Item 1A. Risk Factors
In
addition to the other information provided in our reports, you
should consider the following factors carefully in evaluating our
business and us. Additional risks and uncertainties not presently
known to us, which we currently deem immaterial or that are similar
to those faced by other companies in our industry or business in
general, such as competitive conditions, may also impair our
business operations. If any of the following risks occur, our
business, financial condition, or results of operations could be
materially adversely affected.
Risks Related to our Industry
The IT cybersecurity services industry is highly competitive, and
we may not be able to compete effectively.
We
operate in a highly competitive industry that includes many
participants. We believe that we currently compete principally with
other IT professional services firms, technology vendors and the
internal information systems groups of our clients. Many of the
companies that provide services in our markets have significantly
greater financial, technical and marketing resources than we do.
Our marketplace continues to experience rapid changes in its
competitive landscape. Some of our competitors have sought access
to public and private capital and others have merged or
consolidated with better-capitalized partners. These changes may
create more or larger and better-capitalized competitors with
enhanced abilities to compete for market share generally and our
clients specifically, in some cases, through significant economic
incentives to clients to secure contracts. These competitors may
also be better able to compete for skilled professionals by
offering them large compensation incentives. One or more of our
competitors may develop and implement methodologies that result in
superior productivity and price reductions without adversely
affecting the competitors' profit margins. In addition, there are
relatively few barriers to entry into our markets and we have
faced, and expect to continue to face, competition from new
entrants into our markets. As a result, we may be unable to
continue to compete successfully with our existing or any new
competitors.
If we fail to meet our contractual obligations to our clients, our
ability to compete for future work and our financial condition may
be adversely affected.
If we
fail to meet our contractual obligations, we could be subject to
legal liability, which could adversely affect our business,
operating results and financial condition. The provisions we
typically include in our contracts which are designed to limit our
exposure to legal claims relating to our services may not protect
us or may not be enforceable under some circumstances or under the
laws of some jurisdictions. It is possible, because of the nature
of our business, that we may be exposed to legal claims in the
future. We have errors and omissions insurance with coverage limits
of $1 million, subject to a $100,000 deductible payable by us. The
policy limits may not be adequate to provide protection against all
potential liabilities. As a consulting firm, we depend on our
relationships with our clients and our reputation for high-quality
services to retain and attract clients and employees. As a result,
claims made against us may damage our reputation, which in turn,
could impact our ability to compete for new business.
Our sales may suffer if our patent application for the technology
used by our product, Nodeware, is not approved.
In May
2016, we filed a provisional patent application for our proprietary
product, Nodeware, to protect the
technology that we developed and applied. In May 2017, we
filed a utility patent application for Nodeware. Our patent
application is ready for examination by the U.S. patent application
examiner. We may not have the full protection until it is
fully approved. This may provide an opportunity for our competitors
to develop similar products and technologies and directly compete with us. This may harm our
sales and our ability to earn a return on our investments in this
technology.
Our gross margin from our contracts will suffer if we are not able
to maintain our pricing and utilization rates and control our
costs.
Our
gross profit margin is largely a function of the rates we charge
for our IT Services and the utilization rate, or chargeability, of
our employees. Accordingly, if we are not able to maintain the
rates we charge for our services or an appropriate utilization rate
for our employees, we will not be able to sustain our gross profit
margin and earn a sufficient amount to fund our operating expenses.
The rates we charge for our IT Services are affected by several
factors, including:
●
our clients'
perception of our ability to add value through our
services;
●
introduction of new
services or products by us or our competitors;
●
pricing policies of
our competitors; and
●
general economic
conditions.
Our
utilization rates are also affected by several factors, including:
seasonal trends, primarily because of holidays, vacations, and
slowdowns by our clients, which may have a more significant effect
in the fourth quarter; our ability to transition employees from
completed engagements to new engagements; our ability to forecast
demand for our services and thereby maintain an appropriately
balanced and sized workforce; and our ability to manage employee
turnover.
We have
implemented cost-management programs to manage our costs, including
personnel costs, support and other overhead costs. Some of our
costs, like office rents, are fixed in the short term, which limits
our ability to reduce costs in periods of declining sales. Our
current and future cost-management initiatives may not be
sufficient to maintain our margins as our level of sales
varies.
We sell our product, Nodeware, to
various customers, and we are therefore subject to risks
associated with our sales and operations.
Our potential growth in certain markets could be adversely affected
by:
●
trade regulations
and procedures and actions affecting pricing and marketing of
products, including policies adopted by countries that may champion
or otherwise favor domestic companies and technologies over foreign
competitors;
●
changes in the
international, national or local regulatory and legal environments;
and
●
import, export or
other business licensing requirements or requirements relating to
foreign software licenses, which could increase our cost of doing
business in certain jurisdictions, prevent us from delivering our
product to certain countries or markets.
These
and other factors could harm our ability to generate future revenue
and impact our business, results of operations and financial
condition.
We may be unable to protect our intellectual property adequately,
which could harm our business, financial condition, and results of
operations.
We
believe that our intellectual property is an asset that may
contribute to the growth and profitability of our business. We rely
on a combination of patent and confidentiality procedures and
contractual provisions to establish and protect our intellectual
property rights in the United States and abroad. The efforts we
have taken to protect our intellectual property may not be
sufficient or effective, and no patents may ultimately issue from
any patent applications we have made or may make. Any U.S. or other
patents issued to us may not be sufficiently broad to protect our
proprietary technology or be enforceable at all. We may not be
effective in policing unauthorized use of our intellectual
property. Further, the laws of certain countries do not protect
proprietary rights to the same extent as the laws of the United
States. Therefore, in certain jurisdictions we may be unable to
protect our proprietary technology adequately against unauthorized
third party copying or use. If we do detect violations, litigation
may be necessary to enforce our intellectual property rights. Any
enforcement efforts we undertake, including litigation, could be
time consuming and expensive. It could divert management’s
attention and may result in a court determining that our
intellectual property rights are unenforceable. If we are not
successful in cost effectively protecting our intellectual property
rights, our business, financial condition, and results of
operations could be harmed.
If we or our channel partners fail to properly complete
cybersecurity assessments and other projects for customers, the
customers may assert that we have contributed to cybersecurity
issues that they may incur and seek recourse from us.
We perform cybersecurity assessments and other projects for our
customers. We issue reports that state the results of our work. If
a customer encounters a cybersecurity issue, it may assert that we
did not identify and suggest remediation for the
issue.
Our channel partners use Nodeware in cybersecurity projects. Our
channel partners may incur the same risks that we incur in
completing cybersecurity projects using Nodeware.
For any
security breaches against customers that use our Nodeware scanner
or services, breaches against those customers may result in
customers and the public believing that Nodeware or our services
failed. Our customers may look to our competitors for alternatives
to Nodeware and our services. Real or perceived security breaches
of our customers’ networks could cause disruption or damage
to their networks or other negative consequences and could result
in negative publicity to us, damage to our reputation, declining
sales, increased expenses and customer relations issues. Any real
or perceived defects in our product and services, or failure of our
product and services to detect a vulnerability could result
in:
●
a loss of existing
or potential customers or channel partners;
●
delayed or lost
revenue and harm to our financial condition and results of
operations;
●
a delay in
attaining, or the failure to attain, market
acceptance;
●
an increase in
warranty claims, or an increase in the cost of servicing warranty
claims, either of which would adversely affect our gross margins;
and
●
litigation,
regulatory inquiries, or investigations that may be costly and
further harm our reputation.
These
and other factors could harm our results of operations and
financial condition.
We depend on third party vendors and incur risks associated with
cloud-based technologies and our product,
Nodeware.
We
store certain information in a cloud-based environment with third
party vendors. We are dependent on them to maintain a high level of
security to protect our information and may incur adverse
consequence if each vendor does not provide sufficient
security.
If we cannot continue to produce quality products and services, our
reputation, business, and financial performance may
suffer.
In
operating our business, we must address quality issues associated
with our product, services, and solutions, including defects in
engineering, design and manufacturing processes and unsatisfactory
performance under service contracts, including defects in
third-party components used in our product and unsatisfactory
performance or even malicious acts by third party contractors or
their employees. To address quality issues, we test our product to
determine the causes of problems and to develop and implement
appropriate solutions. However, the product, services, and
solutions that we offer may be complex, and our testing and quality
control efforts may not be effective in controlling or detecting
all quality issues, particularly with respect to faulty components
manufactured by third parties. If we are unable to determine the
cause, find an appropriate solution to address quality issues with
our product, we may delay shipment to customers, which could delay
revenue recognition and receipt of customer payment and could
adversely affect our revenue, cash flows and profitability. After
products are delivered, quality issues may require us to repair or
replace such products. Addressing quality issues can be expensive
and may result in additional repair, replacement and other costs,
adversely affecting our financial performance. If our customers are
dissatisfied with our services or solutions, our results of
operations could be adversely affected, and we could face possible
claims if we fail to meet our customers' expectations. In addition,
quality issues can impair our relationships with our customers
which could adversely affect our results of
operations.
System security risks, data protection breaches, cyberattacks, and
systems integration issues could disrupt our internal operations or
IT services provided to customers, and any such disruption could
reduce our revenue, increase our expenses, damage our
reputation.
We sell
cybersecurity services, third-party software as well as our
internally developed software, Nodeware. As a result, we have
been and will be a target of cyber-attacks designed to impede the
performance of our products, penetrate our network security or the
security of our cloud platform or our internal systems, or that of
our customers, misappropriate proprietary information and/or cause
interruptions to our services. For example, because Nodeware is a
network vulnerability management tool, a successful cyber-attack on
us may be perceived as a victory for the cyber attacker, thereby
increasing the likelihood that we may be a target of more
cyber-attacks, even absent financial motives. Further, if our
systems are breached as a result of third-party action, employee
error or misconduct, attackers could learn critical information
about how our primary product operates to help protect our
customers’ IT infrastructures from cyber risk, thereby making
our customers more vulnerable to cyber-attacks. In addition, if
actual or perceived breaches of our network security occur, they
could adversely affect the market perception of our Nodeware
product, negatively affecting our reputation, and may expose us to
the loss of our proprietary information or information belonging to
our customers, investigations or litigation and possible liability,
including injunctive relief and monetary damages. Such security
breaches could also divert the efforts of our technical and
management personnel. In addition, such security breaches could
impair our ability to operate our business and provide products to
our customers. If this happens, our reputation could be harmed, our
revenue could decline, and our business could suffer. We
monitor our network continuously with our Nodeware product as well
as other cybersecurity software.
We are
not aware of or identified an incident leading to a breach of our
internal or external facing systems. We have implemented
several proactive policies and procedures to mitigate any internal
incidents from outside forces. This includes deploying additional
monitoring software, phishing training, creating an internal
incident response team, and additional awareness through internal
communications around typical attempts that outside forces use.
While we have seen phishing attempts sent to certain email
addresses, we have mitigated those through the aforementioned
steps. Our internal security team has blocked the associated
addresses and/or domains of the senders and has enhanced email
security features to identify external emails. Overall, our
internal security posture continues to evolve as the market
evolves. We have a cyber insurance policy which will cover
certain expenses related to an attack, such as certain business
interruption costs associated with an incident.
We depend on prime contracts or subcontracts with the federal,
state and local governments for a substantial portion of our sales,
and our business would be seriously harmed if the government ceased
doing business with us or our prime contractors or significantly
decreased the amount of business it does with us or our prime
contractors.
We
derived approximately 70% of our sales in 2019 from contracts as
either a prime contractor or a subcontractor from government
contracts. We expect that we will continue to derive a substantial
portion of our sales for the foreseeable future from work performed
under government contracts, as we have in the past, and from
marketing efforts focused on commercial enterprises. If we or our
prime contractors were suspended or prohibited from contracting
with federal, state or local governments, or if our reputation or
relationship with the federal, state or local governments and
commercial enterprises were impaired, or if any of the foregoing
otherwise ceased doing business with us or our prime contractors or
significantly decreased the amount of business it does with us or
our prime contractors, our business, prospects, financial condition
and operating results would be materially adversely
affected.
Our business could be adversely affected by changes in budgetary
priorities of the federal, state and local
governments.
Because
we derive a significant portion of our sales from contracts with
federal, state and local governments, we believe that the success
and development of our business will continue to depend on our
successful participation in their contract programs. Changes in
federal, state and local government budgetary priorities could
directly affect our financial performance. A significant decline in
government expenditures, a shift of expenditures away from programs
which call for the types of services that we provide or a change in
government contracting policies, could cause U.S. Governmental
agencies as well as state and local governments to reduce their
expenditures under contracts, to exercise their right to terminate
contracts at any time without penalty, not to exercise options to
renew contracts or to delay or not originate new contracts. Any of
those actions could seriously harm our business, prospects,
financial condition or operating results. Moreover, although our
contracts with governmental entities may contemplate that our
services will be performed over a period of several years,
government entities usually must approve funds for a given program
each government fiscal year and may significantly reduce or
eliminate funding for a program. Significant reductions in these
appropriations could have a material adverse effect on our
business. Additional factors that could have a serious adverse
effect on our government contracting business include, but may not
be limited to:
●
changes in
government programs or requirements;
●
budgetary
priorities limiting or delaying government spending generally, or
by specific departments or agencies and changes in fiscal policies
or available funding, including potential governmental
shutdowns;
●
reductions in the
government's use of technology solutions firms;
●
a decrease in the
number of contracts reserved for small businesses, or small
business set asides, which could result in our inability to compete
directly for these prime contracts; and
●
curtailment of the
government uses of IT or related professional
services.
The Office of Management and Budget process for ensuring government
agencies properly support capital planning initiatives, including
information technology investments, could reduce or delay federal
information technology spending and cause us to lose
revenue.
The Office of Management and Budget, or OMB, supervises spending by
federal agencies, including enforcement of the Government
Performance Results Act. This Act requires, among other things,
that federal agencies make an adequate business justification to
support capital planning initiatives, including all information
technology investments. The factors considered by the OMB include,
among others, whether the proposed information technology
investment is expected to achieve an appropriate return on
investment, whether related processes are contemporaneously
reviewed, whether inter-operability with existing systems and the
capacity for these systems to share data across government has been
considered, and whether existing off-the-shelf products are being
utilized to the extent possible. If our clients do not adequately
justify proposed information technology investments to the OMB, the
OMB may refuse funding for their new or continuing information
technology investments, and we may lose revenue as a
result.
Our contracts with federal, state and local governments may be
terminated or adversely modified prior to completion, which could
adversely affect our business.
U.S.
Government contracts generally contain provisions, and are subject
to laws and regulations, that give the U.S. Government rights and
remedies not typically found in commercial contracts, including
provisions permitting the U.S. Government to:
●
terminate our
existing contracts;
●
reduce potential
future revenues from our existing contracts;
●
modify some of the
terms and conditions in our existing contracts;
●
suspend or
permanently prohibit us from doing business with the U.S.
Government or with any specific government agency;
●
impose fines and
penalties;
●
subject us to
criminal prosecution;
●
suspend work under
existing multiple year contracts and related task orders if the
necessary funds are not appropriated by Congress;
●
decline to exercise
an option to extend an existing multiple year
contract;
●
subject the award
of some contracts to protest or challenge by competitors, which may
require the contracting U.S. agency or department to suspend our
performance pending the outcome of the protest or challenge and
which may also require the government to solicit new bids for the
contract or result in the termination, reduction or modification of
the awarded contract; and
●
claim rights in
technologies and systems invented, developed or produced by
us.
The
U.S. Government may terminate a contract with us either for
convenience (for instance, due to a change in its perceived needs
or its desire to consolidate work under another contract) or if we
default by failing to perform under the contract. If the U.S.
Government terminates a contract with us for convenience, we
generally would be entitled to recover only our incurred or
committed costs, settlement expenses and profit on the work
completed prior to termination. If the U.S. Government terminates a
contract with us based upon our default, we generally would be
denied any recovery for undelivered work, and instead may be liable
for excess costs incurred by the U.S. Government in procuring
undelivered items from an alternative source. We may in the future
receive show-cause or cure notices under contracts that, if not
addressed to the U.S. Government's satisfaction, could give the
government the right to terminate those contracts for default or to
cease procuring our services under those contracts.
Our
U.S. Government contracts typically have terms of one or more base
years and one or more option years. Many of the option periods
cover more than half of the contract's potential term. U.S.
Governmental agencies generally have the right not to exercise
options to extend a contract. A decision to terminate or not to
exercise options to extend our existing contracts could have a
material adverse effect on our business, prospects, financial
condition and results of operations.
Certain
of our U.S. Government contracts also contain organizational
conflict of interest clauses that could limit our ability to
compete for certain related follow-on contracts. For example, when
we work on the design of a solution, we may be precluded from
competing for the contract to install that solution. While we
actively monitor our contracts to avoid these conflicts, we cannot
guarantee that we will be able to avoid all organizational conflict
of interest issues.
In addition, U.S. Government contracts are frequently awarded only
after formal competitive bidding processes, which have been and may
continue to be protracted, and typically impose provisions that
permit cancellation if funds are unavailable to the public
agency.
The
competitive bidding process presents several risks, including the
following:
●
we expend
substantial funds, managerial time and effort to prepare bids and
proposals for contracts that we may not win;
●
we may be unable to
estimate accurately the resources and costs that will be required
to service any contract we win, which could result in substantial
cost overruns; and
●
we may encounter
expense and delay if our competitors protest or challenge awards of
contracts to us in competitive bidding, and any such protest or
challenge could result in a requirement to resubmit bids on
modified specifications or in the termination, reduction or
modification of the awarded contract.
Unfavorable government audits could require us to refund payments
we have received, to forgo anticipated sales and could subject us
to penalties and sanctions.
The
federal, state and local government entities we work for generally
have the authority to audit and review our contracts with them
and/or our subcontracts with prime contractors. As part of that
process, the government agency reviews our performance on the
contract, our pricing practices, our cost structure and our
compliance with applicable laws, regulations and standards. If the
audit agency determines that we have improperly received payment or
reimbursement, we would be required to refund any such amount. If a
government audit uncovers improper or illegal activities by us, we
may be subject to civil and criminal penalties and administrative
sanctions, including termination of contracts, forfeitures of
profits, suspension of payments, fines and suspension or
disqualification from doing business with the government. Any such
unfavorable determination could adversely impact our ability to bid
for new work which would have a negative impact on our
business.
The failure by federal, state and local governments to approve
budgets on a timely basis could delay procurement of our services
and solutions and cause us to lose future revenues.
On an annual basis, Congress, and state and local governments must
approve budgets that govern spending by government entities that we
support. In years when governments do not complete the budget
process before the end of their fiscal year, governments may fund
operations pursuant to a continuing resolution. A continuing
resolution allows U.S. Government agencies and other government
entities to operate at spending levels approved in the previous
budget cycle. When the government operates under a continuing
resolution, it may delay funding we expect to receive from clients
on work we are already performing and will likely result in new
initiatives being delayed or in some cases cancelled.
We may lose money on some contracts if we do not accurately
estimate the expenses, time, and resources necessary to satisfy our
contractual obligations.
We may
originate two types of government contracts for our services:
time-and-materials and fixed-price. Each of these types of
contracts, to varying degrees, involves some risk that we could
underestimate our cost of fulfilling the contract, which may reduce
the profit we earn or lead to a financial loss on the
contract.
Under
time and materials contracts, we are reimbursed for labor at
negotiated hourly billing rates and for certain expenses. We assume
financial risk on time and material contracts because we assume the
risk of performing those contracts at negotiated hourly
rates.
Under
fixed-price contracts, we perform specific tasks for a fixed price.
Compared to cost-plus contracts, fixed price contracts generally
offer higher margin opportunities, but involve greater financial
risk because we bear the impact of cost overruns and bear the risk
of underestimating the level of effort required to perform the
contractual obligations, which could result in increased costs and
expenses.
Our
profits could be adversely affected if our costs under any of these
contracts exceed the assumptions we used in bidding for the
contract.
If we fail to establish and maintain important relationships with
government entities, our ability to successfully bid for new
business may be adversely affected.
To
develop new business opportunities, we rely on establishing and
maintaining relationships with various government entities. We may
be unable to successfully maintain our relationships with
government entities, and any failure to do so could materially
adversely affect our ability to compete successfully for new
business.
Our business may suffer if our facilities or our employees are
unable to obtain or retain the security clearances or other
qualifications needed to perform services for our
clients.
Many of
our U.S. Government contracts require employees and facilities used
in specific engagements to hold security clearances and to clear
National Agency Checks and Defense Security Service checks. Some of
our contracts require us to employ personnel with specified levels
of education, work experience and security clearances. Depending on
the level of clearance, security clearances can be difficult and
time-consuming to obtain. If our employees or our facilities lose
or are unable to obtain necessary security clearances or
successfully clear necessary National Agency or Defense Security
Service checks, we may not be able to win new business and our
existing clients could terminate their contracts with us or decide
not to renew them, and in each instance our operating results could
be materially adversely affected.
We must comply with a variety of laws, regulations and procedures
and our failure to comply could harm our operating
results.
We must
observe laws and regulations relating to the formation,
administration and performance of government contracts which affect
how we do business with our clients and impose added costs on our
business. For example, the Federal Acquisition Regulation and the
industrial security regulations of the Department of Defense and
related laws include provisions that:
●
allow U.S.
Government entities to terminate or not renew contracts if we come
under foreign ownership, control or influence;
●
require us to
disclose and certify cost and pricing data in connection with
contract negotiations;
●
require us to
prevent unauthorized access to classified information;
and
●
require us to
comply with laws and regulations intended to promote various social
or economic goals.
We are
subject to industrial security regulations of the U.S. Government
agencies that are designed to safeguard against foreigners' access
to classified information. If we were to come under foreign
ownership, control or influence, we could lose our facility
security clearance, which could result in our U.S. Government
clients terminating or deciding not to renew an existing contract
and could impair our ability to obtain new contracts.
In
addition, our employees and independent contractors must often
comply with procedures required by the specific agency for which
work is being performed, such as time recordation or prohibition on
removal of materials from a location.
Our
failure to comply with applicable laws, regulations or procedures,
including U.S. Government procurement regulations and regulations
regarding the protection of classified information, could result in
contract termination, loss of security clearances, suspension or
prohibition from contracting with government entities, civil fines
and damages and criminal prosecution and penalties, any of which
could materially adversely affect our business.
Federal, state and local governments may revise their procurement
or other practices in a manner adverse to us.
Federal,
state and local governments may revise
their procurement practices or adopt new contracting rules and
regulations, such as cost accounting standards. New contracting
methods may be adopted relating to GSA contracts, government-wide
contracts, or new standards for contract awards intended to achieve
certain social or other policy objectives, such as establishing new
set-aside programs for small or minority-owned businesses. In
addition, government entities may face restrictions from new
legislation or regulations, as well as pressure from government
employees and their unions, on the nature and amount of services
they may obtain from private contractors. These changes could
impair our ability to obtain new contracts or contracts under which
we currently perform when those contracts are put up for
re-competition bid. Any new contracting methods could be costly or
administratively difficult for us to implement and could harm our
operating results. For example, the Truthfulness, Responsibility
and Accountability in Contracting Act, proposed in 2001, would have
limited and severely delayed the U.S. Government's ability to use
private service contractors. Although this proposal was not
enacted, it or similar legislation could be proposed at any time.
Any reduction in the U.S. Government's use of private contractors
to provide federal information technology services could materially
adversely impact our business.
Failure to maintain strong relationships with government and
commercial contractors could result in a decline in our
sales.
We
derived approximately 78% of our sales in 2019 from contracts under
which we acted as a subcontractor. Our subcontracts with prime
contractors contain many of the same provisions as the prime
contracts and therefore carry many of the same risks previously
identified in these Risk Factors. As a subcontractor, we often lack
control over fulfillment of a contract, and poor performance on the
contract by others could tarnish our reputation, even when we
perform as required. We expect to continue to depend on
relationships with other contractors for a significant portion of
our sales in the foreseeable future. Moreover, our sales and
operating results could be materially adversely affected if any
prime contractor chooses to offer services of the type that we
provide or if any prime contractor teams with other companies to
independently provide those services.
Risks Related to our Business and Financial Condition
Our results of operations may be negatively impacted by the
coronavirus outbreak.
In
December 2019, the 2019 novel coronavirus surfaced in China and the
virus has now spread to other countries, including the United
States and infections have been reported globally. The impacts of
the outbreak are unknown and rapidly evolving.
To
date, the outbreak has not had a material adverse impact on our
operations. However, the future impact of the outbreak is highly
uncertain and cannot be predicted and there is no assurance that
the outbreak will not have a material adverse impact on our
business, operations and the market for our securities. The extent
of the impact, if any, will depend on future developments,
including actions taken to contain the coronavirus. There can be no
assurance that our personnel will not be impacted by these pandemic
diseases and ultimately see our workforce productivity reduced or
incur increased medical costs / insurance premiums as a result of
these health risks.
In
addition, a significant outbreak of coronavirus could result in a
widespread global health crisis that could adversely affect global
economies and financial markets resulting in an economic
downturn.
We are highly leveraged, which increases our operating deficit and
makes it difficult for us to grow.
At
December 31, 2019, we had current liabilities of approximately $3.8
million and long-term liabilities of $1.0 million and
stockholders’ deficiency of $3,907,310. We had a working
capital deficit of approximately $3.3 million and a current ratio
of .13. For 2019, we had operating income of approximately $330,000
and provided cash of approximately $30,000 for operating
activities. Working capital shortages may impair our business
operations and growth strategy, and accordingly, our business,
operations, and financial condition will be materially adversely
affected. Accordingly, there is substantial doubt about the
Company’s ability to continue as a going
concern.
We have been dependent on a limited number of high net worth
individuals to fund our working capital needs.
From
2003 through 2019, we received approximately $4.7 million in a
combination of equity, debt conversion and debt transactions from
several high net worth investors. We cannot provide assurance that
we will be able to continue to raise additional capital from this
group of investors, or that we will be able to secure funding from
additional sources.
At
December 31, 2019, we have current notes payable of $332,500 to
third parties, which includes convertible notes payable of
approximately $290,000. We have current maturities of long-term
obligations to third parties of $950,000 comprised of $264,000 that
was due on January 1, 2020, $265,000 which was due on January 1,
2018, $175,000 which was due on August 31, 2018 and $246,000 which
was due to the PBGC on September 15, 2018 in accordance with the
October 2011 Settlement Agreement. We have notes payable to related
parties of $58,000 and maturities of our long-term notes to related
parties of $512,935. We cannot provide assurance that we will be
able to repay current notes payable or obtain extensions of
maturity dates for long-term notes payable when they mature or that
we will be able to repay or otherwise refinance the notes at their
scheduled maturities.
We may require additional financing in the future, which may not be
available on acceptable terms.
We may
require additional funds for working capital and general corporate
purposes. We cannot provide assurance that adequate additional
financing will be available or, if available, will be offered on
acceptable terms.
Moreover,
our IT services billings generate accounts receivable that are
generally paid within 30 to 60 days from the invoice date. The cost
of those sales generally consists of employee salaries and benefits
that we must pay prior to our receipt of the accounts receivable to
which these costs relate. We therefore need sufficient cash
resources to cover such employee-related costs which, in many
cases, require us to borrow funds at costly terms.
We have secured 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 $2 million,
including a sublimit for one major client of $1.5 million. This
provides us with the cash needed to finance certain costs and
expenses. At December 31, 2019, we had $67,000 of financing
availability, based on eligible accounts receivable under this
line. We pay fees based on the length of time that the invoice
remains unpaid. As we grow, additional working capital may be
required to support this difference in the timing of cash receipts
versus payroll disbursements. Moreover, our accounts receivable
financing lender may decide to cease subsequent advances at any
time in its discretion, upon our failure to meet certain
contractual requirements or upon the occurrence of certain events
or contingencies that are out of our control. In such event, our
short-term cash requirements would exceed available cash on hand
resulting in material adverse consequences to our
business.
Finally,
any additional equity financing and conversions by the holders of
existing notes payable to common stock will be dilutive to
stockholders. Debt financings, if available, may involve
restrictive covenants that further limit our ability to make
decisions that we believe will be in our best interests. If we
cannot obtain additional financing on terms acceptable to us when
required, our operations will be materially adversely affected, and
we may have to cease or substantially reduce
operations.
We rely on one customer for a large portion of our
revenues.
We depend on one customer for a large portion of our revenue.
During 2019, sales to one customer, including sales under
subcontracts, accounted for 62.6% of total sales and 22.1% of
accounts receivable at December 31, 2019. The loss of this customer
could have a significant impact on our revenues and harm our
business and results of operations.
Events affecting the credit markets may restrict our ability to
access additional financing.
Over the last several years, the U.S. and worldwide capital and
credit markets have experienced significant price volatility,
dislocations, and liquidity disruptions, which have caused market
prices of many stocks to fluctuate substantially and the spreads on
prospective debt financings to widen considerably. These
circumstances have materially impacted liquidity in certain
financial markets, making terms for certain financings less
attractive, costlier, and in some cases, have resulted in the
unavailability of financing. Continued uncertainty and volatility
in the capital and credit markets may negatively impact our
business, including our ability to access additional financing at
reasonable terms, which may negatively affect our ability to fund
current operations or expand our business. These events also may
make it more difficult or costly for us to raise capital through
the issuance of our debt and equity securities.
If we acquire businesses or business assets and do not successfully
integrate the acquisitions, our results of operations could be
adversely affected.
We may
grow our business by acquiring or investing in companies and
businesses and assets that we feel have synergy and will complement
our business plan. As such, we periodically evaluate potential
business combinations and investments in other companies and
assets. We may be unable to profitably manage businesses and assets
that we may acquire or invest in. We may fail to integrate these
businesses and assets successfully without incurring substantial
expenses, delays or other problems that could negatively impact our
results of operations.
Our investments in cybersecurity and other business initiatives may
not be successful.
We have
invested in and continue to invest in cybersecurity capabilities to
add new products and services to address the needs of our clients,
including our newly introduced product, Nodeware. Our investments
may not be successful or increase our revenues. If we are not
successful in creating value from our investments by increasing
sales, our financial condition and prospects could be
harmed.
If we fail to adequately manage the size of our business, it could
have a severe negative impact on our financial results or stock
price.
Our management believes that to be successful we must appropriately
manage the size of our business. This may mean reducing costs and
overhead in certain economic periods, and selectively growing in
periods of economic expansion. In addition, we will be required to
implement operational, financial and management information
procedures and controls that are efficient and appropriate for the
size and scope of our operations. The management skills and systems
currently in place may not be adequate and we may not be able to
manage any significant reductions or growth
effectively.
We may have difficulties in managing our growth.
Our
future growth depends, in part, on our ability to expand, train and
manage our employee base and provide support to an expanded client
base. We must also enhance and implement new operating and software
systems to accommodate our growth and expansion of IT product and
service offerings. If we cannot manage growth effectively, it could
have a material adverse effect on our results of operations,
business and financial condition. In addition, acquisitions,
investments and expansion involve substantial infrastructure costs
and working capital. We cannot provide assurance that we will be
able to integrate acquisitions, if any, and expansions efficiently.
Similarly, we cannot provide assurance that any investments or
expansion will enhance our profitability. If we do not achieve
sufficient sales growth to offset increased expenses associated
with our expansion, our results will be adversely
affected.
We depend on the continued services of our key
personnel.
Our
future success depends, in part, on the continuing efforts of our
senior executive officers. The loss of any of these key employees
may materially adversely affect our business.
Our future success depends on our ability to continue to retain and
attract qualified employees.
We
believe that our future success depends upon our ability to
continue to train, retain, effectively manage and attract highly
skilled technical, managerial, sales and marketing personnel. This
includes skills for our new initiatives in cybersecurity. Employee
turnover is generally high in the IT services industry. If our
efforts in these areas are not successful, our costs may increase,
our sales efforts may be hindered, and the quality of our client
service may suffer. Although we invest significant resources in
recruiting and retaining employees, there is often significant
competition for certain personnel in the IT services industry. From
time to time, we experience difficulties in locating enough highly
qualified candidates in desired geographic locations, or with
required specific expertise.
We may lose revenue and our cash flow and profitability could be
negatively affected if expenditures are incurred prior to final
receipt of a contract or contract funding
modification.
We provide professional services and sometimes procure materials on
behalf of our clients under various contract arrangements. From
time to time, to ensure that we satisfy our clients’ delivery
requirements and schedules, we may elect, based on verbal
authorization, to initiate procurements or provide services in
advance of receiving formal written contractual authorization from
the government client or a prime contractor. If our government or
prime contractor requirements should change or the government
directs the anticipated procurement to a contractor other than us,
or if the materials become obsolete or require modification before
we are under contract for the procurement, our investment might be
at risk. If we do not receive the required funding, our cost of
services incurred that exceed contractual funding may not be
recoverable. This could reduce anticipated revenue or result in a
loss, negatively affecting our cash flow and
profitability.
Our employees or subcontractors may engage in misconduct or other
improper activities, which could cause us to lose
contracts.
While
we have ethics and compliance programs in place, we are exposed to
the risk that employee fraud or other misconduct could occur. We
may enter into arrangements with prime contractors and joint
venture partners to bid on and execute contracts or programs. As a
result, we are exposed to the risk that fraud or other misconduct
or improper activities by such persons may occur. Misconduct by
employees, prime contractors or joint venture partners could
include intentional failures to comply with federal laws, including
U.S. Government procurement regulations, proper handling of
sensitive or classified information, compliance with the terms of
our contracts that we receive, and falsifying time records or
failures to disclose unauthorized or unsuccessful activities to us.
These actions could lead to civil, criminal, and/or administrative
penalties (including fines, imprisonment, suspension and/or bars
from performing U.S. Government contracts) and harm our reputation.
The precautions we take to prevent and detect such activity may not
be effective in controlling unknown or unmanaged risks or losses,
and such misconduct by employees, prime contractors or joint
venture partners could result in serious civil or criminal
penalties or sanctions or harm to our reputation, which could cause
us to lose contracts or cause a reduction in revenue.
Risks Related to our Common Stock
Certain stockholders own a significant portion of our stock and may
delay or prevent a change in control or adversely affect the stock
price through sales in the open market.
As of March 25, 2020, one related party and one third party, who is
a former member of the board of directors, hold convertible notes
payable with the right to convert the notes payable and accrued
interest into shares of common stock at $.05 per share. If these
parties converted all principal and accrued interest into common
stock, these two individuals would own approximately 12.1% and
27.1%, respectively, (39.2% in the aggregate of our then
outstanding common stock, excluding stock options. However, such
notes may not be converted if such conversion would result
in a change in control which would limit the use of our net
operating loss carryforwards. We
estimate as of the date of this report that substantially all
convertible notes payable and accrued interest due to all related
parties could be converted to shares of common stock, which may
affect a change of control that would limit the use of our net
operating loss carryforwards.
The concentration of large percentages of ownership by a single
stockholder or a few stockholders may delay or prevent a change in
control. Additionally, the sale of a significant number of our
shares in the open market by a single stockholder or otherwise
could adversely affect our stock price.
The price of our common stock may be adversely affected by the
possible issuance of shares to third parties upon conversion of
outstanding notes.
We have three convertible notes outstanding to third parties that
are convertible into shares of common stock at prices ranging from
$.05 to $.25 per share. If these notes were converted into common
stock, the holders would receive 4,700,000 shares of our common
stock or approximately 13.9% of
our common stock outstanding as of March 25,
2020.
Our stock price is volatile and could be further affected by events
not within our control.
The
trading price of our common stock has been volatile and will
continue to be subject to volatility in the trading markets and
other factors.
The
closing market price for our common stock varied between a low of
$.005 and a high of $.085 in 2019. This volatility may affect the
price at which a stockholder could sell its shares of common stock,
and the sale of substantial amounts of our common stock could
adversely affect the price of our common stock. Our stock price is
likely to continue to be volatile and subject to significant price
and volume fluctuations in response to market and other factors,
including variations in our quarterly operating results and
announcement by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures, or capital
commitments.
Our common stock is currently
quoted on the Over The Counter (OTC) Bulletin Board. Because there
is a limited public market for our common stock, a stockholder may
not be able to sell shares when he or she wants.
We cannot assure you that an active
trading market for our common stock will ever
develop.
There
is limited trading in our common stock, and we cannot assure you
that an active public market for our common stock will ever
develop. The lack of an active public trading market means that a
stockholder may not be able to sell shares of common stock when
wanted, thereby increasing market risk. Until our common stock is
listed on an exchange, we expect that the shares will continue to
be quoted on the OTC Bulletin Board. However, an investor may find
it difficult to obtain accurate quotations regarding the common
stock’s market value. In addition, if we failed to meet the
criteria set forth in SEC regulations, various requirements would
be imposed by law on broker-dealers who sell our securities to
persons other than established customers and accredited investors.
Consequently, such regulations may deter broker-dealers from
recommending or selling our common stock, which may further affect
the shares liquidity. Moreover, our ability to obtain future
financing may be adversely affected by the consequences of our
common stock trading on the OTC Bulletin Board.
Our common stock may be considered a “penny stock” and
may be difficult to buy or sell.
The
Securities and Exchange Commission (SEC) has adopted regulations
which generally define “penny stock” to be an equity
security that has a market or exercise price of less than $5.00 per
share, subject to specific exemptions. The market price of our
common stock is currently below $5.00 per share and therefore may
be designated as a “penny stock” according to SEC
rules. This designation requires any broker or dealer selling these
securities to disclose certain information concerning the
transaction, obtain a written agreement from the purchaser and
determine that the purchaser is reasonably suitable to purchase the
securities. These rules may restrict the ability of brokers or
dealers to accept our share certificates into a customer account
and may affect the ability of our stockholders to sell their
shares.
PART III
Item 10. Directors, Executive Officers, and Corporate
Governance
Set forth below are the names, ages and positions of our executive
officers and directors.
|
Name
|
|
Position
|
|
|
James Villa
(1)
|
62
|
Chief Executive
Officer and President
|
2003
|
|
Donald W. Reeve
(1)
|
73
|
Chairman of the
Board
|
2013
|
|
Andrew
Hoyen
|
49
|
Director and Chief
Operating Officer
|
2014
|
|
Richard
Glickman
|
58
|
VP Finance and
Chief Accounting Officer
|
2019
|
________________________
(1) Member of the audit and compensation committees.
Each director is elected for a period of one year and serves until
his successor is duly elected and qualified. Officers are elected
by and serve at the will of our Board.
Background
The
principal occupation of each of our directors and executive
officers for at least the past five years is as
follows:
James Villa is our President and Chief Executive Officer and
a director. He became a director on July 1, 2008, our President on
February 25, 2010 and our Chief Executive Officer on January 21,
2014. He is also chairman of the audit and compensation committees.
Mr. Villa was our Acting Chief Executive Officer from December 31,
2010 to January 21, 2014. Mr. Villa brings to the Board his
experience with us since 2003 as well as professional experience
gained from his services to a variety of public and privately held
middle market businesses.
Donald W. Reeve became a director on December 31, 2013. He
became Chairman of the Board on August 20, 2019. Since January
2013, he has been the principal partner at ReTech Services, LLC, a
management consulting practice. Since August 2013, Mr. Reeve has
been providing consulting services to us on a part time basis
without cash compensation. Previously, Mr. Reeve was Senior Vice
President and Chief Information Officer for Wegmans Food Markets, Inc. (Wegmans)
from May 1986 until his retirement in August 2012. In that
position, he managed an information technology staff of
approximately 300 professionals with responsibilities for
development, application and support services of computer
technology. Prior to May 1986 and since 1970, he held various
positions of increasing responsibility for Wegmans. He attended
Monroe Community College and SUNY Empire State College, earned an
associate's degree at Rochester Business Institute and is a veteran
of the U.S. Army. Mr. Reeve brings to the Board the experience of
managing the IT requirements for a growing company in a competitive
environment. Mr. Reeve provides strategic guidance to the Board and
our management as we continue to enter various commercial IT
markets.
Andrew Hoyen was appointed Chief Administrative Officer and
Senior Vice President of Business Development on October 1, 2014.
In January 2016, he was appointed Chief Operating Officer. On July
18, 2017, he was elected to the board of directors. Mr. Hoyen is
responsible for developing and implementing our strategic direction
through improved operations, sales and marketing, product
development, and overall collaboration across the enterprise.
Previously, since 2011, he was Vice President of National Accounts
at Toyota Material Handling North America. Prior to that, from 2002
to 2011, he served in several executive roles in operations,
service and sales at Eastman Kodak Company and their spin-off,
Carestream Health. His last position at Carestream Health was Vice
President of Sales and Service for the Northeast Region. He holds a
Bachelor of Science degree in biotechnology from Worcester
Polytechnic Institute, a Master of Public Health degree from State
University of New York at Albany and a Master of Business
Administration degree from Rochester Institute of
Technology.
Committees of the Board of Directors
Our
Board has an audit committee and a compensation committee. The
audit committee reviews the scope and results of the audit and
other services provided by our independent registered public
accounting firm and our internal controls. The compensation
committee is responsible for the approval of compensation
arrangements for our officers and the review of our compensation
plans and policies. Each committee is comprised of Mr. Villa and
Mr. Reeve.
Audit Committee Financial Expert
Our
audit committee is comprised of Mr. Villa, as chairman, and Mr.
Reeve. The Board has determined that Mr. Villa qualifies as our
audit committee financial expert, as that term is defined in Item
407(d)(5) of Regulation S-K. Neither Mr. Villa nor Mr. Reeve is
independent for audit committee purposes under the definition
contained in Section 10A(m)(3) of the Exchange Act.
Code of Ethics
We have adopted a code of business conduct and ethics that applies
to our principal executive officer, principal financial officer and
other persons performing similar functions, as well as all
employees and directors. This code of business conduct and ethics is posted on
our website at www.IGIus.com under Business Conduct
Guidelines.
Section 16(a) Beneficial Ownership Reporting
Compliance
Section
16(a) of the Exchange Act requires our officers and directors, and
persons who own more than ten percent of a registered class of our
equity securities, to file reports of ownership and changes in
ownership with the SEC. Officers, directors and greater than
ten-percent stockholders are required by SEC regulation to furnish
us with copies of all Section 16(a) forms they file. Based solely
on review of the copies of such forms furnished to us, or written
representations that no Forms 5 were required, we believe that all
required Section 16(a) filings were timely made for the year ended
December 31, 2019. With respect to any of our former directors,
officers, and greater than ten-percent stockholders, we have no
knowledge of any known failure to comply with the filing
requirements of Section 16(a).
Item 11. Executive Compensation
The
Summary Compensation Table below includes, for each of the years
ended December 31, 2019 and 2018, individual compensation for
services to Infinite Group, Inc. paid to: (i) our Chief Executive
Officer, our Chief Financial Officer and (ii) the next most highly
paid executive officers whose total compensation exceeded $100,000
for the year ended December 31, 2019 (together, the Named
Executives).
|
Name
and Principal Position
|
Year
|
|
|
|
|
James
Villa
|
2019
|
$223,401
|
$5,575
|
$228,976
|
|
Chairman, President
and Chief Executive Officer
|
2018
|
$215,000
|
$-
|
$215,000
|
|
Andrew
Hoyen
|
2019
|
$214,251
|
$8,875
|
$223,126
|
|
Chief Operating
Officer
|
2018
|
$210,000
|
$-
|
$222,450
|
|
James
Witzel**
|
2019
|
$30,846
|
$-
|
$30,846
|
|
Chief Financial
Officer
|
2018
|
$100,000
|
$-
|
$100,000
|
|
Richard
Glickman
|
2019
|
$97,308
|
$3,325
|
$100,633
|
|
VP Finance and
Chief Accounting Officer
|
|
|
|
|
_________________
* The
amounts in this column reflect the grant date fair value for stock
option awards granted during the year and do not reflect whether
the recipient has realized a financial gain from such awards such
as by exercising stock options. The fair value of the stock option
awards was determined using the Black-Scholes option pricing model.
See Note 3 to the financial statements in this report regarding
assumptions underlying valuation of equity awards.
**
James Witzel retired in July 2019.
Stock Options
The following table provides information with respect to the value
of all unexercised options previously awarded to our Named
Executives as of December 31, 2019.
|
Name
|
Number
of Securities Underlying Unexercised Options
-
Exercisable
|
Number of Securities Underlying Unexercised
Options - Unexercisable
|
|
Option Expiration Date
|
|
James
Villa
|
500,000
|
-
|
$.115
|
1/20/2024
|
|
|
500,000
|
-
|
$.04
|
9/29/2021
|
|
|
250,000
|
-
|
$.05
|
12/22/2024
|
|
|
|
|
|
|
|
Andrew
Hoyen
|
250,000
|
-
|
$.02
|
6/1/2026
|
|
|
500,000
|
-
|
$.04
|
9/29/2021
|
|
|
400,000
|
-
|
$.04
|
7/31/2022
|
|
|
100,000
|
-
|
$.04
|
7/17/2022
|
|
|
200,000
|
-
|
$.04
|
12/09/2024
|
|
|
250,000
|
-
|
$.05
|
12/22/2024
|
|
|
|
|
|
|
|
James
Witzel
|
300,000
|
-
|
$.145
|
6/17/2020
|
|
|
473,000
|
-
|
$.093
|
8/11/2021
|
|
|
210,000
|
-
|
$.115
|
1/20/2024
|
|
|
100,000
|
-
|
$.05
|
12/30/2024
|
|
|
40,000
|
-
|
$.05
|
3/2/2025
|
|
|
|
|
|
|
|
Richard
Glickman
|
100,000
|
100,000
|
$.02
|
7/23/2024
|
|
|
50,000
|
-
|
$.04
|
12/9/2024
|
Employment Agreements
We do
not have any employment agreements with any of the Named
Executives.
Compensation of Directors
Effective
August 13, 2019, we established that in connection with rendering
services as a Board of Directors, each non-management Director may
receive compensation, as applicable to each Director, if approved
by the Board. Directors are reimbursed for the costs relating to
attending Board and committee meetings.
Effective
August 20, 2019, the Board resolved to compensate Donald W. Reeve
$12,000 annually as Chairman of the Board.
At
December 31, 2019, Donald W. Reeve held exercisable options
for:
●
600,000 shares of
our common stock at an exercise price of $.05 per share which
expires on November 30, 2024;
●
500,000 shares of
common stock at an exercise price of $.15 per share which expires
on September 4, 2023; and
●
800,000 shares of
common stock at an exercise price of $.04 per share which expires
on September 29, 2021; and
●
250,000 shares of
common stock at an exercise price of $.05 per share which expires
on December 22, 2024.
On
December 1, 2014, we entered into an unsecured line of credit
financing agreement with Mr. Reeve. We paid an origination fee
consisting of (i) 600,000 shares of our common stock valued at
$30,000 and (ii) an immediately exercisable option to purchase
600,000 shares of our common stock at an exercise price of $.05
valued at $23,400 using the Black-Scholes option-pricing
model.
On September 30, 2016, the unsecured line of credit
financing agreement maturity date was
extended from December 31, 2017 to January 1, 2020. As
consideration for extending the maturity date, we granted an
immediately exercisable 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.
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
The following table sets forth information regarding the beneficial
ownership of our common stock, our only class of voting securities,
as of March 24, 2020 by:
●
each
person known to us to be the beneficial owner of more than 5% of
our outstanding shares;
●
each
Named Executive named in the Summary Compensation Table above;
and
●
all
directors and executive officers as a group.
Except as otherwise indicated, the persons listed below have sole
voting and investment power with respect to all shares of common
stock owned by them. All information with respect to beneficial
ownership has been furnished to us by the respective stockholder.
The address of record of each individual listed in this table,
except if set forth below, is c/o Infinite Group, Inc., 175
Sully’s Trail, Suite 202, Pittsford, New York
14534.
|
Name of Beneficial Owner (1)
|
Shares
of Common Stock Beneficially Owned (1)
|
|
|
Richard
Glickman
|
190,000 (3)
|
0.7%
|
|
Andrew
Hoyen
|
2,136,734 (4)
|
6.9%
|
|
Donald
W. Reeve
|
2,981,460 (5)
|
9.6%
|
|
James
Villa
|
6,963,137 (6)
|
19.8%
|
|
All
Directors and Officers (4 persons) as a group
|
12,271,331 (2)
|
31.1%
|
|
|
|
|
|
5% Stockholders:
|
|
|
|
Paul J.
Delmore
|
|
|
|
One America
Place
|
|
|
|
600 West Broadway,
28th Floor
|
|
|
|
San
Diego, CA 92101
|
2,545,151 (8)
|
8.8%
|
|
|
|
|
|
James
Leonardo
|
2,500,000
|
8.6%
|
|
435
Smith Street
|
|
|
|
Rochester,
New York 14608
|
|
|
|
|
|
|
|
Allan
M. Robbins
|
12,544,887 (9)
|
30.9%
|
|
44
Hampstead Drive
|
|
|
|
Webster,
NY 14580
|
|
|
|
|
|
|
|
James
Witzel
|
2,024,901 (7)
|
6.6%
|
|
12677
Dundee Lane
|
|
|
|
Naples
, FL 34120
|
|
|
|
(1)
|
Pursuant
to the rules of the Securities and Exchange Commission, shares of
common stock include shares for which
the individual, directly or indirectly, has voting or shares voting
or disposition power, whether or not they are held for the
individual’s benefit, and shares which an individual
or group has a right to acquire within 60 days from March 25, 2020
pursuant to the exercise of options or upon the conversion of
securities are deemed to be outstanding for the purpose of
computing the percent of ownership of such individual or group, but
are not deemed to be outstanding for the purpose of computing the
percentage ownership of any other person shown in the table. On
March 25, 2020, we had 29,061,883 shares of common stock
outstanding.
|
(2)
|
Assumes
that all currently exercisable options, which total 5,473,000
shares, and convertible securities, which total 16,565,566 shares,
owned by members of the group have been exercised.
|
|
(3)
|
Includes
150,000 shares subject to currently exercisable
options.
|
|
(4)
|
Includes
250,000 shares, which are issuable upon the conversion of a note in
the principal amount of $25,000 through March 25, 2020; and
1,250,000 shares subject to currently exercisable
options.
|
|
(5)
|
Includes
2,150,000 shares subject to currently exercisable
options.
|
|
(6)
|
Includes
4,901,137 shares, which are issuable upon the conversion of notes
to Northwest Hampton Holdings, LLC, whose sole member is James
Villa, including principal in the amount of $146,300 and accrued
interest in the amount of $98,757 through March 24, 2020; and
1,000,000 shares subject to currently exercisable
options.
|
(7)
|
Includes
317,594 shares, which are issuable upon the conversion of a note in
the principal amount of $9,000 and accrued interest in the amount
of $6,880 through March 24, 2020; and 1,123,000 shares subject to
currently exercisable options.
|
|
(8)
|
Includes
2,360,000 shares owned of record by Upstate Holding Group, LLC, an
entity wholly-owned by Mr. Delmore.
|
|
(9)
|
Includes
11,544,887 shares, which are issuable upon the conversion of the
notes including principal in the amount of $304,000 and accrued
interest in the amount of $295,063 through March 24,
2020.
|
Securities Authorized for Issuance Under Equity Compensation
Plans
The
Company’s Board and stockholders approved a stock option
plans adopted in 2005, which has authority to grant options to
purchase up to an aggregate of 990,000 common shares at December
31, 2019. Since this plan has expired, no more options may be
granted.
The
2009 Plan was established in February 2009 to align the interests
of our employees, consultants, agents and affiliates with those of
our stockholders to incent them to increase their efforts on our
behalf and to promote the success of our business. Under the 2009
Plan up to 4,000,000 shares of common stock were authorized for
option grants. The 2009 Plan expired on February 3, 2019;
therefore, expired options after that date could not be re-issued.
Generally, the 2009 Plan is administered by the compensation
committee of the Board and provides (i) for the granting of
non-qualified stock options, (ii) that the maximum term for options
granted under the plan is 10 years and (iii) that the exercise
price for the options may not be less than 100% of the fair market
value of our common stock on the date of grant. As of December 31,
2019, an aggregate of 3,000 shares were available under our 2009
stock option plan (the 2009 Plan) for option grants.
The
2019 Plan was established in August 2019 to align the interests of
our employees, consultants, agents and affiliates with those of our
stockholders to incent them to increase their efforts on our behalf
and to promote the success of our business. Under the 2019 Plan up
to 1,500,000 shares of common stock were authorized for option
grants. Generally, the 2019 Plan is administered by the
compensation committee of the Board and provides (i) for the
granting of non-qualified stock options, (ii) that the maximum term
for options granted under the plan is 10 years and (iii) that the
exercise price for the options may not be less than 100% of the
fair market value of our common stock on the date of grant. As of
December 31, 2019, an aggregate of 141,500 shares were available
under our 2019 stock option plan (the 2019 Plan) for option
grants.
The
following table summarizes, as of December 31, 2019, the (i)
options granted under our option plans and (ii) all other
securities subject to contracts, options, warrants, and rights or
authorized for future issuance outside of our plans. The shares
covered by outstanding options or authorized for future issuance
are subject to adjustment for changes in capitalization stock
splits, stock dividends and similar events.
|
|
Equity Compensation Plan Table
|
|
|
Number of securities to be issued upon exercise of outstanding
options, warrants and rights
|
Weighted-average exercise price of outstanding options, warrants
and rights
|
Number of securities remaining available for future issuance under
equity compensation plans (excluding securities reflected in column
(a))
|
|
|
|
|
|
|
Equity compensation
plans previously approved by security holders (1)
|
990,000
|
$.10
|
-
|
|
Equity compensation
plans not previously approved by security holders (2)
|
5,120,500
|
$.05
|
144,500
|
|
Individual option
grants that have not been approved by security holders
(3)
|
4,800,000
|
$.04
|
-
|
|
Total
|
10,910,500
|
$.05
|
144,500
|
___________________________
|
(1)
|
Consists
of grants under our 2005 Stock Option Plans of which all are
exercisable at December 31, 2019.
|
|
(2)
|
Consists
of grants under our 2009 Plan and 2019 Plan of which 4,995,500 are
exercisable at December 31, 2019.
|
|
(3)
|
Consists
of individual option grants approved by the Board of which all are
exercisable at December 31, 2019.
|
Item 13. Certain Relationships and Related Transactions, and
Director Independence
Officers, Directors, and Equity Investment
On May
7, 2019, we entered into a note payable agreement for up to
$500,000 with Dr. Harry Hoyen. Dr. Harry Hoyen is the brother of
Mr. Andrew Hoyen, our Chief Operating Officer and member of our
Board. The note has an interest rate of 7.5% and is due on August
31, 2026. We borrowed $200,000 during the year ended December 31,
2019, which remains outstanding as of December 31, 2019. As
consideration for providing this financing, we granted a stock
option to purchase a total of 2,500,000 common shares at an
exercise price of $.02 and recorded interest expense of $14,250
using the Black-Scholes option pricing model to determine the
estimated fair value of the option.
On July
12, 2018, we issued an unsecured demand note payable to Northwest
Hampton Holdings, LLC (Northwest) in the principal amount of
$70,000 with interest at 6% per annum. On June 19, and July 17,
2017, we issued unsecured demand notes payable to Northwest in the
principal amount of $12,000 with interest at 6% per annum. On
August 1, 2019, we paid $40,000 plus accrued interest to the
noteholder. On December 11, 2019, we paid $4,000 of principal only
to the noteholder. Mr. James Villa, our Chief Executive Officer and
President, is the sole member of Northwest.
On June
29, 2017, we issued an unsecured demand note payable to Mr. Donald
Reeve, a member of our board, in the principal amount of $20,000
with interest at 6% per annum.
On July
18, 2017, we entered into an unsecured line of credit financing
agreement for $100,000 with Mr. Andrew Hoyen, our Chief Operating
Officer and member of our Board. The LOC Agreement provides for
working capital of up to $100,000 with interest at 6% due quarterly
through July 1, 2022. The principal balance owed was $90,000 at
December 31, 2019. In consideration for providing the financing,
Mr. Andrew Hoyen was granted an option to purchase 400,000 shares
of common stock at $.04 per share with
an estimated fair value of $9,960 using the Black-Scholes
option-pricing model. The option expires on July 31,
2022.
On
September 21, 2017, we entered into an unsecured line of credit
financing agreement for $75,000 with Mr. Harry Hoyen, a related
party. The LOC Agreement provides for working capital of up to
$75,000 with interest at 6% due quarterly through January 2, 2023.
The principal balance owed was $70,000 at December 31, 2019. In
consideration for providing the financing, Mr. Harry Hoyen was
granted an option to purchase 400,000 shares of common stock at
$.04 per share with an estimated fair
value of $4,080 using the Black-Scholes option-pricing
model. The option expires on January 2, 2023.
We are
obligated under a convertible note payable to Northwest. At March
24, 2020, Northwest is the holder of a convertible note bearing
interest at 6% with principal of $146,300 and convertible accrued
interest of $98,757 which matured on January 1, 2020 and is
convertible into shares of our common stock at a conversion price
of $.05 per share for a total of 4,901,137 shares. Principal of
$203,324 was reduced by payments of $53,700 during 2015 and $3,324
during 2014 on this note.
At
March 24, 2020, Mr. James Witzel, our former Chief Financial
Officer, is the holder of a convertible note bearing interest at
6%, with principal of $9,000 and convertible accrued interest of
$6,880 which matures on January 1, 2021 and is convertible into
shares of our common stock at a conversion price of $.05 per share
for a total 317,594 shares.
The
interest rates on the notes payable to Northwest and Mr. Witzel
(collectively, the Notes) are adjusted annually, on January
1st of each year, to a rate
equal to the prime rate in effect on December 31st of the
immediately preceding year, plus one and one quarter percent, but
in no event less than 6% per annum. The interest rate was 6% at
March 24, 2020. The Notes are secured by a security interest in all
our assets.
Generally, upon notice, prior to the maturity date, note holders
can convert all or a portion of the outstanding principal on the
Notes. However, the Notes are not convertible into shares of our
common stock to the extent conversion would result in a change of
control which would limit the use of our net operating loss
carryforwards; provided, however, this limitation will not apply if
we close a transaction with another third party or parties that
results in a change of control which will limit the use of our net
operating loss carryforwards. Prior to any conversion, the holders of the Notes
are entitled to convert their Notes, on a pari passu basis and upon
any such participation the requesting note holder shall
proportionately adjust his conversion request such that, in the
aggregate, a change of control, which will limit the use of our net
operating loss carryforwards, does not occur; provided, however,
the right to participate is only available to a noteholder if his
Note is then convertible into 5% or more of our common
stock.
On
December 1, 2014, we entered into an unsecured line of credit
financing agreement with Mr. Donald W. Reeve, a member of our board
of directors which provides for working capital of up to $400,000.
We paid an origination fee consisting of (i) 600,000 shares of our
common stock valued at $30,000 and (ii) immediately exercisable
options to purchase 600,000 shares of our common stock at an
exercise price of $.05 valued at $23,400 using the Black-Scholes
option-pricing model. On September 30,
2016, the maturity date was extended from December 31, 2017 to
January 1, 2020. As consideration for extending the maturity date
to January 1. 2020, we granted an immediately exercisable 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 note balance was $363,955
at March 24, 2020 with interest at 6.60% payable monthly in
arrears.
On
February 12, 2015, we issued a note payable to Mr. Andrew Hoyen,
our Chief Administrative Officer and Senior Vice President of
Business Development, in the principal amount of $25,000 with
interest at 7% per annum which matured on March 31, 2018. During,
2019, Mr. Hoyen extended the maturity date to March 31, 2021. At
the election of the holder, the principal of the note is
convertible into shares of our common stock at a conversion price
of $.10 per share for a total of 250,000 shares.
Director Independence
Our Board has determined that Donald Reeve is independent in
accordance with the NASDAQ’s independence standards. Our
audit and compensation committees consist of Mr. Villa and Mr.
Reeve, of which only Mr. Reeve is sufficiently independent for
compensation committee purposes under NASDAQ’s standards and
neither of them is sufficiently independent for audit committee
purposes under NASDAQ’s standards due to their respective
beneficial ownership of our common stock.
Item 14. Principal Accountant Fees and Services
The
aggregate fees billed by our principal accounting firm, Freed
Maxick CPAs, P.C. for the years ended December 31, 2019 and 2018
are as follows:
|
|
|
|
|
Audit
fees
|
$80,000
|
$70,500
|
Audit fees for 2019 and 2018 were for professional services
rendered for the audits of our annual financial statements and
reviews of the financial statements included in our Quarterly
Reports on Form 10-Q. There were no tax or other non-audit related
services provided by the independent accountants for 2019 and
2018.
As a matter of policy, each permitted non-audit service is
pre-approved by the audit committee or the audit committee’s
chairman pursuant to delegated authority by the audit committee,
other than de minimus non-audit services for which the pre-approval
requirements are waived in accordance with the rules and
regulations of the SEC.
Audit Committee Pre-Approval Policies and Procedures
The
audit committee charter provides that the audit committee will
pre-approve audit services and non-audit services to be provided by
our independent auditors before the accountant is engaged to render
these services. The audit committee may consult with management in
the decision-making process, but may not delegate this authority to
management. The audit committee may delegate its authority to
pre-approve services to one or more committee members, provided
that the designees present the pre-approvals to the full committee
at the next committee meeting.