Quest Resource Holding Corp - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2016

Commission file number: 001-36451

Quest Resource Holding Corporation

(Exact Name of Registrant as Specified in Its Charter)

3481 Plano Parkway

The Colony, Texas 75056

(Address of Principal Executive Offices and Zip Code)

(972) 464-0004

(Registrant’s Telephone Number, Including Area Code)

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

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

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

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

As of August 11, 2016, there were outstanding 14,844,502 shares of the registrant’s common stock, $0.001 par value.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2016, GIVEN RETROACTIVE ADJUSTMENT

FOR THE 1-FOR-8 REVERSE STOCK SPLIT ON AUGUST 10, 2016

(UNAUDITED)

The accompanying notes are an integral part of this condensed consolidated statement.

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

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

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. The Company, Description of Business, and Liquidity

The accompanying condensed consolidated financial statements include the accounts of Quest Resource Holding Corporation (“QRHC”) and its subsidiaries, Earth911, Inc. (“Earth911”), Quest Resource Management Group, LLC (“Quest”), Landfill Diversion Innovations, LLC, and Youchange, Inc. (“YouChange”) (collectively, “we,” “us,” “our,” or “our company”).

Operations – We provide businesses with one-stop management programs to reuse, recycle, and dispose of a wide variety of waste streams and recyclables generated by their businesses.  Our comprehensive reuse, recycling, and proper disposal management programs are designed to enable regional and national customers to have a single point of contact for managing a variety of waste streams and recyclables.  This business generates substantially all of our revenue.  We also operate environmentally based social media and online data platforms that contain information and instructions necessary to empower consumers and consumer product companies to recycle or properly dispose of household products and materials.  Our directory of local recycling and proper disposal options empowers consumers directly and enables consumer product companies to empower their customers by giving them the guidance necessary for the proper recycling or disposal of a wide range of household products and materials, including the “why, where, and how” of recycling.  Two customers accounted for 55.6% and 59.3% of revenue for the three months ended June 30, 2016 and 2015, respectively.  Two customers accounted for 55.4% and 60.3% of revenue for the six months ended June 30, 2016 and 2015, respectively.  Our principal offices are located in The Colony, Texas.

Liquidity – As of June 30, 2016 and December 31, 2015, our working capital balance was $2,758,126 and $2,059,248, respectively.

2. Summary of Significant Accounting Policies

Principals of Presentation and Consolidation

The condensed consolidated financial statements included herein have been prepared by us without audit pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with our audited financial statements for the year ended December 31, 2015. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted as permitted by the SEC, although we believe the disclosures that are made are adequate to make the information presented herein not misleading.

The accompanying condensed consolidated financial statements reflect, in our opinion, all normal recurring adjustments necessary to present fairly our financial position at June 30, 2016 and the results of our operations and cash flows for the periods presented. We derived the December 31, 2015 condensed consolidated balance sheet data from audited financial statements, but did not include all disclosures required by GAAP. As Quest, Earth911, and YouChange each operate as ecology based green service companies, we did not deem segment reporting necessary.

All intercompany accounts and transactions have been eliminated in consolidation. Interim results are subject to seasonal variations, and the results of operations for the three and six months ended June 30, 2016 are not necessarily indicative of the results to be expected for the full year.

On August 10, 2016, we filed amended and restated articles of incorporation with the Secretary of State of the state of Nevada to effect a 1-for-8 reverse stock split of our common stock.  As required by GAAP, we retroactively adjusted all share and per share amounts in our condensed consolidated financial statements and notes thereto to reflect the 1-for-8 reverse stock split effective August 10, 2016, subject to anticipated fractional share adjustments. See Note 10 for a discussion of the reverse stock split.

Revenue Recognition

We recognize revenue only when all of the following criteria have been met:

Persuasive Evidence of an Arrangement Exists – We document all terms of an arrangement in a service agreement or quote signed or confirmed by the customer prior to recognizing revenue.

Delivery Has Occurred or Services Have Been Rendered – We perform all services or deliver all products prior to recognizing revenue. Services are deemed to be performed when the services are complete.

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

(UNAUDITED)

The Fee for the Arrangement is Fixed or Determinable – Prior to recognizing revenue, a customer’s fee is either fixed or determinable under the terms of the quote, service agreement, or accepted customer purchase order.

Collectability Is Reasonably Assured – We assess collectability on a customer by customer basis based on criteria developed by us.

We provide businesses with management programs to reuse, recycle, and dispose of a wide variety of waste streams and recyclables generated by their business. We utilize third-party subcontractors to execute the collection, transport, and recycling or disposal of used motor oil, oil filters, scrap tires, cooking oil, and expired food products. We evaluate the criteria outlined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 605-45, Revenue Recognition—Principal Agent Considerations, in determining whether it is appropriate to record the gross amount of service revenue and related costs or the net amount earned as management fees. Generally, when we are primarily obligated in a transaction, have latitude in establishing prices and selecting suppliers, have credit risk, or have several but not all of these indicators, we record revenue gross.  We record amounts collected from customers for sales tax on a net basis. In situations in which we are not primarily obligated, we do not have credit risk, or we determine amounts earned using fixed percentage or fixed payment schedules, we record the net amounts as management fees earned. Currently, we have one contract accounted for as management fees with revenue of $63,036 and $150,725 for the three and six months ended June 30, 2016, respectively.  Our gross billings on this management fee contract were $1,143,667 and $2,265,310 for the three and six months ended June 30, 2016, respectively.  Our net and gross revenue on this contract for the three and six months ended June 30, 2015 was nil.

We recognize licensing fees ratably over the term of the license. We derive some revenue from advertising contracts, which we recognize ratably over the term that the advertisement appears on our website.

Net Loss Per Share

We compute basic net loss per share by dividing net loss applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period. We have other potentially dilutive securities outstanding that are not shown in a diluted net loss per share calculation because their effect in both 2016 and 2015 would be anti-dilutive. These potentially dilutive securities include stock options, restricted stock units, and warrants and related to 3,261,023 and 2,113,522 shares at June 30, 2016 and 2015, respectively.

The following table sets forth the anti-dilutive securities excluded from diluted loss per share:

Inventories

We record inventories within “Prepaid expenses and other current assets” in our condensed consolidated balance sheets.  As of June 30, 2016 and December 31, 2015, all inventories were waste disposal equipment with cost balances of $181,251 and $54,473, respectively, with no reserve for inventory obsolescence at either date.

3. Property and Equipment, Net, and Other Assets

At June 30, 2016 and December 31, 2015, property and equipment, net, and other assets consisted of the following:

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

(UNAUDITED)

We compute depreciation using the straight-line method over the estimated useful lives of the property and equipment. The depreciation expense for the three months ended June 30, 2016 was $122,296, inclusive of $38,848 of depreciation expense reflected within “Cost of revenue” in our condensed consolidated statement of operations as it related to assets used in directly servicing customer contracts.  The depreciation expense for the six months ended June 30, 2016 was $231,212, inclusive of $48,265 of depreciation expense recorded to “Cost of revenue.”  The depreciation expense for the three and six months ended June 30, 2015 was $70,335 and $146,381, respectively, with no depreciation expense recorded to “Cost of revenue.” At June 30, 2016, our capital lease assets were $392,971, net of $100,722 of accumulated depreciation. At December 31, 2015, our capital lease assets were $426,757, net of $34,041 of accumulated depreciation.

4. Goodwill and Other Intangible Assets

The components of goodwill and other intangible assets were as follows:

We compute amortization using the straight-line method over the estimated useful lives of the finite lived intangible assets. The amortization expense related to finite lived intangible assets was $924,416 and $901,998 for the three months ended June 30, 2016 and 2015, respectively.  The amortization expense related to finite lived intangible assets was $1,843,481 and $1,805,090 for the six months ended June 30, 2016 and 2015, respectively.  We have no indefinite-lived intangible assets other than goodwill. The goodwill is not deductible for tax purposes.

5. Line of Credit

On December 15, 2010, Quest entered into a Revolving Credit Note and Loan Agreement with Regions Bank (“Regions”), a national banking association. This agreement, as amended, provides Quest with a loan facility of up to $15,000,000 for working capital with advances generally limited to 80% of eligible accounts receivable from Quest’s largest customer and 85% of all other eligible accounts receivable. The facility matures May 13, 2018.  The interest on the outstanding principal amount accrues daily and is payable monthly based on a fluctuating interest rate per annum, which is the base rate plus 1.50% (2.70% as of June 30, 2016). The base rate for any day is the greater of (a) the federal funds rate plus one-half of 1%, (b) Region’s published effective prime rate, or (c) the Eurodollar rate for such day based on an interest period of one month. To secure the amounts due under the agreement, Quest granted Regions a security interest in all of its assets with guarantees from QRHC and Earth911. Quest had $4,000,000 outstanding and

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

(UNAUDITED)

$10,645,734 available to be borrowed as of June 30, 2016. The amount of interest expense related to the Regions line of credit for the three months ended June 30, 2016 and 2015 was $55,002 and $53,479, respectively.  The amount of interest expense related to the Regions line of credit for the six months ended June 30, 2016 and 2015 was $108,259 and $88,529, respectively.  As of June 30, 2016, we were in compliance with the financial covenants.  

6. Capital Lease Obligations

At June 30, 2016 and December 31, 2015, total capital lease obligations outstanding consisted of the following:

Our capital lease obligations are included within “Deferred revenue and other current liabilities” and “Other long-term liabilities” in our condensed consolidated balance sheets.  The amount of interest expense related to our capital leases for the three months ended June 30, 2016 and 2015 was $1,749 and $426, respectively.  The amount of interest expense related to our capital leases for the six months ended June 30, 2016 and 2015 was $3,705 and $913, respectively.

7. Income Taxes

We compute income taxes using the asset and liability method in accordance with FASB ASC Topic 740, Income Taxes. Under the asset and liability method, we determine deferred income tax assets and liabilities based on the differences between the financial reporting and tax bases of assets and liabilities and measure them using currently enacted tax rates and laws. We provide a valuation allowance for the amount of deferred tax assets that, based on available evidence, are more likely than not to be realized. Realization of our net operating loss carryforward was not reasonably assured as of June 30, 2016 and December 31, 2015, and we have recorded a valuation allowance of $12,600,000 and $12,313,000, respectively, against deferred tax assets in excess of deferred tax liabilities in the accompanying condensed consolidated financial statements. As of June 30, 2016 and December 31, 2015, we had federal income tax net operating loss carryforwards of approximately $16,300,000 and $14,500,000, respectively, which expire at various dates beginning in 2031.

8. Fair Value of Financial Instruments

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, line of credit, and capital lease obligations. We do not believe that we are exposed to significant interest, currency, or credit risks arising from these financial instruments.  The fair values of these financial instruments approximate their carrying values using Level 3 inputs, based on their short maturities or, for long-term portions of capital lease obligations and line of credit, based on borrowing rates currently available to us for loans with similar terms and maturities.

9. Stockholders’ Equity

Preferred Stock – Our authorized preferred stock includes 10,000,000 shares of preferred stock with a par value of $0.001, of which no shares have been issued or are outstanding.

Common Stock – Our authorized common stock includes 200,000,000 shares of common stock with a par value of $0.001, of which 14,844,502 and 13,973,528 shares were issued and outstanding as of June 30, 2016 and December 31, 2015, respectively.

During the six months ended June 30, 2016, we issued shares of common stock as follows:

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QUEST RESOURCE HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

(UNAUDITED)

Warrants – During the six months ended June 30, 2016, we issued warrants to purchase 521,057 shares and no holders exercised warrants.  At June 30, 2016, we had outstanding exercisable warrants to purchase 1,994,936 shares of common stock.  

The following table summarizes the warrants issued and outstanding as of June 30, 2016:

Employee Stock Purchase Plan – On September 17, 2014, our stockholders approved the ESPP. We recorded expense of $15,466 and $25,102 related to the ESPP during the three months ended June 30, 2016 and 2015, respectively.  We recorded expense of $24,672 and $36,924 related to the ESPP during the six months ended June 30, 2016 and 2015, respectively.

Stock Options – The following table summarizes the stock option activity for the six month period ended June 30, 2016:

10. Material Subsequent Events

On August 10, 2016, we filed amended and restated articles of incorporation with the Secretary of State of the state of Nevada to effect a 1-for-8 reverse stock split of our common stock.  The reverse split became effective as of 5:00 p.m. Eastern time on Wednesday, August 10, 2016, or the Effective Time.  At the Effective Time, each lot of eight shares of common stock issued and outstanding immediately prior to the Effective Time were, automatically and without any further action on the part of our stockholders, converted into and became one share of common stock, and each certificate which, immediately prior to the Effective Time represented pre-reverse split shares, was deemed cancelled and, for all corporate purposes, was deemed to evidence ownership of post-reverse split shares.  In lieu of issuing any fractional shares, we will round up to the nearest whole share in the event a stockholder would be entitled to receive less than one share of common stock.  As required by GAAP, we retroactively adjusted all share and per share amounts in our condensed consolidated financial statements and notes thereto to reflect the 1-for-8 reverse stock split effective August 10, 2016, subject to anticipated fractional share adjustments.

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

You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Report on Form 10-K for the year ended December 31, 2015. This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve substantial risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, including, but not limited to, statements regarding our expectations, beliefs, intentions, strategies, future operations, future financial position, future revenue, projected expenses, and plans and objectives of management. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “predict,” “potential,” “continue,” “objective,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and involve known risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievement to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in our Report on Form 10-K for the year ended December 31, 2015. Furthermore, such forward-looking statements speak only as of the date of their issuance. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

We were incorporated in Nevada in July 2002 under the name BlueStar Financial Group, Inc. On July 16, 2013, we acquired all of the issued and outstanding membership interests of Quest Resource Management Group, LLC, or Quest, held by Quest Resource Group LLC, or QRG, comprising 50% of the membership interests of Quest, or the Quest Interests. Our wholly owned subsidiary, Earth911, held the remaining 50% of the membership interests of Quest for several years.  Concurrently with our acquisition of the Quest Interests, we assigned the Quest Interests to Earth911 so that Earth911 now holds 100% of the issued and outstanding membership interests of Quest. On October 28, 2013, we changed our name to Quest Resource Holding Corporation.

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based on and relates primarily to the operations of QRHC, Quest, and Earth911.

Three and Six Months Ended June 30, 2016 and 2015 Operating Results

The following table summarizes our operating results for the three and six months ended June 30, 2016 and 2015:

Three and Six Months Ended June 30, 2016 compared to Three and Six Months Ended June 30, 2015

Revenue

For the quarter ended June 30, 2016, revenue was $46.8 million, an increase of $4.5 million, or 10.7%, compared with $42.3 million for the quarter ended June 30, 2015.  The increase was primarily due to a combination of new and expanded services with customers added after the second quarter of 2015.

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For the six months ended June 30, 2016, revenue was $92.6 million, an increase of $10.3 million, or 12.5%, compared with $82.3 million for the six months ended June 30, 2015.  The increase was primarily due to a combination of new and expanded services with customers added after the second quarter of 2015.

Cost of Revenue/Gross Profit

Cost of revenue increased $4.3 million to $43.2 million for the quarter ended June 30, 2016 from $38.9 million for the quarter ended June 30, 2015.  The increase related primarily to the cost of servicing the new and expanded services with customers added after the second quarter of 2015. Gross profit increased $238,000 to $3.7 million for the quarter ended June 30, 2016 from $3.4 million for the quarter ended June 30, 2015. The gross profit margin was 7.8% of second quarter 2016 net sales compared with 8.1% of second quarter 2015 net sales.  The decrease in gross profit margin percentage for the three months ended June 30, 2016 was primarily due to the change in the mix of services and increased cost of certain contracted services.  

Cost of revenue increased $9.9 million to $85.5 million for the six months ended June 30, 2016 from $75.6 million for the six months ended June 30, 2015.  The increase related primarily to the cost of servicing the new and expanded services with customers added in 2015.  Gross profit increased $439,000 to $7.1 million for the six months ended June 30, 2016 from $6.7 million for the six months ended June 30, 2015.  The gross profit margin was 7.7% of net sales for the six months ended June 30, 2016 compared with 8.1% of net sales for the six months ended June 30, 2015.  The decrease in gross profit margin percentage for the six months ended June 30, 2016 was primarily due to the change in the mix of services and increased cost of certain contracted services.

Margins are affected quarter to quarter by the volumes of waste and recycling materials generated by our customers, frequency of services delivered, service price and commodity index adjustments, cost of contracted services, advertising rates, and the sales mix between advertising, consulting, commodities, and services in any one reporting period.

Operating Expenses

For the quarter ended June 30, 2016, operating expenses increased $767,000 to $5.6 million from $4.9 million for the comparable quarter in 2015.  For the six months ended June 30, 2016, operating expenses increased $1.7 million to $11.3 million from $9.6 million for the six months ended June 30, 2015.

Selling, general, and administrative expenses were $4.6 million and $3.9 million for the three months ended June 30, 2016 and 2015, respectively, an increase of $731,000. Selling, general, and administrative expenses were $9.3 million and $7.7 million for the six months ended June 30, 2016 and 2015, respectively, an increase of $1.6 million.  The increase related primarily to an increase in stock-related compensation of $209,000 and $463,000 for the three and six months ended June 30, 2016, respectively, and in selling, general, and administrative expenses of approximately $350,000 and $750,000 for the three and six months ended June 30, 2016, respectively, for integrating and servicing an increased number of customer locations in the period ended June 30, 2016.  

Operating expenses also included depreciation and amortization of $1.0 million for the three months ended June 30, 2016 and 2015.  Depreciation and amortization expenses were $2.0 million for the six months ended June 30, 2016 and 2015.      

Interest Expense

For the three months ended June 30, 2016, interest expense increased $15,000 to $57,000 from $42,000 for the three months ended June 30, 2015.  For the six months ended June 30, 2016, interest expense increased $23,000 to $114,000 from $91,000 for the six months ended June 30, 2015.  The increases were due to a higher interest rate and outstanding balance on our line of credit.  

Net Loss

Net loss for the quarter ended June 30, 2016 was $(2.0) million compared with a net loss of $(1.5) million for the quarter ended June 30, 2015.  Net loss for the six months ended June 30, 2016 was $(4.3) million compared with a net loss of $(3.0) million for the six months ended June 30, 2015.  The explanations above detail the majority of the changes related to the net loss.

Loss Per Share

Net loss per basic and diluted share was $(0.14) for the quarter ended June 30, 2016 compared with a net loss per basic and diluted share of $(0.11) for the quarter ended June 30, 2015. The weighted average number of shares of common stock outstanding increased to 14.8 million for the three months ended June 30, 2016 from 14.0 million for the three months ended June 30, 2015.

Net loss per basic and diluted share was $(0.30) for the six months ended June 30, 2016 compared with a net loss per basic and diluted share of $(0.22) for the six months ended June 30, 2015.  The weighted average number of shares of common stock outstanding increased to 14.4 million for the six months ended June 30, 2016 from 14.0 million for the six months ended June 30, 2015.  The increase in the share count for the three and six months ended June 30, 2016 was primarily from the issuance of shares for Employee Stock Purchase Plan options exercised during 2015 and 2016 and the stock offering during the first quarter of 2016.

Our business, including revenue, operating expenses, and operating margins, may vary depending on commodity prices, the blend of services, the nature of the contracts, and sales volumes.

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EBITDAS

We use the non-GAAP measurement of earnings before interest, taxes, depreciation, amortization, and stock-related compensation charges, or EBITDAS, to evaluate our performance. EBITDAS is a non-GAAP measure that we believe can be helpful in assessing our overall performance as an indicator of operating and earnings quality. We suggest that EBITDAS be viewed in conjunction with our reported financial results or other financial information prepared in accordance with accounting principles generally accepted in the United States, or GAAP.

The following table reflects the EBITDAS for the three and six months ended June 30, 2016 and 2015:

RECONCILIATION OF NET LOSS TO EBITDAS

(UNAUDITED)

Liquidity and Capital Resources

As of June 30, 2016, we had $2.0 million in cash and cash equivalents compared with $3.0 million as of December 31, 2015. Working capital was $2.8 million as of June 30, 2016 compared with $2.1 million as of December 31, 2015.

We derive our primary sources of funds for conducting our business activities from sales of services, commodities, consulting, and advertising; borrowings under our credit facilities; and the placement of our equity securities with investors.  We require working capital primarily to carry accounts receivable, service debt, purchase capital assets, fund operating expenses, address unanticipated competitive threats or technical problems, withstand adverse economic conditions, fund potential acquisition transactions, and pursue our following goals:

We believe our existing cash and cash equivalents of $2.0 million, available borrowing capacity under our credit facility as of June 30, 2016 of $10.6 million, placements of our securities, and cash expected to be generated from operations will be sufficient to fund our operations for the next 12 months.

Cash Flows

The following discussion relates to the major components of our cash flows for the six months ended June 30, 2016 and 2015.

Cash Flows from Operating Activities

Cash used in operating activities was $3.2 million for the six months ended June 30, 2016 compared with cash used in operating activities of $3.9 million for the six months ended June 30, 2015. Cash used in operating activities for the six months ended June 30, 2016 included the net loss of $4.3 million and cash used in the net change in operating assets and liabilities of $2.2 million, offset by non-cash items of $3.3 million.  The cash provided by operating activities for the six months ended June 30, 2015 related to the net loss of $3.0 million and cash used in the net change in operating assets and liabilities of $3.5 million, offset by non-cash items of $2.6 million. The non-cash items primarily reflected depreciation, amortization of intangible assets, provision for doubtful accounts, and stock-based compensation. The net changes in operating assets and liabilities were primarily related to changes in accounts receivable and accounts payable and accrued liabilities. Our business, including revenue, operating expenses, and operating margins, may vary depending on commodity prices, the blend of services we provide to our customers, the terms of customer contracts, and our business levels. Our operating activities may require additional cash in the future from debt and/or equity financings depending on the level of our operations until such time as we generate sustained positive cash flow from operations.

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Cash Flows from Investing Activities

Cash used in investing activities for the six months ended June 30, 2016 and 2015 was $590,000 and $717,000, respectively, primarily from purchases of property and equipment and costs related to software development.  The decrease in cash used during the six months ended June 30, 2016 was primarily due to a decrease in the purchase of software development in 2016 compared with 2015.

Cash Flows from Financing Activities

Cash provided by financing activities was $2.9 million for the six months ended June 30, 2016, primarily from $2.9 million from the sale of stock and warrants.  Cash used in financing activities was $2.0 million for the six months ended June 30, 2015, primarily from proceeds on our line of credit.  

Inflation

We do not believe that inflation had a material impact on us during the three and six months ended June 30, 2016 and 2015.

Critical Accounting Estimates and Policies

Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to areas that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. These areas include carrying amounts of accounts receivable, long-lived assets, goodwill and other intangible assets, stock-based compensation expense, and deferred taxes. We base our estimates on historical experience, our observance of trends in particular areas, and information or valuations and various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying value of assets and liabilities that may not be readily apparent from other sources. Actual amounts could differ significantly from amounts previously estimated.

We believe that of our significant accounting policies, the following may involve a higher degree of judgment and complexity.

Collectability of Accounts Receivable

Our accounts receivable consist primarily of amounts due from customers for the performance of services, and we record the amount net of an allowance for doubtful accounts. To record our accounts receivable at their net realizable value, we assess their collectability, which requires a considerable amount of judgment. We perform a detailed analysis of the aging of our receivables, the credit worthiness of our customers, our historical bad debts, and other adjustments. If economic, industry, or customer specific business trends worsen, we increase the allowance for uncollectible accounts by recording additional expense in the period in which we become aware of the new conditions.

Long-Lived Assets

We periodically evaluate whether events and circumstances have occurred that may warrant revision of the estimated useful life of property and equipment or whether the remaining balance of property and equipment, or other long-lived assets should be evaluated for possible impairment. Instances that may lead to an impairment include the following: (i) a significant decrease in the market price of a long-lived asset group; (ii) a significant adverse change in the extent or manner in which a long-lived asset or asset group is being used or in its physical condition; (iii) a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset or asset group, including an adverse action or assessment by a regulator; (iv) an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset or asset group; (v) a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group; or (vi) a current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

Upon recognition of an event, as previously described, we use an estimate of the related undiscounted cash flows, excluding interest, over the remaining life of the property and equipment and long-lived assets in assessing their recoverability. We measure impairment loss as the amount by which the carrying amount of the asset exceeds the fair value of the asset. We primarily employ the two following methodologies for determining the fair value of a long-lived asset: (i) the amount at which the asset could be bought or sold in an arm’s-length transaction between unrelated willing parties; or (ii) the present value of expected future cash flows grouped at the lowest level for which there are identifiable independent cash flows.

Impairment of Goodwill and Other Intangible Assets

In accordance with ASC Topic 350, Intangibles – Goodwill and Other, we perform goodwill impairment testing at least annually during the third quarter, unless indicators of impairment exist in interim periods. Our test of goodwill impairment includes assessing qualitative factors and the use of judgment in evaluating economic conditions, industry and market conditions, cost factors, and entity-specific events, as well as overall financial performance. The impairment test for goodwill uses a two-step approach. Step 1 compares

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the estimated fair value of a reporting unit with goodwill to its carrying value. If the carrying value exceeds the estimated fair value, Step 2 must be performed. Step 2 compares the carrying value of the reporting unit to the fair value of all of the assets and liabilities of the reporting unit (including any unrecognized intangibles) as if the reporting unit was acquired in a business combination. If the carrying amount of a reporting unit’s goodwill exceeds the implied fair value of its goodwill, we recognize an impairment loss equal to the excess.

In addition to the required goodwill impairment analysis, we also review the recoverability of our net intangible assets with finite lives when an indicator of impairment exists. Based on our analysis of estimated undiscounted future cash flows expected to result from the use of these net intangibles with finite lives, we determine if we will recover their carrying values as of the test date. If not recoverable, we record an impairment charge.  

We performed our Step 1 impairment analysis for goodwill and other intangible assets in the third quarter of 2015 with no impairment recorded.  On March 30, 2016, we closed a secondary public offering and our stock price reflected a decline compared to prior to the offering, resulting in our carrying value exceeding our market capitalization.  We determined that an impairment analysis was not required as our market capitalization preceding the offering was higher than our carrying value and the bulk sale of shares at a discount the day before the end of the period temporarily decreased our stock price and market capitalization.  Continued declines or a lack of recovery in our stock price could require a future Step 2 impairment assessment and could result in the write off of a portion or all of our goodwill and other intangible assets in future periods.

Stock Options

We estimate the fair value of stock options using the Black-Scholes-Merton valuation model. Significant assumptions used in the calculation were determined as follows:

Accounting for Income Taxes

We use the asset and liability method to account for income taxes. We use significant judgment in determining the provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets. In preparing our condensed consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax liability together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, depreciation on property and equipment, intangible assets, goodwill, and benefits of net operating loss tax carryforwards. These differences result in deferred tax assets, which include tax loss carryforwards and liabilities, which are included within our condensed consolidated balance sheets. We then assess the likelihood that deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not likely or there is insufficient operating history, we establish a valuation allowance. To the extent we establish or increase a valuation allowance in a period, we include an adjustment within the tax provision of our condensed consolidated statements of operations. As of June 30, 2016 and December 31, 2015, we had established a full valuation allowance for all deferred tax assets.

As of June 30, 2016 and December 31, 2015, we did not recognize any assets or liabilities relative to uncertain tax positions, nor do we anticipate any significant unrecognized tax benefits will be recorded during the next 12 months. We recognize any interest or penalties related to unrecognized tax benefits in income tax expense. Since there are no unrecognized tax benefits as a result of tax positions taken, there are no accrued penalties or interest.

Financial Instruments

Our financial instruments as of June 30, 2016 and December 31, 2015 consisted of cash and cash equivalents, accounts receivable, line of credit, accounts payable, accrued liabilities, and capital lease obligations. We do not believe that we are exposed to significant interest, currency, or credit risks arising from these financial instruments. The fair values of these financial instruments approximates their carrying values using Level 3 inputs, based on their short maturities or for long-term debt and long-term portions of capital lease obligations, based on borrowing rates currently available to us for loans with similar terms and maturities.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. This new standard will replace all current GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company

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should recognize revenue to correlate with the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year, while allowing a company to adopt the new revenue standard early but not before the original effective date.  This guidance will be effective as to us on January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the impact of adopting ASU 2014-09 on our consolidated financial statements.

In August 2014, the FASB issued Accounting Standards Update 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, or ASU 2014-15. The update provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The amendments in ASU 2014-15 are effective for annual reporting periods ending after December 15, 2016 and interim periods thereafter. Early application is permitted. We do not expect the adoption of ASU 2014-15 to have a significant impact on our consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update 2016-02, Leases, or ASU 2016-02.  The update improves financial reporting about leasing transactions by requiring a lessee to record on the balance sheet the assets and liabilities for the rights and obligations created by lease terms of more than 12 months. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are evaluating the impact of adopting ASU 2016-02 on our consolidated financial statements.

In March 2016, the FASB issued Accounting Standards Update 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, or ASU 2016-09. The purpose of ASU 2016-09 is to simplify the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification of such activity on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those years. Early adoption is permitted. We are evaluating the impact of adopting ASU 2016-09 on our consolidated financial statements.  

There have been no other recent accounting pronouncements or changes in accounting pronouncements that have been issued but not yet adopted that are of significance, or potential significance to us.

Off-Balance Sheet Arrangements

We have no off-balance sheet debt or similar obligations. We have no transactions or obligations with related parties that are not disclosed, consolidated into, or reflected in our reported results of operations or financial position. We do not guarantee any third-party debt.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not Applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of June 30, 2016.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, misstatements, errors, and instances of fraud, if any, within our Company have been or will be prevented or detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls also can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. We base the design of any system of controls in part

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on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, internal controls may become inadequate as a result of changes in conditions, or through the deterioration of the degree of compliance with policies or procedures.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We may be subject to legal proceedings in the ordinary course of business. As of the date of this Quarterly Report on Form 10-Q, we are not aware of any legal proceedings to which we are a party that we believe could have a material adverse effect on us.

Item 1A. Risk Factors

Not Applicable.

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

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

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Item 6. Exhibits

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SIGNATURES

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

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