company’s common stock with a fair value of $3.38 per common share. Refer to Note 17, Stockholders’ Equity, for further detail on this transaction.

 

At June 30, 2016, $5,830 principal amount of the convertible promissory note remained outstanding, which was payable on demand.

 

Convertible Promissory Note to Scott Davis

 

On July 1, 2014, the Company issued an unsecured $250 convertible promissory note to Scott Davis, who is a related party. The note bears interest at the rate of 8% per annum, originally matured on January 1, 2015 and is convertible into shares of the Company’s common stock at an initial conversion price of $6.59. The Company evaluated the convertible feature and determined that the value was de minimis and as such, the Company did not bifurcate the feature.

 

On March 25, 2015, the Company and Mr. Davis agreed to a modification of the convertible promissory note pursuant to which the term of the note was extended to May 30, 2016 and the initial conversion price was amended to $2.22 per share of the Company’s common stock. In consideration for this modification, the Company issued to Mr. Davis 22,222 shares of common stock with a fair value of $2.16 per share.

 

On May 31, 2015, Mr. Davis converted $25 principal amount of the convertible promissory note into 11,261 shares of common stock, with a fair value of $3.53 per share and recorded a loss on debt conversion of $13 on the Company’s consolidated statement of operations.

 

At June 30, 2016, $225 principal amount of the convertible promissory note was outstanding, which was payable on demand.

 

13. SEGMENTS

 

The Company operates in three reportable segments: applications and infrastructure, professional services, and managed services. The Company identified its operating segments based on the services provided by its various operations and the financial information used by its chief operating decision maker to make decisions regarding the allocation of resources to and the financial performance of the operating segments. The reporting segments represent an aggregation of individual operating segments with similar economic characteristics. The applications and infrastructure operating segment is an aggregation of the component operations of TNS, the AWS Entities, Tropical, RM Leasing, and RM Engineering. The professional services operating segment is an aggregation of the operations of the ADEX Entities and SDN. The managed services operating segment is comprised of the operations of IPC, RentVM and Nottingham.

 

In addition to the operating segments, the Company has determined that certain costs related to the general operations of the Company cannot be reasonably allocated to each individual segment. These costs are not part of the factors that the chief operating decision maker uses to calculate gross margin. As such, the Company has chosen to present those costs within a general “Corporate” line item for presentation purposes. The Company’s former VaultLogix and Axim subsidiaries, which we included in the Company’s cloud services segment, were reclassified as “discontinued operations” to conform to classifications used in the current period related to the sale of VaultLogix, VaultLogix’s subsidiaries and Axim.

 

  42  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Segment information relating to the Company’s results of continuing operations was as follows:

 

 

Revenue by Segment   Three months ended June 30,     Six months ended June 30,  
    2016     2015     2016     2015  
          (Revised)           (Revised)  
Applications and infrastructure   $ 6,597     $ 4,761     $ 11,832     $ 9,491  
Professional services     11,825       6,310       18,345       13,174  
Managed services     4,172       8,488       10,046       15,132  
Total   $ 22,594     $ 19,559     $ 40,223     $ 37,797  

 

Gross Profit   Three months ended June 30,     Six months ended June 30,  
    2016     2015     2016     2015  
          (Revised)           (Revised)  
Applications and infrastructure   $ 1,127     $ 1,460     $ 1,853     $ 2,656  
Professional services     2,922       1,237       4,375       2,689  
Managed services     1,170       1,700       3,405       4,118  
Total   $ 5,219     $ 4,397     $ 9,633     $ 9,463  

 

Operating Income (Loss) by Segment   Three months ended June 30,     Six months ended June 30,  
    2016     2015     2016     2015  
          (Revised)           (Revised)  
Applications and infrastructure   $ (198 )   $ 316     $ (651 )   $ 248  
Professional services     983       (16 )     857       (99 )
Managed services     (1,198 )     (692 )     (1,044 )     (1,072 )
Corporate     (3,905 )     (6,888 )     (7,022 )     (9,795 )
Total   $ (4,318 )   $ (7,280 )   $ (7,860 )   $ (10,718 )

 

Interest Expense   Three months ended June 30,     Six months ended June 30,  
    2016     2015     2016     2015  
          (Revised)           (Revised)  
Applications and infrastructure   $ 4     $ 7     $ 8     $ 15  
Professional services     -       -       -       -  
Managed services     11       -       13       -  
Corporate     3,403       1,799       8,112       4,940  
Total   $ 3,418     $ 1,806     $ 8,133     $ 4,955  

 

Total Assets by Segment   June 30,
2016
    December 31, 2015  
          (Revised)  
Applications and infrastructure   $ 17,488     $ 19,593  
Professional services     25,284       18,449  
Managed services     20,843       24,718  
Cloud services     10,669       3,840  
Corporate     9,324       3,788  
Assets of discontinued operations     -       21,843  
Total   $ 83,608     $ 92,231  

 

Goodwill   June 30,
2016
    December 31,
2015
 
             
Applications and infrastructure   $ 6,906     $ 6,906  
Professional services     10,080       9,257  
Managed services     7,495       7,495  
Total   $ 24,481     $ 23,658  

 

  43  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Revenues by Segment by   Three months ended June 30, 2016     Six months ended June 30, 2016  
Geographic Region   Domestic     Foreign     Total     Domestic     Foreign     Total  
Applications and infrastructure   $ 6,426     $ 171     $ 6,597     $ 11,470     $ 362     $ 11,832  
Professional services     11,729       96       11,825       18,217       128       18,345  
Managed services     4,172       -       4,172       10,046       -       10,046  
Total   $ 22,327     $ 267     $ 22,594     $ 39,733     $ 490     $ 40,223  

 

Revenues by Segment by   Three months ended June 30, 2015     Six months ended June 30, 2015  
Geographic Region   Domestic     Foreign     Total     Domestic     Foreign     Total  
    (Revised)     (Revised)  
Applications and infrastructure   $ 4,536     $ 225     $ 4,761     $ 8,853     $ 638     $ 9,491  
Professional services     6,286       24       6,310       13,102       72       13,174  
Managed services     8,488       -       8,488       15,132       -       15,132  
Total   $ 19,310     $ 249     $ 19,559     $ 37,087     $ 710     $ 37,797  

 

Gross Profit by   Three months ended June 30, 2016     Six months ended June 30, 2016  
Segment by Region   Domestic     Foreign     Total     Domestic     Foreign     Total  
Applications and infrastructure   $ 808     $ 319     $ 1,127     $ 1,491     $ 362     $ 1,853  
Professional services     2,800       122       2,922       4,247       128       4,375  
Managed services     1,170       -       1,170       3,405       -       3,405  
Total   $ 4,778     $ 441     $ 5,219     $ 9,143     $ 490     $ 9,633  

 

Gross Profit by   Three months ended June 30, 2015     Six months ended June 30, 2015  
Segment by Region     Domestic     Foreign     Total     Domestic     Foreign     Total  
    (Revised)     (Revised)  
Applications and infrastructure   $ 1,383     $ 77     $ 1,460     $ 2,525     $ 131     $ 2,656  
Professional services     1,232       5       1,237       2,669       20       2,689  
Managed services     1,700       -       1,700       4,118       -       4,118  
Total   $ 4,315     $ 82     $ 4,397     $ 9,312     $ 151     $ 9,463  

 

Operating (Loss) Income by   Three months ended June 30, 2016     Six months ended June 30, 2016  
Segment by Region     Domestic     Foreign     Total     Domestic     Foreign     Total  
Applications and infrastructure   $ (153 )   $ (45 )   $ (198 )   $ (628 )   $ (23 )   $ (651 )
Professional services     973       10       983       845       12       857  
Managed services     (1,198 )     -       (1,198 )     (1,044 )     -       (1,044 )
Corporate     (3,905 )     -       (3,905 )     (7,022 )     -       (7,022 )
Total   $ (4,283 )   $ (35 )   $ (4,318 )   $ (7,849 )   $ (11 )   $ (7,860 )

 

Operating (Loss) Income by   Three months ended June 30, 2015     Six months ended June 30, 2015  
Segment by Region   Domestic     Foreign     Total     Domestic     Foreign     Total  
    (Revised)     (Revised)  
Applications and infrastructure   $ 275     $ 41     $ 316     $ 199     $ 49     $ 248  
Professional services     22       (38 )     (16 )     (74 )     (25 )     (99 )
Managed services     (692 )     -       (692 )     (1,072 )     -       (1,072 )
Corporate     (6,888 )     -       (6,888 )     (9,795 )     -       (9,795 )
Total   $ (7,283 )   $ 3     $ (7,280 )   $ (10,742 )   $ 24     $ (10,718 )

 

  44  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

14. DISCONTINUED OPERATIONS 

 

On February 17, 2016, the Company consummated the sale of certain assets of its former wholly-owned subsidiary, VaultLogix, and its subsidiaries, pursuant to the terms of an asset purchase agreement, dated as of February 17, 2016 among the Company, VaultLogix and its subsidiares and KeepItSafe, Inc., a Delaware corporation. The cash purchase price paid to the Company for the assets was $24,000, which was paid to the Company as follows: (i) $22,000 paid in cash on the closing date and (ii) $2,000 deposited in an escrow account to secure the performance of the obligations of the Company and VaultLogix, including any potential indemnification claims, under the asset purchase agreement, to be released on February 17, 2017. The closing payments were subject to customary working capital adjustments.

 

The assets of VaultLogix and its subsidiaries have been included within the unaudited condensed consolidated balance sheet as non-current assets of discontinued operations as of December 31, 2015. The results of operations of VaultLogix and its subsidiaries have been included within the line-item labelled net income (loss) on discontinued operations, net of tax within the consolidated statement of operations for the three and six months ended June 30, 2016 and 2015. The Company recorded a gain on the disposal of these assets of $0 and $2,637 for the three and six months ended June 30, 2016, respectively.

 

On April 29, 2016, the Company consummated the disposal of certain assets of its former wholly-owned subsidiary, Axim, for the following future consideration: in the event that the purchaser of Axim undertakes a sale or disposition of assets related to Axim, the purchaser of Axim shall pay to the Company an amount equal to the lesser of (i) 50% of the gross proceeds of such sale or disposition or (ii) $1,500.

 

The assets of Axim have been included within the unaudited condensed consolidated balance sheet as current assets of discontinued operations, non-current assets of discontinued operations, and non-current liabilities of discontinued operations as of December 31, 2015. The results of operations of Axim have been included within the line-item labelled net income (loss) on discontinued operations, net of tax within the consolidated statement of operations for the three and six months ended June 30, 2016 and 2015. The Company recorded a loss on the disposal of these assets of $1,063 for the three and six months ended June 30, 2016.

 

The following tables show the major classes of the Company’s discontinued operations as of December 31, 2015 and for the three and six months ended June 30, 2016 and 2015.

 

    December 31,  
    2015  
       
Current assets      
Accounts receivable, net of allowances of $52   $ 91  
Current assets of discontinued operations   $ 91  
         
Long-term assets:        
Property and equipment, net   $ 1,245  
Goodwill     10,130  
Intangible assets, net     10,377  
Long-term assets of discontinued operations   $ 21,752  
         
Current Liabilities:        
Accrued expenses   $ 5  
Current liabilities of discontinued operations   $ 5  

 

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INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

    For the three months ended     For the six months ended  
    June 30,     June 30,  
    2016     2015     2016     2015  
                         
Revenues   $ -     $ 2,687     $ 1,377     $ 5,442  
Cost of revenue     15       446       274       893  
Gross profit     (15 )     2,241       1,103       4,549  
                                 
Operating expenses:                                
Depreciation and amortization     -       758       439       1,501  
Salaries and wages     -       552       844       1,220  
Selling, general and administrative     (8 )     491       528       1,046  
Total operating expenses     (8 )     1,801       1,811       3,767  
                                 
(Loss) income from operations     (7 )     440       (708 )     782  
                                 
Other income (expenses):                                
Interest expense     -       (605 )     (243 )     (1,116 )
Other expense     (128 )     (14 )     (158 )     (28 )
(Loss) gain on disposal     (1,063 )     -       1,574       -  
Total other income (expense)     (1,191 )     (619 )     1,173       (1,144 )
                                 
Net (loss) income on discontinued operations   $ (1,198 )   $ (179 )   $ 465     $ (362 )

 

15. SUBSEQUENT EVENTS

 

Related Party Debt Conversions

 

During July 2016, the Company issued 125,000 shares of its common stock to Mark Munro pursuant to the conversion of $100 principal amount of promissory notes payable.

 

During July 2016, the Company issued 125,000 shares of its common stock to Pascack Road, LLC pursuant to the conversion of $100 principal amount of promissory notes payable.

 

Promissory Note Debt Conversions

 

During July 2016, the Company issued 288,512 shares of its common stock to the investor who holds the August 6, 2015 senior convertible note pursuant to the conversion of $158 of principal and related accrued interest.

 

During July 2016, the Company issued 300,099 shares of its common stock to the investor who holds the November 12, 2015 senior convertible note pursuant to the conversion of $124 of principal and related accrued interest.

 

During August 2016, the Company issued 138,741 shares of its common stock to the investor who holds the November 12, 2015 senior convertible note pursuant to the conversion of $44 of principal and related accrued interest.

 

  46  

 

 

INTERCLOUD SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

 

Richard Smithline Senior Convertible Note

 

During July 2016, the Company issued 98,386 shares of its common stock to Richard Smithline pursuant to the conversion of $47 of principal and related accrued interest.

 

Forward Investments, LLC Promissory Note Conversions

 

During July 2016, the Company issued 793,519 shares of its common stock to Forward Investments, LLC pursuant to conversion of $446 principal amount of promissory notes outstanding.

 

During August 2016, the Company issued 312,522 shares of its common stock to Forward Investments, LLC pursuant to conversion of $146 principal amount of promissory notes outstanding.

 

JGB Waltham

 

During July 2016, the Company paid $169 of principal and $1 of related interest in cash to JGB Waltham related to the outstanding December 2015 senior secured convertible debenture.

 

During July 2016, the Company paid $76 of principal and $12 of related interest in cash to JGB Waltham related to the outstanding 2.7 Note.

 

During August 2016, the Company paid $76 of principal and $12 of related interest in cash to JGB Waltham related to the outstanding 2.7 Note.

 

JGB Concord

 

During July 2016, the Company paid $145 of principal and $23 of related interest in cash to JGB Concord related to the outstanding 5.2 Note.

 

During August 2016, the Company paid $145 of principal and $23 of related interest in cash to JGB Concord related to the outstanding 5.2 Note.

 

  47  

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion of our financial condition and results of operations for the three and months ended June 30, 2016 and 2015 should be read in conjunction with our unaudited condensed consolidated financial statements and the notes to those statements that are included elsewhere in this report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under Item 1A. Risk Factors appearing in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed on June 17, 2016 with the Securities and Exchange Commission. We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements. See the information under the caption “Forward Looking Statements” on page 1 of this report.

 

Unless expressed otherwise, all dollar amounts other than per share amounts are expressed in thousands.

 

Overview

 

We operate in three reportable segments: applications and infrastructure, professional services, and managed services. The applications and infrastructure operating segment is an aggregation of the component operations of RM Leasing, TNS and the AWS Entities. On January 1, 2015, we merged the operations of Tropical into the operations of AWS. The professional services operating segment is an aggregation of the operations of the ADEX Entities and SDN. The managed services operating segment is primarily comprised of the operations of IPC. On January 1, 2015, we merged the operations of RentVM with the operations of IPC.

 

On February 17, 2016, we sold certain assets of our formerly-owned VaultLogix and subsidiaries reporting unit, which was included in our cloud services segment. On April 29, 2016, we sold our formerly-owned Axim subsidiary, which was included in our cloud services segment. The operations of VaultLogix and its subsidiaries as well as Axim have been excluded from the comparative tables noted below and are included within the line item “net income (loss) on discontinued operations” within our unaudited condensed consolidated statement of operations.

 

Results of Continuing Operations – Three months ended June 30, 2016 and 2015

 

Revenues:

 

    Three months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 6,597     $ 4,761     $ 1,836       39 %
Professional services     11,825       6,310       5,515       87 %
Managed services     4,172       8,488       (4,316 )     -51 %
Total   $ 22,594     $ 19,559     $ 3,035       16 %

 

Revenues for the three-month period ended June 30, 2016 increased by $3.0 million, or 16%, to $22.6 million, as compared to $19.6 million for the corresponding period in 2015. The increase in revenues resulted primarily from an increase in our professional services segment due to a one-time event at a large telecommunications carrier that resulted in increased revenue. Additionally, increased revenue from our applications and infrastructure segment was offset by a decrease in revenue from our managed services segment.

 

During the three-month period ended June 30, 2016, 52% of our revenue was derived from our professional services segment, 18% from our managed services segment, and 29% from our applications and infrastructure segment. During the three-month period ended June 30, 2015, 32% of our revenue was derived from our professional services segment, 43% from our managed services segment, and 24% from our applications and infrastructure. Revenues from our managed services segment tends to be recurring in nature. Such recurring revenue was $2.4 million and $4.4 million for the three months ended June 30, 2016 and 2015, respectively.

 

  48  

 

 

Cost of revenue and gross margin:

 

    Three months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure                        
Cost of revenue   $ 5,470     $ 3,301     $ 2,169       66 %
Gross profit   $ 1,127     $ 1,460     $ (333 )     -23 %
Gross profit percentage     17 %     31 %                
                                 
Professional services                                
Cost of revenue   $ 8,903     $ 5,073     $ 3,830       75 %
Gross profit   $ 2,922     $ 1,237     $ 1,685       136 %
Gross profit percentage     25 %     20 %                
                                 
Managed services                                
Cost of revenue   $ 3,002     $ 6,788     $ (3,786 )     -56 %
Gross profit   $ 1,170     $ 1,700     $ (530 )     -31 %
Gross profit percentage     28 %     20 %                
                                 
Total                                
Cost of revenue   $ 17,375     $ 15,162     $ 2,213       15 %
Gross profit   $ 5,219     $ 4,397     $ 822       19 %
Gross profit percentage     23 %     22 %                

 

Cost of revenue for the three-month periods ended June 30, 2016 and 2015 primarily consisted of direct labor provided by employees, services provided by subcontractors, direct material and other related costs. For a majority of the contract services we perform, our customers provide all necessary materials and we provide the personnel, tools and equipment necessary to perform installation and maintenance services. The increase in cost of revenue of $2.2 million, or 15%, for the three-month period ended June 30, 2016 was primarily attributable increase in cost of revenue in our professional services and application and infrastructure segments. This increase in cost of goods sold from our professional services segment is directly related to the increase in revenue resulting from a one-time event at a large telecommunications carrier referred to above. The increase in cost of goods sold related to our applications and infrastructure segment resulted from declining gross margins during this period. Costs of revenue as a percentage of revenues was 77% for the three-month period ended June 30, 2016, as compared to 78% for the same period in 2015.

 

Our gross profit percentage was 23% for the three-month period ended June 30, 2016, as compared to 22% for the comparable period in 2015. The overall increase in gross profit percentage was primarily due to higher margins realized on jobs within our professional services segment.

 

Salaries and wages:

 

    Three months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 483     $ 465     $ 18       4 %
Percentage of total revenue     2 %     2 %                
                                 
Professional services   $ 1,324     $ 805     $ 519       64 %
Percentage of total revenue     6 %     4 %                
                                 
Managed services   $ 1,122     $ 1,297     $ (175 )     -13 %
Percentage of total revenue     5 %     7 %                
                                 
Corporate   $ 1,276     $ 5,752     $ (4,476 )     -78 %
Percentage of total revenue     6 %     29 %                
                                 
Total   $ 4,205     $ 8,319     $ (4,114 )     -49 %
Percentage of total revenue     19 %     43 %                

 

  49  

 

 

For the three-month period ended June 30, 2016, salaries and wages decreased $4.1 million to $4.2 million as compared to approximately $8.3 million for the same period in 2015. The decrease resulted primarily from a decrease in salaries and wages in our corporate segment, which resulted from a decrease in stock compensation expense of $4.6 million during the 2016 period compared to the same period in 2015. This decrease was offset by increased salary and wages expense in our professional services segment. Salaries and wages were 19% of revenue in the three-month period ended June 30, 2016, as compared to 43% for the same period in 2015. Our salaries and wages will not increase proportionally to an increase in our revenue. 

 

General and Administrative:

 

    Three months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 651     $ 430     $ 221       51 %
Percentage of total revenue     3 %     2 %                
                                 
Professional services   $ 605     $ 377     $ 228       60 %
Percentage of total revenue     3 %     2 %                
                                 
Managed services   $ 895     $ 554     $ 341       62 %
Percentage of total revenue     4 %     3 %                
                                 
Corporate   $ 2,625     $ 1,134     $ 1,491       131 %
Percentage of total revenue     12 %     6 %                
                                 
Total   $ 4,776     $ 2,495     $ 2,281       91 %
Percentage of total revenue     21 %     13 %                

   

General and administrative costs include all of our corporate costs, as well as the costs of our subsidiaries’ management personnel and administrative overhead. These costs consist of office rental, legal, consulting and professional fees, travel costs and other costs that are not directly related to the performance of our services under customer contracts. General and administrative expenses increased approximately $2.3 million, or 91%, to $4.8 million in the three-month period ended June 30, 2016, as compared to $2.5 million in the comparable period of 2015. This increase primarily resulted from increases in accounting and legal expense primarily resulting from changing independent auditors. Accounting and legal expense increased $1.5 million during the second quarter compared to the same period in 2015. Additionally, marketing development funds decreased by $0.4 million during the second quarter of 2016. Marketing development funds offset general and administrative expense. As a result, general and administrative expense increased by this amount. General and administrative expenses increased to 21% of revenues in the three-month period ended June 30, 2016, from 13% in the comparable period in 2015.

 

Interest Expense:

 

Interest expense for the three-month period ended June 30, 2016 and 2015 was $3.4 million and $1.8 million, respectively. The increase in interest expense primarily resulted from debt incurred during December 31, 2015 and February 2016.

 

Net Loss Attributable to our Common Stockholders:

 

Net loss attributable to our common stockholders was $13.4 million for three-month period ended June 30, 2016, as compared to net loss attributable to common stockholders of $14.5 million for the three months ended June 30, 2015. The decrease in net loss was primarily due to a decrease in loss from operations of approximately $3.0 million. This decrease was offset by increased losses of $0.9 million in our former cloud services segment, which is shown as a loss on discontinued operations. Additionally, non-cash gains related to our derivative instruments increased by $1.9 million.

 

  50  

 

 

Results of Continuing Operations – Six months ended June 30, 2016 and 2015

 

Revenues:

 

    Six months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 11,832     $ 9,491     $ 2,341       25 %
Professional services     18,345       13,174       5,171       39 %
Managed services     10,046       15,132       (5,086 )     -34 %
Total   $ 40,223     $ 37,797     $ 2,426       6 %

 

Revenues for the six-month period ended June 30, 2016 increased by $2.4 million, or 6%, to $40.2 million, as compared to $37.8 million for the corresponding period in 2015. The increase in revenues resulted primarily from an increase in our professional services segment due to a one-time event at a large telecommunications carrier which resulted in increased revenue. Additionally, increased revenue from our applications and infrastructure segment was offset by a decrease in revenue from our managed services segment.

 

During the six-month period ended June 30, 2016, 46% of our revenue was derived from our professional services segment, 25% from our managed services segment, and 29% from our applications and infrastructure segment. During the six-month period ended June 30, 2015, 35% of our revenue was derived from our professional services segment, 40% from our managed services segment, and 25% from our applications and infrastructure segment. Revenues from our managed services segment tends to be recurring in nature. Such recurring revenue was $5.3 million and $7.1 million for the six months ended June 30, 2016 and 2015, respectively.

 

  51  

 

 

Cost of revenue and gross margin:

 

    Six months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure                        
Cost of revenue   $ 9,979     $ 6,835     $ 3,144       46 %
Gross profit   $ 1,853     $ 2,656     $ (803 )     -30 %
Gross profit percentage     16 %     28 %                
                                 
Professional services                                
Cost of revenue   $ 13,970     $ 10,485     $ 3,485       33 %
Gross profit   $ 4,375     $ 2,689     $ 1,686       63 %
Gross profit percentage     24 %     20 %                
                                 
Managed services                                
Cost of revenue   $ 6,641     $ 11,014     $ (4,373 )     -40 %
Gross profit   $ 3,405     $ 4,118     $ (713 )     -17 %
Gross profit percentage     34 %     27 %                
                                 
Total                                
Cost of revenue   $ 30,590     $ 28,334     $ 2,256       8 %
Gross profit   $ 9,633     $ 9,463     $ 170       2 %
Gross profit percentage     24 %     25 %                

 

Cost of revenue for the six-month periods ended June 30, 2016 and 2015 primarily consisted of direct labor provided by employees, services provided by subcontractors, direct material and other related costs. For a majority of the contract services we perform, our customers provide all necessary materials and we provide the personnel, tools and equipment necessary to perform installation and maintenance services. The increase in cost of revenue of $2.3 million, or 8%, for the six-month period ended June 30, 2016 was primarily attributable to an increase in cost of revenue in our professional services and application and infrastructure segments. This increase in cost of goods sold from our professional services segment is directly related to the increase in revenue resulting from a one-time event at a large telecommunications carrier referred to above. The increase in cost of goods sold related to our applications and infrastructure segment resulted from declining gross margins during this period. Costs of revenue as a percentage of revenues was 76% for the six-month period ended June 30, 2016, as compared to 75% for the same period in 2015.

 

Our gross profit percentage was 24% for the six-month period ended June 30, 2016, as compared to 25% for the comparable period in 2015. The overall decrease in gross profit percentage was primarily due to lower margins realized on jobs within our applications and infrastructure segment.

 

Salaries and wages:

 

    Six months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 926     $ 971     $ (45 )     -5 %
Percentage of total revenue     2 %     3 %                
                                 
Professional services   $ 2,434     $ 1,854     $ 580       31 %
Percentage of total revenue     6 %     5 %                
                                 
Managed services   $ 2,272     $ 3,134     $ (862 )     -28 %
Percentage of total revenue     6 %     8 %                
                                 
Corporate   $ 2,679     $ 7,401     $ (4,722 )     -64 %
Percentage of total revenue     7 %     20 %                
                                 
Total   $ 8,311     $ 13,360     $ (5,049 )     -38 %
Percentage of total revenue     21 %     35 %                

 

  52  

 

 

For the six-month period ended June 30, 2016, salaries and wages decreased $5.0 million to $8.3 million as compared to approximately $13.4 million for the same period in 2015. The decrease resulted primarily from a decrease in salaries and wages in our corporate segment, which resulted from a decrease in stock compensation expense of $5.1 million during the six months ended June 30, 2016 compared to the same period in 2015. This decrease was offset by increased salary and wages expense in our professional services segment. Salaries and wages were 21% of revenue in the six month period ended June 30, 2016, as compared to 35% for the same period in 2015. Our salaries and wages will not increase proportionally to an increase in our revenue. 

 

General and Administrative:

 

    Six months ended June 30,     Change  
(dollar amounts in thousands)   2016     2015     Dollars     Percentage  
Applications and infrastructure   $ 1,176     $ 941     $ 235       25 %
Percentage of total revenue     3 %     2 %                
                                 
Professional services   $ 1,039     $ 793     $ 246       31 %
Percentage of total revenue     3 %     2 %                
                                 
Managed services   $ 1,524     $ 829     $ 695       84 %
Percentage of total revenue     4 %     2 %                
                                 
Corporate   $ 4,331     $ 2,757     $ 1,574       57 %
Percentage of total revenue     11 %     7 %                
                                 
Total   $ 8,070     $ 5,320     $ 2,750       52 %
Percentage of total revenue     20 %     14 %                

   

General and administrative costs include all of our corporate costs, as well as the costs of our subsidiaries’ management personnel and administrative overhead. These costs consist of office rental, legal, consulting and professional fees, travel costs and other costs that are not directly related to the performance of our services under customer contracts. General and administrative expenses increased approximately $2.8 million, or 52%, to $8.1 million in the six-month period ended June 30, 2016, as compared to $5.3 million in the comparable period of 2015. This increase primarily resulted from increases in accounting and legal expense primarily resulting from changing independent auditors. Accounting and legal expense increased $1.7 million during the six months ended June 30, 2016 compared to the same period in 2015. Additionally, marketing development funds decreased by $0.7 million during this period in 2016. Marketing development funds offset general and administrative expense. As a result, general and administrative expense increased by this amount. General and administrative expenses increased to 20% of revenues in the six-month period ended June 30, 2016, from 14% in the comparable period in 2015.

 

Interest Expense:

 

Interest expense for the six-month period ended June 30, 2016 and 2015 was $8.1 million and $5.0 million, respectively. The increase in interest expense primarily resulted from debt incurred during December 31, 2015 and February 2016.

 

Net Loss Attributable to our Common Stockholders.

 

Net loss attributable to our common stockholders was $17.7 million for six-month period ended June 30, 2016, as compared to net loss attributable to common stockholders of $24.8 million for the six months ended June 30, 2015. The decrease in net loss was primarily due to a decrease of $2.9 million in loss from operations. Additionally, non-cash gains related to our derivative instruments increased by $4.8 million.

 

Liquidity and Capital Resources

 

We believe that our available cash balance as of the date of this filing will not be sufficient to fund our anticipated level of operations for at least the next twelve months. The Independent Registered Public Accounting Firms’ Report issued in connection with our audited financial statements for the year ended December 31, 2015 stated that there is “substantial doubt about the Company’s ability to continue as a going concern”. Management believes that our ability to continue our operations depends on our ability to sustain and grow revenue and results of operations as well as our ability to access capital markets when necessary to accomplish our strategic objectives. Management believes that we will continue to incur losses for the immediate future. For the three and six months ended June 30, 2016, we generated gross profits from operations but were unable to achieve positive cash flow from operations. We expect to finance our cash needs from our operations and, depending on results of operations, we may need additional equity or debt financing until we can achieve profitability and positive cash flows from operating activities, if ever.

 

At June 30, 2016, we had a working capital deficit of $21.8 million, as compared to a working capital deficit of $11.4 million at December 31, 2015.

 

We anticipate meeting our cash obligations on our indebtedness that is payable on or prior to June 30, 2017 from our cash flows from operations. Additionally, during February 2016, we sold the assets of our wholly owned subsidiary, VaultLogix, for $24 million plus a working capital adjustment of approximately $2 million, which is held in an escrow account. However, of the proceeds we received from such sale, approximately $12 million was deposited in a restricted account and has been pledged in escrow for the repayment of our outstanding indebtedness to JGB Waltham and JGB Concord.

 

  53  

 

 

Our future capital requirements for our operations will depend on many factors, including the profitability of our businesses, the number and cash requirements of other acquisition candidates that we pursue, and the costs of our operations. We have been investing in sales personnel in anticipation of increasing revenue opportunities in the cloud services and managed services segments of our business, which has contributed to our losses from operations. Our management has taken several actions to ensure that we will have sufficient liquidity to meet our obligations through June 30, 2017, including the reduction of certain general and administrative expenses, consulting expenses and other professional services fees. Additionally, if our actual revenues are less than forecasted, we anticipate implementing headcount reductions to a level that more appropriately matches then-current revenue and expense levels. We also are evaluating other measures to further improve our liquidity, including, the sale of equity or debt securities and entering into joint ventures with third parties. Lastly, we may elect to reduce certain related-party and third-party debt by converting such debt into common shares. We are currently in discussions with a third party on a credit facility to enhance our liquidity position. Our management believes that these actions will enable us to meet our liquidity requirements through June 30, 2017. There is no assurance that we will be successful in any capital-raising efforts that we may undertake to fund operations during 2016.

 

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

 

We had capital expenditures of $0.08 million and $0.03 million for the three-month periods ended June 30, 2016 and 2015, respectively, and $0.1 million and $0.05 million for the six-month periods ended June 30, 2016 and 2015, respectively. We expect our capital expenditures for the 12 months ending June 30, 2017 to be consistent with our prior spending. These capital expenditures will be primarily utilized for equipment needed to generate revenue and for office equipment. We expect to fund such capital expenditures out of our working capital.

 

The following summary of our cash flows for the periods indicated has been derived from our historical consolidated financial statements, which are included elsewhere in this report:

 

Summary of Cash Flows

 

    Three months ended
March 31,
 
    2016     2015  
Net cash (used in) provided by operating activities   $ (11,535 )   $ 752  
Net cash provided by (used in) investing activities     8,041       (1,262 )
Net cash (used in) provided by financing activities     (2,018 )     314  

 

  54  

 

 

Net cash used in operating activities for the six months ended June 30, 2016 was $11.5 million, which included $1.4 million in stock compensation charges, gains on the fair value of derivative liabilities of $4.8 million, losses on the extinguishment of debt of $7.8 million and changes in accounts receivable, inventory, other assets, deferred revenue and accounts payable and accrued expenses of $3.0 million.

 

Net cash provided by investing activities for the six months ended June 30, 2016 was $8.0 million. This consisted primarily of the net cash provided by the investing activities of discontinued operations in regards to the disposal of our former VaultLogix subsidiary.

 

Net cash used in financing activities was $2.0 million for the six months ended June 30, 2016. This consisted of repayments of bank borrowings and term loans.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable for a smaller reporting company.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

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

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation and the material weaknesses described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective such that the information relating to our company required to be disclosed in our SEC reports (i) is not recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is not accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. The material weaknesses relate to our inability to timely file our reports and other information with the SEC as required under Section 13 of the Exchange Act, together with material weaknesses in our internal control over financial reporting. Our management also has identified material weaknesses in our internal controls over financial reporting relating to (i) our failure to effectively implement comprehensive entity-level internal controls, (ii) our lack of a sufficient complement of personnel with an appropriate level of knowledge and experience in the application of U.S. GAAP commensurate with our financial reporting requirements and, (iii) our lack of the quantity of resources necessary to implement an appropriate level of review controls to properly evaluate the completeness and accuracy of the transactions into which we enter. Our management believes that these weaknesses are due in part to the small size of our staff, which makes it challenging to maintain adequate disclosure controls. To remediate the material weaknesses in disclosure controls and procedures during 2016 we hired a third-party firm to assess, document and test our internal controls over financial reporting. We plan to hire additional experienced accounting and other personnel to assist with filings and financial record keeping and to take additional steps to improve our financial reporting systems and implement new policies, procedures and controls.

 

Changes in Internal Control over Financial Reporting

 

The disposal of our former Axim subsidiary, which was the remaining cloud services segment component, constitutes a change in internal control over financial reporting that occurred during the three months covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

  55  

 

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

There have been no material developments in any of the legal proceedings discussed in Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2015 or Item 1 of Part II of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2016, except as described below.

 

Derivative Action . On July 12, 2016, a derivative compliant entitled John Scrutchens, derivatively and on behalf of InterCloud Systems, Inc. v. Mark E. Munro, Mark F. Durfee, Charles K. Miller, Neal Oristano, and Roger Ponder, Defendants, and InterCloud Systems, Inc., Nominal Defendant, Case No.: 3:16-CV-04207-FLW-DEA (D.N.J.) was filed in the United States Federal District Court for the District of New Jersey. This action arises out of the same conduct at issue in the purported class action lawsuit filed against our company. In the complaint, nominal plaintiff alleges that the individual defendants violated Section 14(a) of the Securities Exchange Act of 1934, as amended, and Rule 14a-9 promulgated thereunder because in exercising reasonable care as directors of our company, the defendants knew or should have known that statements contained in our proxy statements for our annual stockholders’ meetings held in 2013 and 2014 were false and misleading in that such proxy statements (i) omitted material information regarding, among other wrongdoings, the purported wrongdoings of the defendants that generally are at issue in the purported class action lawsuit filed against us and the other derivative actions filed against the defendants, and (ii) included by reference materially false and misleading financial statements.  Plaintiffs seek unspecified damages, amendments to our corporate governance and internal procedures to comply with applicable laws and to protect our company and our stockholders from a repeat of the purported wrongdoings of the defendants, punitive damages from the individual defendants, disgorgement from the individual defendants and costs and disbursements in the action.

 

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

 

Item 1A. Risk Factors.

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015, which could materially affect our business, financial condition, or future results. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and operating results.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

During the quarter ended June 30, 2016, we issued securities in the following transactions, each of which was exempt from the registration requirements of the Securities Act. Except for the shares of our common stock that were issued upon the conversion of our convertible debt securities or the grants of shares of common stock under our 2012 Performance Incentive Plan, all of the below-referenced securities were issued pursuant to the exemption from registration under Section 4(2) of the Securities Act and are deemed to be restricted securities for purposes of the Securities Act. There were no underwriters or placement agents employed in connection with any of these transactions. Use of the exemption provided in Section 4(2) for transactions not involving a public offering is based on the following facts:

 

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

 

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

 

The shares of our common stock that were granted to employees under our 2012 Performance Incentive Plan were issued pursuant to the exemption from registration under the Securities Act in reliance on Rule 701 of the Securities Act as offers and sales of securities under compensatory benefit plans and contracts relating to compensation in compliance with Rule 701. Each of the recipients of securities in any transaction exempt from registration either received or had adequate access, through employment, business or other relationships, to information about us.

 

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

 

On April 11, 2016, we issued an aggregate of 73,996 shares of common stock upon conversion of $48 principal amount of term loans and related accrued interest, which were issued at $0.65 per share.

 

  56  

 

 

On May 12, 2016, we issued an aggregate of 88,532 shares of common stock upon conversion of $48 principal amount of term loans and related accrued interest, which were issued at $0.54 per share.

 

On June 13, 2016, we issued an aggregate of 68,254 shares of common stock upon conversion of $47 principal amount of term loans, which were issued at $0.69 per share.

 

On June 23, 2016, we issued an aggregate of 900,000 shares of common stock related to the restructuring of certain notes payable, which were issued at $0.92 per share.

 

On June 30, 2016, we issued an aggregate of 284,406 shares of common stock upon conversion of $156 principal amount of term loans and related accrued interest, which were issued at $0.55 per share.

 

(c) Stock Repurchases

 

During the second quarter of 2016, we purchased shares of our outstanding common stock as follows:

 

Period   Total Number of Shares Purchased     Average  Price Paid per Share     Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (b)     Approximate Dollar Value of Shares that May Yet be Purchased under the Plans or Programs (b)  
                         
April 1, 2016 to April 30, 2016     -       -       -       -  
May 1, 2016 to May 31, 2016     -       -       -       -  
June 1, 2016 to June 30, 2016     55,167 (a)     0.01       -       -  

 

  (a) The Company repurchased 55,167 shares of common shares related to the unvested portion of stock grants issued to employees who terminated their employment during the second quarter of 2016.
     
  (b) We have no publicly-announced repurchase program in place.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

31.1   Certification of Principal Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2   Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.1   Certification of Principal Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
32.2   Certification of Principal Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
101.INS*   XBRL Instance Document
101.SCH*   XBRL Taxonomy Schema Document
101.CAL*   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*   XBRL Taxonomy Extension Label Linkbase Document
101.PRE*   XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*   XBRL Taxonomy Extension Definition Linkbase Document

 

* Furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise not subject to liability under these sections.

 

  57  

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  INTERCLOUD SYSTEMS, INC.
     
August 9, 2016 By: /s/ Timothy A. Larkin
   

Timothy A. Larkin, Chief Financial Officer,

Principal Financial Officer and

Principal Accounting Officer

 

 

58

 

 

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