Note 2. Management Plans - Capital Resources
The
Company reported operating losses of $114,939 and $394,021 and net
losses of $303,070 and $688,289 for the nine months ended September
30, 2016 and 2015, respectively. Accordingly, there is substantial
doubt about the Company’s ability to continue as a going
concern through November 4, 2017.
The
Company’s business strategy is summarized as
follows.
On
October 1, 2014, the Company hired an executive officer, who is now
our Chief Operating Officer and is responsible for developing and
implementing the strategic direction of the Company through
improved operations, sales and marketing, product development, and
overall collaboration across the enterprise.
Beginning
in 2014, the Company performed vulnerability scans against internal
and external networks using licensed software. In February 2015,
the Company purchased proprietary cybersecurity reporting software
and created a Director of Cybersecurity position with expertise in
designing, developing, marketing, and selling network security
assessment software and project assessments (see Note 7). The
Company provides technical and executive summary reports of ongoing
risks, identifies and prioritizes security vulnerabilities and
communicates remediation recommendations. Since early 2015, the
Company has developed new hardware and software that is a
cybersecurity vulnerability management solution for small and
medium sized businesses (SMBs), that is for sale through
IGI’s channel partner program. The Company markets this
patent pending product as “Nodeware”.
The
Company's strategy is to build its business by delivering a wide
range of IT solutions and services that address challenges common
to many U.S. Government agencies, state and local governments and
commercial companies including SMBs. The Company’s plans
include continuing to provide cloud and large scale remote IT
managed services and solutions and continued expansion into the
commercial SMB sector. The Company also reviews potential
acquisitions of IT assets and businesses. The Company is committed
to remaining on the leading edge of technologies and trends in the
IT service sector. The Company’s ability to succeed may
depend on how successful it is in differentiating itself from
competition at a time when competition in these markets is on the
rise.
The
Company has established four pillars or business groups to focus
on:
●
Cybersecurity
solutions. The Company brings innovative solutions to market such
as Nodeware and cybersecurity projects through its professional
services organization (PSO);
●
Commercial IT sales
to SMB’s. The Company’s inside sales organization
drives a channel strategy to the commercial SMB market by bringing
IT solutions to its channel partners. The Company markets Nodeware,
Webroot (antivirus/malware protection), and VMware solutions such
as Airwatch.
●
Managed services to
enterprise customers. The Company provides optimization and
continuity planning, operational support services, internal
automation, platform management as a service, virtualization
licensing and services, and management of server, network and
mobile devices; and
●
Software licenses
and services reseller. As a VMware Enterprise level partner, the
Company is a software licenses and services reseller that is
focused on growing its direct to business revenue. This includes
selling architecting, integration and support services while
continuing to work with the VMware PSO as a subcontractor on
multiple engagements.
Continue to Improve Operations and Capital Resources
The
Company's goal is to increase sales and generate cash flow from
operations on a consistent basis. The Company used ISO 9001-2008
practices as a tool for improvement that has aided expense
reduction and internal performance.
On March 14, 2016, the Company entered into
an unsecured
financing agreement with a third party lender to provide working
capital as discussed in Note 8. The Company intends to build the
infrastructure to market its new cyber security product, Nodeware.
Further, the Company’s business plans require improving the
results of its operations in future periods.
On
December 1, 2014, the Company entered into an unsecured line of
credit financing agreement (the “LOC Agreement”) with a
member of its board of directors. The LOC Agreement, as modified,
provides for working capital of up to $400,000 through January 1,
2020. At September 30, 2016, there is $11,956 available on this
line.
The
Company believes the capital resources available under its
factoring line of credit, cash from additional related party and
third party loans and cash generated by improving the results of
its operations provide sources to fund its ongoing operations and
to support the internal growth of the Company. If the Company
experiences significant growth in its sales, the Company believes
that this may require it to increase its financing line, finance
additional accounts receivable, or obtain additional working
capital from other sources to support its sales
growth.
The
Company's primary source of liquidity is cash provided by
collections of accounts receivable and its factoring line of
credit. At September 30, 2016, the Company had approximately
$203,000 of availability under this line. During the nine months
ended September 30, 2016, the Company financed its business
activities through sales with recourse of accounts receivable and a
loan from a third party.
The
Company’s working capital deficit increased from
approximately $1,900,000 at December 31, 2015 to approximately
$2,143,000 at September 30, 2016 principally due to the scheduled
maturity on January 1, 2017 of notes payable of $146,300 to a
related party and $264,000 to others which total $410,300. The
Company plans to renegotiate the terms of its notes payable, seek
funds to repay the notes or use a combination of both
alternatives.
Note
3. Summary of Significant Accounting Policies
There
are several accounting policies that the Company believes are
significant to the presentation of its financial statements. These
policies require management to make complex or subjective judgments
about matters that are inherently uncertain. Note 3 to the
Company’s audited financial statements for the year ended
December 31, 2015 presents a summary of significant accounting
policies as included in the Company's Annual Report on Form 10-K as
filed with the SEC. The Company adopted ASU 2015-03 Simplifying the
Presentation of Debt Issuance Costs during the three months ended
March 31, 2016. The guidance was applied retrospectively and
resulted in a reclassification between assets and liabilities of
$62,031 and $34,638 as of September 30, 2016 and December 31, 2015,
respectively.
Reclassifications
– The Company reclassifies amounts
in its financial statements to comply with recently adopted
accounting pronouncements.
Fair Value of Financial Instruments
- The carrying amounts
reported in the balance sheets for cash, accounts receivable,
accounts payable, and accrued expenses approximate fair value
because of the immediate short-term maturity of these financial
instruments. The carrying value of notes payable and convertible
notes payable approximates the fair value based on rates currently
available from financial institutions and various
lenders.
Recent Accounting Pronouncements Not Yet Adopted -
In May
2014, the FASB issued new accounting guidance on revenue from
contracts with customers. The new guidance requires an entity to
recognize the amount of revenue to which it expects to be entitled
for the transfer of promised goods or services to customers. The
updated guidance will replace most existing revenue recognition
guidance in GAAP when it becomes effective and permits the use of
either a retrospective or cumulative effect transition method. This
guidance is effective for fiscal years, and interim periods within
those fiscal years, beginning after December 15, 2017. The Company
will evaluate the effect that the updated standard will have on its
financial statements and related disclosures and select a
transition method.
In
November 2015, the FASB issued new accounting guidance on the
classification of deferred taxes. The new guidance requires that
all deferred tax asset and liabilities be classified as noncurrent
in a classified statement of financial position. This guidance is
effective for financial statements issued for fiscal years
beginning after December 15, 2016 and interim periods within those
fiscal years. Early application is permitted. When the guidance is
effective all deferred tax assets and liabilities will be presented
as noncurrent. The Company does not believe this guidance will have
a material effect on the Company’s financial statements when
adopted.
In
February 2016, the FASB issued amended guidance for lease
arrangements in order to increase transparency and comparability by
providing additional information to users of financial statements
regarding an entity's leasing activities. The revised guidance
seeks to achieve this objective by requiring reporting entities to
recognize lease assets and lease liabilities on the balance sheet
for substantially all lease arrangements. The guidance, which is
required to be adopted in the first quarter of 2019, will be
applied on a modified retrospective basis beginning with the
earliest period presented. Early adoption is permitted. The Company
is currently evaluating the impact of adopting this guidance on our
financial statements.
Note 4. Sale of Certain Accounts Receivable
The
Company has available a financing line with a financial institution
(the Purchaser) which enables the Company to sell selected accounts
receivable invoices to the Purchaser with full recourse against the
Company.
Pursuant
to the provisions of FASB ASC 860, the Company reflects the
transactions as a sale of assets and establishes an accounts
receivable from the Purchaser for the retained amount less the
costs of the transaction and less any anticipated future loss in
the value of the retained asset. Through August 28, 2016, the
retained amount was equal to 15% of the total accounts receivable
invoice sold to the Purchaser. The fee was charged at prime plus 4%
against the average daily outstanding balance of funds advanced. On
August 29, 2016, the Company completed a revised financing
agreement with the Purchaser. The retained amount was revised to
10% of the total accounts receivable invoice sold to the Purchaser.
The fee is charged at prime plus 3.6% (effective rate of 7.1% at
September 30, 2016) against the average daily outstanding balance
of funds advanced.
The
estimated future loss reserve for each receivable included in the
estimated value of the retained asset is based on the payment
history of the accounts receivable customer and is included in the
allowance for doubtful accounts, if any. As collateral, the Company
granted the Purchaser a first priority interest in accounts
receivable and a blanket lien, which may be junior to other
creditors, on all other assets.
The
financing line provides the Company the ability to finance up to
$2,000,000 of selected accounts receivable invoices, which includes
a sublimit for one of the Company’s customers of $1,500,000.
During the nine months ended September 30, 2016, the Company sold
approximately $4,524,000 ($5,443,000 - September 30, 2015) of its
accounts receivable to the Purchaser. As of September 30, 2016,
approximately $428,000 ($566,561 - December 31, 2015) of these
receivables remained outstanding. Additionally, as of September 30,
2016, the Company had approximately $203,000 available under the
financing line with the financial institution ($20,000 - December
31, 2015). After deducting estimated fees and advances from the
Purchaser, the net receivable from the Purchaser amounted to
$42,839 at September 30, 2016 ($82,341 - December 31 2015) and is
included in accounts receivable in the accompanying balance
sheets.
There
were no gains or losses on the sale of the accounts receivable
because all were collected. The cost associated with the financing
line totaled approximately $53,063 for the nine months ended
September 30, 2016 ($60,500 - September 30, 2015). These financing
line fees are classified on the statements of operations as
interest expense.
Note 5. Earnings Per Share
Basic
earnings per share is based on the weighted average number of
common shares outstanding during the periods presented. Diluted
earnings per share is based on the weighted average number of
common shares outstanding, as well as dilutive potential common
shares which, in the Company’s case, comprise shares issuable
under convertible notes payable and stock options. The treasury
stock method is used to calculate dilutive shares, which reduces
the gross number of dilutive shares by the number of shares
purchasable from the proceeds of the options and convertible notes
assumed to be exercised. In a loss period, the calculation for
basic and diluted earnings per share is considered to be the same,
as the impact of potential common shares is
anti-dilutive.
The following table sets forth the computation of basic and diluted
net loss per share.
|
|
Three months ended
September 30,
|
Nine
months ended
September
30,
|
|
|
|
|
|
|
|
Numerator
for basic and diluted net loss per share:
|
|
|
|
|
|
Net
loss
|
$
(83,342
)
|
$
(337,754
)
|
$
(303,070
)
|
$
(688,289
)
|
|
Denominator
for basic and diluted net loss per share:
|
|
|
|
|
|
Weighted
average common shares outstanding
|
29,061,883
|
26,561,883
|
28,127,817
|
26,561,883
|
|
Basic
and diluted net loss per share
|
$
.00
|
$
(.01
)
|
$
(.01
)
|
$
(.03
)
|
|
|
|
|
|
|
|
Anti-dilutive
shares excluded from net loss per share
|
28,829,443
|
28,418,880
|
28,829,443
|
28,418,880
|
|
|
|
|
|
|
Certain common shares issuable under stock options and convertible
notes payable have been omitted from the diluted net loss per share
calculation because their inclusion is considered anti-dilutive
because the exercise prices were greater than the average market
price of the common shares or their inclusion would have been
anti-dilutive.
Note 6. Investment
During
2014 and 2013, the Company purchased 300,000 shares of the
authorized but unissued shares of Series A Convertible Preferred
Stock (“Series A stock”), $.001 par value, of Sudo.me
Corporation (goSudo) for an aggregate purchase price of $300,000
pursuant to the terms and conditions of a preferred stock purchase
agreement. As a result, at September 30, 2016, the Company owns
approximately 9.4% of the total outstanding shares of
goSudo.
During
2015,
the investment
was
written down using the equity method because of the net losses
recorded by goSudo. In addition, the remaining carrying value of
the investment was considered impaired at September 30, 2015 due to
continued net losses of goSudo. During the nine months ended
September 30, 2016 and 2015, goSudo earned consulting fees of $0
and $76,766, respectively, from the Company.
Note 7. Software Purchase
On
February 6, 2015, the Company purchased all rights to cyber
security network vulnerability assessment reporting software (the
“Software”). Under the purchase agreement, the Company
agreed to pay the Seller the base purchase price of $180,000, of
which $100,000 was paid in cash at the closing and the remaining
$80,000 of which was paid by delivery at the closing of the
Company’s secured promissory note. As security for its
obligations under the promissory note, the Company granted the
Seller a security interest in the Software. After April 7, 2015,
the note accrues interest at 10% per annum. The remaining balance
of $20,000 was payable on the note on June 30, 2016 but was not
paid then although the balance was reduced by $7,500 during the
three months ended September 30, 2016. To date, the Seller has not
taken any action to collect the amount past due on the note or to
enforce the security interest in the Software. At September 30,
2016, the total principal amount payable under the note is $12,500
with accrued interest payable of $6,901. The asset cost of $180,000
is amortized over the estimated useful life which was revised from
five years to three years effective July 1, 2016. Amortization
expense in future periods is estimated to be $5,000 per month or
$15,000 in 2016, $60,000 in 2017 and $45,000 in 2018.
Under
the purchase agreement, in addition to the base purchase price, the
Company also agreed to pay the Seller: (i) a percentage of the
licensing fees paid to the Company within three years after the
closing date; provided, that the maximum amount payable to the
Seller with respect to that three-year period is $800,000; plus
(ii) a percentage of the licensing fees paid to the Company during
the three years beginning on the date, if any, on which the
aggregate amount of the licensing fees paid to Seller with respect
to the initial three-year period equals $800,000. The Company has
no plans to license this software and accordingly there were no
royalties earned or payable for the nine months ended September 30,
2016 or 2015.
The
purchase agreement also provides that the Company will pay the
Seller one half of the amount by which the total software
development costs incurred by the Company in connection with
upgrading the Software to include specific functional
specifications
is less than $500,000.
The Company is not further upgrading the software and, accordingly,
has determined the potential obligation is not probable and
therefore no liability was recorded at September 30,
2016.
Note 8. Note Payable
-
Banks
and Other
On March 14, 2016, the Company entered into
an unsecured
financing agreement with a third party lender (“2016
Financing Agreement”). The agreement provides for $500,000 of
working capital with draws of $200,000 which occurred on April 13,
2016, $200,000 which occurred on August 1, 2016 and $100,000
expected to occur in 2016. Borrowings bear interest at 6% with
interest payments due quarterly. Principal is due on December 31,
2021. Principal and interest may become immediately due and payable
upon the occurrence of customary events of default. In
consideration for providing the financing, the Company paid the
lender a fee at the first closing consisting of 2,500,000 shares of
its common stock valued at $37,500 on the date of the agreement
based upon the closing bid quotation of its common stock on the OTC
Bulletin Board on that date. These deferred financing costs are
recorded as a reduction of the principal owed and are amortized
over the life of the debt. The balance of the note payable was
$365,586 at September 30, 2016 consisting of principal due of
$400,000 offset by deferred financing costs of $34,414. The lender
has piggy back registration rights for these shares. The
Company’s Chief Executive Officer and President agreed to
guarantee the loan obligations if he is no longer an
“affiliate” of the Company as defined by Securities and
Exchange Commission rules.
Note 9. Note Payable - Related Party
Note payable, line of credit, 6.35%, unsecured -
The balance
of the note payable, after monthly principal payments, was $366,395
at September 30, 2016 ($359,390 at December 31, 2015) consisting of
principal due of $388,044 less deferred financing costs of $21,649
($394,028 less $34,638 at December 31, 2015).
Principal and interest are paid monthly using an
amortization schedule for a fifteen year fully amortizing loan. On
September 30, 2016, the note maturity date was extended from
December 31, 2017 to January 1, 2020. As consideration for
extending the maturity date, the Company granted the lender an
option to purchase 800,000 common shares at $.04 per share with an
estimated fair value of $14,720
using the Black-Scholes
option-pricing model. The option value will be amortized to
interest expense over the extension period. The option expires on
September 29, 2021.
Note 10. Stock Option Plans and Agreements
The
Company has approved stock options plans and agreements covering up
to an aggregate of 9,844,500 shares of common stock. Plan options
may be designated at the time of grant as either incentive stock
options or nonqualified stock options. Stock based compensation
consists of charges for stock option awards to employees, directors
and consultants.
The
fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model. The following
assumptions were used for the nine months ended September 30, 2016
and 2015.
|
|
|
|
|
|
|
|
|
Risk-free interest
rate
|
.88 % to 1.50
%
|
|
|
Expected dividend
yield
|
0%
|
|
|
Expected
stock price volatility
|
100%
|
|
|
Expected
life of options
|
|
|
The
Company recorded expense for options issued to employees and
independent service providers of $23,364 and $12,191 for the three
months ended September 30, 2016 and 2015, respectively, and $31,301
and $42,843 for the nine months ended September 30, 2016 and 2015,
respectively.
At
September 30, 2016, there was approximately $18,800 of unrecognized
compensation cost related to non-vested options. This cost is
expected to be recognized over a weighted average period of
approximately one year. The total fair value of shares that vested
during the nine months ended September 30, 2016 was approximately
$233,000. The weighted average fair value of options granted during
the nine months ended September 30, 2016 was approximately $.02
($.03 during the nine months ended September 30, 2015). No options
were exercised during the nine months ended September 30, 2016 and
2015.
A
summary of all stock option activity for the nine months ended
September 30, 2016 follows.
|
|
|
Weighted
Average
Exercise
Price
|
Weighted-Average
Remaining Contractual Term
|
Aggregate Intrinsic
Value
|
|
|
|
|
|
|
|
Outstanding at
December 31, 2015
|
8,443,500
|
$
.16
|
|
|
|
Options
granted
|
3,223,000
|
$
.09
|
|
|
|
Options
expired
|
(53,333
)
|
$
.13
|
|
|
|
Options
forfeited
|
(2,811,667
)
|
$
.16
|
|
|
|
Outstanding at
September 30, 2016
|
8,801,500
|
$
.12
|
4.5
years
|
$
3,500
|
|
Vested or expected
to vest at
|
|
|
|
|
|
September
30, 2016
|
6,113,500
|
$
.10
|
5.6
years
|
$
3,500
|
|
|
|
|
|
|
Exercisable at
September 30, 2016
|
5,787,667
|
$
.10
|
5.6
years
|
$
3,400
|
Note 11. Related Party - Accrued Interest Payable
Accrued
Interest Payable – Included in accrued interest payable is
accrued interest payable to related parties of $78,729 at September
30, 2016 ($411,303 - December 31, 2015). During 2015, related party
interest expense included amounts accrued on behalf of a member of
the board of directors, who resigned his position effective on
January 1, 2016 and subsequently is no longer a related
party.
Note 12. Supplemental Cash Flow Information
On
April 13, 2016, as payment of a fee under the first closing of the
2016 Financing Agreement, the Company issued 2,500,000 shares of
its common stock valued on the date of execution of this agreement
at $.015 per share for $37,500 (See Note 8).
On
February 6, 2015, the Company executed and delivered a secured
promissory note in the principal amount of $80,000 in connection
with the acquisition of cybersecurity software (See Note
7).
************
Item
2.
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Business Overview
We have
established four pillars or business groups to focus
on:
●
Cybersecurity
solutions. We bring innovative solutions to market such as Nodeware
and cybersecurity projects through our professional services
organization (PSO);
●
Commercial IT sales
to SMBs. Our inside sales organization drives a channel strategy to
the commercial SMB market by bringing IT solutions to the
Company’s channel partners. We market Nodeware, Webroot
(antivirus/malware protection), and VMware solutions such as
Airwatch.
●
Managed services to
enterprise customers. We provide optimization and continuity
planning, operational support services, internal automation,
platform management as a service, virtualization licensing and
services, and management of server, network and mobile devices;
and
●
Software licenses
and services reseller. As a VMware Enterprise level partner, we are
a software licenses and services reseller that is focused on
growing its direct to business revenue. This includes selling
architecting, integration and support services while continuing to
work with the VMware PSO as a subcontractor on multiple
engagements.
Results of Operations
Comparison of Three and Nine Month Periods ended September 30, 2016
and 2015
The
following tables compare our statements of operations data for the
three and nine months ended
September
30, 2016 and 2015.
The trends suggested by this table are not indicative of future
operating results.
|
|
Three Months Ended
September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
$
1,849,639
|
100.0
%
|
$
1,919,065
|
100.0
%
|
$
(69,426
)
|
(3.6
)%
|
|
Cost of
sales
|
1,344,974
|
72.7
|
1,423,547
|
74.2
|
(78,573
)
|
(5.5
)
|
|
Gross
profit
|
504,665
|
27.3
|
495,518
|
25.8
|
9,147
|
1.8
|
|
General and
administrative
|
297,346
|
16.1
|
438,501
|
22.8
|
(141,155
)
|
(32.2
)
|
|
Selling
|
228,590
|
12.4
|
238,126
|
12.4
|
(9,536
)
|
(4.0
)
|
|
Total operating
expenses
|
525,936
|
28.4
|
676,627
|
35.3
|
(150,691
)
|
(22.3
)
|
|
Operating
loss
|
(21,271
)
|
(1.2
)
|
(181,109
)
|
(9.4
)
|
159,838
|
88.3
|
|
Loss on
investment
|
0
|
0.0
|
(96,000
)
|
(5.0
)
|
96,000
|
100.0
|
|
Interest
expense
|
(62,071
)
|
(3.4
)
|
(60,645
)
|
(3.2
)
|
1,426
|
2.4
|
|
Net
loss
|
$
(83,342
)
|
(4.5
)%
|
$
(337,754
)
|
(17.6
)%
|
$
254,412
|
75.3
%
|
|
Net loss per share
- basic and diluted
|
$
.00
|
|
$
(.01
)
|
|
$
.01
|
|
|
|
Nine
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
$
5,512,890
|
100.0
%
|
$
6,159,770
|
100.0
%
|
$
(646,880
)
|
(10.5
)%
|
|
Cost of
sales
|
4,034,619
|
73.2
|
4,703,093
|
76.4
|
(668,474
)
|
(14.2
)
|
|
Gross
profit
|
1,478,271
|
26.8
|
1,456,677
|
23.6
|
21,594
|
1.5
|
|
General and
administrative
|
947,978
|
17.2
|
1,178,511
|
19.1
|
(230,533
)
|
(19.6
)
|
|
Selling
|
645,232
|
11.7
|
672,187
|
10.9
|
(26,955
)
|
(4.0
)
|
|
Total operating
expenses
|
1,593,210
|
28.9
|
1,850,698
|
30.0
|
(257,488
)
|
(13.9
)
|
|
Operating
loss
|
(114,939
)
|
(2.1
)
|
(394,021
)
|
(6.4
)
|
279,082
|
70.8
|
|
Loss on
investment
|
0
|
0.0
|
(109,000
)
|
(1.8
)
|
109,000
|
100.0
|
|
Interest
expense
|
(188,131
)
|
(3.4
)
|
(185,268
)
|
(3.0
)
|
2,863
|
1.5
|
|
Net
loss
|
$
(303,070
)
|
(5.5
)%
|
$
(688,289
)
|
(11.2
)%
|
$
385,219
|
56.0
%
|
|
Net loss per share
- basic and diluted
|
$
(.01
)
|
|
$
(.03
)
|
|
$
.02
|
|
Sales
Sales for the
nine
months ended September 30, 2016 were
$5,512,890 a decrease of $646,880 or 10.5% as compared to sales for
the
nine
months
ended September 30, 2015 of $6,159,770. Sales for the three months
ended September 30, 2016 were $1,849,639, a decrease of $69,426 or
3.6% as compared to sales for the three months ended September 30,
2015 of $1,919,065
. Sales of virtualization projects
decreased by approximately 25% due to the completion of projects in
2015 that were not replaced by new projects in 2016. This decrease
was offset in part by sales growth from our commercial SMB
businesses during the nine months ended
September
30, 2016 as
compared to 2015. We continue to close new contracts and expect
future sales from sales of Nodeware and cybersecurity projects. Our
commercial SMB business continues to establish new relationships
with channel partners who purchase IT solutions from
us.
One of
our priorities is to increase sales. Accordingly, during 2016 and
2015 we hired additional commercial SMB sales personnel in an
effort to increase commercial sales. During 2016, we hired
employees to focus on sales of Nodeware and cyber security
projects. Due to the lengthy lead times typically needed to
generate new sales in these areas, we do not expect to realize a
return from the addition of new sales personnel for one or more
quarters. As a result, we may experience net losses from these
investments in personnel until sufficient sales are generated. We
expect to fund the cost for the new sales personnel from our
operating cash flows and incremental borrowings, as
needed.
Cost
of Sales and Gross Profit
Cost of
sales principally represents the cost of employee services related
to our IT Services Group. We also incurred cost of sales for third
party software licenses for our SMB partners. Cost of sales for the
nine months ended September 30, 2016 was $4,034,619 or 73.2% of
sales as compared to $4,703,093 or 76.4% of sales for the nine
months ended September 30, 2015. This decrease was attributable to
a reduction of personnel in our enterprise IT Services Group in
2016. Gross profit was $1,478,271 or 26.8% of sales for the nine
months ended September 30, 2016 compared to $1,456,677 or 23.6% of
sales for the nine months ended September 30, 2015.
Cost of
sales for the three months ended September 30, 2016 was $1,344,974
or 72.7% of sales as compared to $1,423,547 or 74.2% of sales for
the three months ended September 30, 2015. This decrease was
attributable to a reduction of personnel in our enterprise IT
Services Group in 2016. Gross profit was $504,665 or 27.3% of sales
for the three months ended September 30, 2016 compared to $495,518
or 25.8% of sales for the three months ended September 30,
2015.
Gross
profit increased by $21,594 although sales decreased by 10.5% for
the nine month period ended
September
30, 2016. This was
due to a reduction of personnel in our enterprise IT Services Group
in 2016.
General
and Administrative Expenses
General and administrative expenses include corporate overhead such
as compensation and benefits for executive, administrative and
finance personnel, rent, insurance, professional fees, travel, and
office expenses.
General and administrative expenses for the
nine
months ended
September 30, 2016 decreased by $230,533 or 19.6% from $1,178,511
for the
nine
months ended September 30, 2015 to $947,978 for the
nine
months ended September
30, 2016. As a percentage of sales, general and administrative
expenses were 17.2% and 19.1% for the
nine
months ended September
30, 2016 and 2015, respectively.
General
and administrative expenses for the three months ended September
30, 2016 were $297,346 which was a decrease of $141,155 or 32.2% as
compared to $438,501 for the three months ended September 30, 2015.
As a percentage of sales, general and administrative expense was
16.1% and 22.8% for the three months ended September 30, 2016 and
2015, respectively.
The
decrease in general and administrative expenses in 2016 was
principally due to the following. At September 30, 2015, the
accounts receivable balance of $110,000 due from Sudo.me
Corporation (goSudo) was converted to a demand note with interest
at 10% and was fully reserved upon conversion, due to continued net
losses of goSudo. Accordingly, bad debt expense of $110,000 was
recorded for the nine months ended September 30, 2015 and is
included in general and administrative expenses. No bad debt
expense was incurred in 2016. In 2016, we also realized expense
reductions of approximately $55,000 related to reductions in
administrative personnel, approximately $11,100 for stock options
expense, $17,600 for insurance expense, and approximately $17,500
in legal and professional fees.
Selling
Expenses
For the
nine
months ended
September 30, 2016, we incurred selling expenses of $645,232
compared to $672,187 for the
nine
months ended September
30, 2015, a decrease of $26,955 or 4.0%. For the three months ended
September 30, 2016, we incurred selling expenses of $228,590 as
compared to $238,126 for the three months ended September 30, 2015,
a decrease of $9,536 or 4.0%.
This
decrease is due to various minor changes in expense items from
period to period. We continue to hire additional sales personnel,
such as in SMB channel sales, in an effort to increase sales,
however, we eliminated certain other sales positions, which offset
a portion of the expenses associated with these new
personnel.
Operating
Loss
For the
nine
months ended
September 30, 2016, our operating loss was $114,939 compared to an
operating loss of $394,021 for the
nine
months ended September
30, 2015, an improvement of $279,082. The improvement is
attributable to an increase in our gross profit of $21,594 and
decreases in our general and administrative expenses of $230,533
and our selling expenses of $26,955 during the
nine
months ended September
30, 2016.
For the
three months ended September 30, 2016, our operating loss was
$21,271 compared to an operating loss of $181,109 for the three
months ended September 30, 2015, an improvement of $159,838. This
is attributable to an increase in our gross profit of $9,147 and
decreases in our general and administrative expenses of $141,155
and our selling expenses of $9,536 during the three months ended
September 30, 2016.
Loss
on Investment
For the
nine months ended
September
30, 2016, we had no
loss on investment. We recorded a loss on investment of $96,000 and
$109,000 during the three and nine months ended September 30, 2015,
respectively.
The loss on investment
was related to our investment in Sudo.me Corporation (goSudo).
During 2014 and 2013, we purchased 300,000 shares of Series A
Convertible Preferred Stock of goSudo for $300,000 pursuant to the
terms and conditions of a preferred stock purchase agreement. As a
result, at
September
30, 2016 we own
approximately 9.4% of the total outstanding shares of goSudo.
goSudo's web site is http://goSudo.com (the information contained
in goSudo’s website shall not be considered a part of this
Report). Our management
exercises
significant influence over the operating and financial policies of
goSudo. The investment was
fully reserved and written down
to zero at September 30, 2015.
Interest
Expense
Interest
expense includes interest on indebtedness and fees for financing
accounts receivable invoices. Interest expense was $188,131 for the
nine
months ended
September 30, 2016, an increase of $2,863 from interest expense of
$185,268 for the
nine
months ended September
30, 2015. Interest expense was $62,071 for the three months ended
September 30, 2016, an increase of $1,426 from interest expense of
$60,645 for the three months ended September 30, 2015.
The
increase principally results from new loans totaling $400,000 under
the 2016 Financing Agreement (described below) with interest at 6%
in 2016. A portion of this increase was offset by a decrease in
interest due to principal payments of $68,145 on other
loans.
Net
Loss
For the
nine
months ended
September 30, 2016,
we
recorded a net loss of $303,070 or $.01 per share compared to a net
loss of $688,289 or $.03 per share for the
nine
months ended September
30, 2015
.
For the three
months ended September 30, 2016,
we recorded a net loss of $83,342
or $.00 per share compared to net loss of $337,754 or $.01 per
share for the three months ended September 30, 2015
.
Liquidity
and Capital Resources
At
September
30,
2016, we had cash of $31,880 available for working capital needs
and planned capital asset expenditures. During 2016, we financed
our business activities principally through cash flows provided by
operations and sales with recourse of our accounts receivable. Our
primary source of liquidity is cash provided by collections of
accounts receivable and our factoring line of credit. At
September
30,
2016, we had approximately $34,000 of availability under this
line.
On
March 14, 2016, we entered into an unsecured financing agreement
with a third party lender (the “2016 Financing
Agreement”). The agreement provides for $500,000 of working
capital with draws of $200,000 which occurred on April 13, 2006,
$200,000 which occurred on August 1, 2016 and $100,000 expected to
occur in 2016. Borrowings bear interest at 6% with interest
payments due quarterly. Principal is due on December 31, 2021.
Principal and interest may become immediately due and payable upon
the occurrence of customary events of default.
On
December 1, 2014, we entered into an unsecured line of credit
financing agreement (the “LOC Agreement”) with a member
of our board of directors. The LOC Agreement provides for working
capital of up to $400,000 through January 1, 2020. At September 30,
2016, we had $11,956 of availability under the LOC
Agreement.
At
September
30,
2016, we had a working capital deficit of approximately $2,143,000
and a current ratio of .18. This increase in the working capital
deficit from $1,900,000 at December 31, 2015 is principally due to
the scheduled maturity on January 1, 2017 of notes payable of
$146,300 to a related party and $264,000 to a third party. We plan
to renegotiate the terms of the notes payable, seek funds to repay
the notes or use a combination of both alternatives. Our objective
is to improve our working capital position through profitable
operations.
The
following table sets forth our cash flow information for the
periods presented:
|
|
Nine Months Ended
September
30,
|
|
|
|
|
|
|
|
|
|
Net cash (used)
provided by operating activities
|
$
(309,412
)
|
$
17,985
|
|
Net cash used by
investing activities
|
(4,073
)
|
(103,812
)
|
|
Net cash provided
by financing activities
|
331,855
|
97,415
|
|
Net increase in
cash
|
$
18,370
|
$
11,588
|
Cash
Flows (Used) Provided by Operating Activities
Cash used by operations was $309,412 during the
nine
months ended September
30, 2016 compared with cash provided of $17,985 for the
nine
months ended September
30, 2015.
Our operating cash flow is primarily affected by
the overall profitability of our contracts, our ability to invoice
and collect from our clients in a timely manner, and our ability to
manage our vendor payments. We bill our clients weekly or monthly
after services are performed, depending on the contract terms. Our
net loss of $303,070 for 2016 was offset by non-cash expenses of
$97,176 resulting in a net use of funds of $205,894. In addition,
increases in current liabilities of $215,534 offset by an increase
in accounts receivable and other assets of $313,253 resulted in a
use of funds of $103,518.
We
continue to hire additional sales personnel in an effort to
increase commercial sales and cybersecurity sales. Due to the
lengthy lead times typically needed to generate new sales in these
areas, we do not expect to realize a return from the addition of
the new sales personnel for one or more quarters. As a result, we
may experience net losses from these investments in personnel until
sufficient sales are generated. We expect to fund the cost for the
new sales personnel from our operating cash flows and incremental
borrowings, as needed.
Cash
Flows Used by Investing Activities
Cash
used by investing activities was $4,073 during the nine months
ended
September
30, 2016. In 2016, we incurred capital expenditures for computer
software. We expect to continue to invest in computer hardware and
software to update our technology to support the growth of our
business.
Cash
Flows Provided by Financing Activities
Cash
provided by financing activities was $331,855 as compared to cash
provided of $97,415 for the nine months ended
September
30, 2016 and 2015,
respectively. During 2016, we borrowed $400,000 for working capital
under our 2016 Financing Agreement. We made principal payments of
$5,984 to related parties and $62,161 to other note
holders.
Our
current maturities of long-term obligation-other of $532,000 are
comprised of a $100,000 note which matured on October 3, 2016;
$150,000 of notes scheduled to mature on December 31, 2016;
$264,000 due to a former director that is scheduled to mature on
January 1, 2017; and $18,000 due to the Pension Benefit Guarantee
Corporation (PBGC) under the secured promissory note dated October
17, 2011 that we issued to the PBGC pursuant to our settlement
agreement with the PBGC dated September 6, 2011. Our current
maturities of long-term obligations-related parties of $146,581 is
reduced by debt financing costs of $17,319. Without those costs the
obligations are $163,900 which consist of notes of $146,300
scheduled to mature on January 1, 2017 and $17,600 of maturities
under our LOC agreement. We plan to evaluate alternatives which may
include renegotiating the terms of the notes, seeking conversion of
the notes to shares of common stock and seeking funds to repay the
notes. We continue to evaluate repayment of our notes payable based
on our cash flow.
We
maintain an accounts receivable financing line of credit from an
independent financial
institution
that allows us to sell selected accounts
receivable invoices to the financial institution with full recourse
against us in the amount of up to $2,000,000, including a sublimit
for one major client of up to $1,500,000. This provides us with the
cash needed to finance certain costs and expenses. At September 30,
2016, we had financing availability, based on eligible accounts
receivable, of approximately $203,000 under this line. We pay fees
based on the length of time that the invoice remains
unpaid.
We
believe the capital resources available under our factoring line of
credit, cash from additional related party loans and cash generated
by improving the results of our operations will be sufficient to
fund our ongoing operations and to support the internal growth we
expect to achieve for at least the next 12 months. However, if we
do not continue to improve the results of our operations in future
periods, we expect that additional working capital will be required
to fund our business. There is no assurance that in the event we
need additional funds that adequate additional working capital will
be available or, if available, will be offered on acceptable
terms.
We
anticipate financing growth from acquisitions of other businesses,
if any, and our longer-term internal growth through one or more of
the following sources: cash from collections of accounts
receivable; additional borrowing from related and third parties;
issuance of equity; use of our existing accounts receivable credit
facility; or a refinancing of our accounts receivable credit
facility.