Sphere 3D Corp. - Quarter Report: 2018 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from___________________________to ___________________________
Commission File Number: 001-36532
__________________________________
Sphere 3D Corp.
(Exact name of Registrant as specified in its charter)
__________________________________
Ontario, Canada | 98-1220792 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
240 Matheson Blvd. East | ||
Mississauga, Ontario, Canada, L4Z 1X | ||
(Address of principal executive offices) | ||
(408) 283-4754
(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, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer ¨ Smaller reporting company x
(Do not check if a smaller reporting company) Emerging growth company x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨
As of May 1, 2018, there were 13,748,744 shares of the registrant’s common stock outstanding.
TABLE OF CONTENTS
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PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
Sphere 3D Corp.
Condensed Consolidated Statements of Operations
(in thousands of U.S. dollars, except per share amounts)
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Net revenue: | (Unaudited) | ||||||
Product revenue | $ | 17,419 | $ | 19,445 | |||
Service revenue | 2,029 | 2,293 | |||||
19,448 | 21,738 | ||||||
Cost of product revenue | 12,535 | 14,085 | |||||
Cost of service revenue | 903 | 822 | |||||
Gross profit | 6,010 | 6,831 | |||||
Operating expenses: | |||||||
Sales and marketing | 4,390 | 4,797 | |||||
Research and development | 1,288 | 1,771 | |||||
General and administrative | 5,421 | 4,989 | |||||
11,099 | 11,557 | ||||||
Loss from operations | (5,089 | ) | (4,726 | ) | |||
Other expense: | |||||||
Interest expense | (453 | ) | (1,190 | ) | |||
Interest expense, related party | (655 | ) | (660 | ) | |||
Other expense, net | (286 | ) | (927 | ) | |||
Loss before income taxes | (6,483 | ) | (7,503 | ) | |||
Provision for income taxes | 340 | 306 | |||||
Net loss | $ | (6,823 | ) | $ | (7,809 | ) | |
Net loss per share: | |||||||
Basic and diluted | $ | (0.89 | ) | $ | (2.50 | ) | |
Shares used in computing net loss per share: | |||||||
Basic and diluted | 7,679 | 3,118 | |||||
See accompanying notes to condensed consolidated financial statements.
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Sphere 3D Corp.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands of U.S. dollars)
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
(Unaudited) | |||||||
Net loss | $ | (6,823 | ) | $ | (7,809 | ) | |
Other comprehensive loss: | |||||||
Foreign currency translation adjustment | 641 | (9 | ) | ||||
Total other comprehensive income (loss) | 641 | (9 | ) | ||||
Comprehensive loss | $ | (6,182 | ) | $ | (7,818 | ) | |
See accompanying notes to condensed consolidated financial statements.
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Sphere 3D Corp.
Condensed Consolidated Balance Sheets
(in thousands of U.S. dollars)
March 31, 2018 | December 31, 2017 | ||||||
Assets | (Unaudited) | ||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 2,327 | $ | 4,598 | |||
Accounts receivable, net of allowance for doubtful accounts of $1,699 and $1,675, respectively | 10,606 | 11,482 | |||||
Inventories | 7,697 | 8,366 | |||||
Other current assets | 2,325 | 1,829 | |||||
Total current assets | 22,955 | 26,275 | |||||
Property and equipment, net | 2,676 | 2,742 | |||||
Intangible assets, net | 40,130 | 41,473 | |||||
Goodwill | 11,590 | 11,590 | |||||
Other assets | 1,236 | 1,200 | |||||
Total assets | $ | 78,587 | $ | 83,280 | |||
Liabilities and Shareholders’ Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 10,788 | $ | 9,362 | |||
Accrued liabilities | 4,538 | 4,157 | |||||
Accrued payroll and employee compensation | 2,419 | 3,240 | |||||
Deferred revenue | 4,318 | 5,060 | |||||
Debt, related party | 25,854 | 26,613 | |||||
Debt | 18,109 | 18,195 | |||||
Other current liabilities | 1,023 | 1,283 | |||||
Total current liabilities | 67,049 | 67,910 | |||||
Deferred revenue, long-term | 1,321 | 1,276 | |||||
Deferred income taxes | 1,368 | 1,342 | |||||
Other non-current liabilities | 794 | 2,289 | |||||
Total liabilities | 70,532 | 72,817 | |||||
Commitments and contingencies (Note 12) | |||||||
Shareholders’ equity: | |||||||
Common shares, no par value; 9,428 and 7,116 shares issued and outstanding as of March 31, 2018 and December 31, 2017, respectively | 177,371 | 173,871 | |||||
Accumulated other comprehensive loss | (1,340 | ) | (1,981 | ) | |||
Accumulated deficit | (167,976 | ) | (161,427 | ) | |||
Total shareholders’ equity | 8,055 | 10,463 | |||||
Total liabilities and shareholders’ equity | $ | 78,587 | $ | 83,280 | |||
See accompanying notes to condensed consolidated financial statements.
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Sphere 3D Corp.
Condensed Consolidated Statements of Cash Flows
(in thousands of U.S. dollars)
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Operating activities: | (Unaudited) | ||||||
Net loss | $ | (6,823 | ) | $ | (7,809 | ) | |
Adjustments to reconcile net loss to cash used in operating activities: | |||||||
Depreciation and amortization | 1,484 | 1,526 | |||||
Share-based compensation | 821 | 2,169 | |||||
Amortization of debt issuance costs | 183 | 951 | |||||
Fair value adjustment of warrants | (259 | ) | (187 | ) | |||
Payment in-kind interest expense, related party | 63 | — | |||||
Loss on revaluation of investment | — | 1,145 | |||||
Changes in operating assets and liabilities (net of effects of acquisition): | |||||||
Accounts receivable | 1,036 | (756 | ) | ||||
Inventories | 709 | (496 | ) | ||||
Accounts payable and accrued liabilities | 2,228 | 1,298 | |||||
Accrued payroll and employee compensation | (823 | ) | (414 | ) | |||
Deferred revenue | (465 | ) | 124 | ||||
Other assets and liabilities, net | (265 | ) | (1,523 | ) | |||
Net cash used in operating activities | (2,111 | ) | (3,972 | ) | |||
Investing activities: | |||||||
Acquisition, net of cash acquired | — | (1,051 | ) | ||||
Purchase of fixed assets | (8 | ) | (4 | ) | |||
Net cash used in investing activities | (8 | ) | (1,055 | ) | |||
Financing activities: | |||||||
Proceeds from issuance of common shares and warrants | — | 7,862 | |||||
Payment for issuance costs | — | (433 | ) | ||||
Payments on debt, related party | (192 | ) | (577 | ) | |||
Net cash (used in) provided by financing activities | (192 | ) | 6,852 | ||||
Effect of exchange rate changes on cash | 40 | 23 | |||||
Net (decrease) increase in cash and cash equivalents | (2,271 | ) | 1,848 | ||||
Cash and cash equivalents, beginning of period | 4,598 | 5,056 | |||||
Cash and cash equivalents, end of period | $ | 2,327 | $ | 6,904 | |||
Supplemental disclosures of cash flow information: | |||||||
Cash paid for interest | $ | 379 | $ | 404 | |||
Supplemental disclosures of non-cash investing and financing activities: | |||||||
Issuance of common shares for settlement of liabilities | $ | 787 | $ | 52 | |||
Issuance of common shares for related party liabilities | $ | 483 | $ | — | |||
Issuance of common shares for acquisition | $ | — | $ | 346 | |||
Costs accrued for issuance of common shares | $ | — | $ | 250 | |||
See accompanying notes to condensed consolidated financial statements.
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Sphere 3D Corp.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. | Organization and Business |
Sphere 3D Corp. (the “Company”) was incorporated under the Business Corporations Act (Ontario) on May 2, 2007 as T.B. Mining Ventures Inc. On March 24, 2015, the Company completed a short-form amalgamation with a wholly-owned subsidiary. In connection with the short-form amalgamation, the Company changed its name to “Sphere 3D Corp.”
The Company delivers data management, and desktop and application virtualization solutions through hybrid cloud, cloud and on premise implementations by its global reseller network. The Company achieves this through a combination of containerized applications, virtual desktops, virtual storage and physical hyper-converged platforms. The Company’s products allow organizations to deploy a combination of public, private or hybrid cloud strategies while backing them up with the latest storage solutions. The Company has a portfolio of brands including RDX®, Glassware 2.0™, SnapCLOUD®, SnapServer®, SnapSync™, NEO®, and V3®.
Related Party Share Purchase Agreement
On February 20, 2018, the Company, Overland Storage, Inc., a California corporation and a wholly owned subsidiary of the Company (“Overland”), and Silicon Valley Technology Partners LLC, a Delaware limited liability company established and controlled by Eric Kelly, the Company’s Chief Executive Officer and Chairman of the Board of Directors (the “Purchaser”) entered into a share purchase agreement (the “Purchase Agreement”), pursuant to which, among other things, and subject to certain closing conditions, the Company will sell to Purchaser all of the issued and outstanding shares of capital stock of Overland for $45.0 million (the “Purchase Price”), subject to a working capital adjustment (the “Share Purchase”). The net proceeds from the Share Purchase will be used to repay: (i) the Company’s outstanding obligations under its Credit Agreement with Opus Bank; (ii) its outstanding obligations under the related party convertible note with FBC Holdings S.a.r.l. (“FBC Holdings”); and (iii) its related party subordinated promissory note with MF Ventures, LLC. The Special Committee of the Board of Directors of the Company and the Board of Directors of the Company (with Eric Kelly recusing himself) unanimously approved the entry into the Purchase Agreement by the Company. The Company will hold a special shareholder meeting on May 31, 2018 to seek shareholder approval for the Share Purchase and, subject to the receipt of requisite shareholder approval and meeting the other closing conditions contained therein (including Purchaser’s receipt of adequate funding to close the Share Purchase), anticipates the transaction will close shortly thereafter.
Under the terms of the Purchase Agreement, the Share Purchase is contingent upon, and Purchaser must use its best efforts to arrange for, debt and/or equity financing in an amount at least equal to the Purchase Price in order to consummate the Share Purchase (the “Financing”). In addition, the Company must use commercially reasonable efforts to provide all cooperation reasonably requested by Purchaser regarding the Financing. Until the Financing is committed in accordance with a Contingency Termination Event (as defined below), the Company is free to solicit and negotiate other offers to purchase the Company, Overland or any or all of their assets and has the right to terminate the Purchase Agreement for any or no reason without penalty (subject to the expense reimbursement provisions described below).
The closing of the Share Purchase and of the other transactions contemplated by the Purchase Agreement are subject to (i) the adoption of the Purchase Agreement by the affirmative vote of the holders of (a) at least 66 2/3% of the outstanding common shares of the Company cast in person or by proxy at the special meeting of shareholders and (b) a majority of the votes cast by certain “minority shareholders” in person or by proxy at the special meeting of shareholders (the “Shareholder Approval”) and (ii) the transfer by the Company of (a) the businesses of (x) Unified ConneXions, Inc. and (y) HVE ConneXions, LLC (including the provision of information technology consulting services and hardware solutions around cloud computing, data storage and server virtualization to corporate, government, and educational institutions), and (b) the SNAP network attached storage business to a subsidiary of the Company other than Overland or a subsidiary of Overland. The closing of the Share Purchase and of the other
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transactions contemplated by the Purchase Agreement are also subject to various other conditions, including the consummation of the Financing, the absence of any order, statute, rule, regulation, executive order, decree or injunction issued by any governmental entity prohibiting the Share Purchase, the absence of a pending claim, suit, action or proceeding material claims seeking to prohibit the Share Purchase, the accuracy of the representations and warranties contained in the Purchase Agreement, compliance with the covenants and agreements contained in the Purchase Agreement in all material respects, and the absence of a material adverse effect on either the Company or Overland.
The Company has made customary representations, warranties and covenants in the Purchase Agreement, including, among others, covenants (i) to conduct its business in the ordinary course during the period between the execution of the Purchaser Agreement and the closing of the Share Purchase, (ii) not to engage in specified types of transactions during this period unless agreed to in writing by Purchaser, (iii) to convene and hold a meeting of its shareholders for the purpose of obtaining the Shareholder Approval and (iv) subject to certain exceptions and only following the occurrence of the Contingency Termination Event (as defined below), not to solicit and negotiate other offers to purchase the Company, Overland or any or all of their assets or to withdraw, modify or qualify in a manner adverse to Purchaser the recommendation of the Board that the Company’s shareholders vote in favor of approving the Share Purchase. The Company has also agreed to indemnification provisions in favor of Purchaser that are customary for transactions of this type.
Prior to the (i) execution and delivery of financing commitments in forms reasonably acceptable to the Company, which provide, among other things, for commitments from financing sources sufficient to pay the Purchase Price in the Share Purchase, (ii) execution and delivery by Purchaser of an irrevocable waiver in a form reasonably acceptable to the Company waiving Purchaser’s condition to the obligation to close the Share Purchase that the Financing has been received and (iii) an executed certificate delivered by Purchaser to the Company regarding the accuracy of certain representations regarding the Financing (the “Contingency Termination Event”), the Company has the right to terminate the Purchase Agreement for any reason or for no reason. The Purchase Agreement also provides that, upon such termination of the Purchase Agreement by the Company, the Company has agreed to reimburse Purchaser up to approximately $350,000 for the reasonable and documented out-of-pocket expenses incurred by the Purchaser and the sources for the Financing in connection with the negotiation, execution and performance of the Purchase Agreement and the transactions contemplated thereby, as well as the fees and expenses of the Purchaser's outside counsel.
In addition, the Purchase Agreement contains certain other termination rights, including, following the occurrence of the Contingency Termination Event, the right of the Company to terminate the Purchase Agreement under specified circumstances to accept an unsolicited superior proposal from a third party. The Purchase Agreement provides that, following the occurrence of the Contingency Termination Event and upon termination of the Purchase Agreement by the Company under specified circumstances (including termination by the Company to accept a superior proposal) or by Purchaser under specified circumstances, a termination fee equal to the lesser of (i) $1.0 million and (ii) the amount of Purchaser’s reasonable fees and expenses in connection with the negotiation, execution and performance of the Purchase Agreement (including the amount that the Purchaser must pay or reimburse to the sources for the Financing) will be payable by the Company to the Purchaser. Such termination fee is also payable following the occurrence of the Contingency Termination Event under certain other specified circumstances set forth in the Purchase Agreement. The Purchase Agreement also provides that each party to the Purchase Agreement may compel the other party or parties thereto to specifically perform its or their obligations under the Purchase Agreement. However, if the Purchase Agreement is terminated such that the Company termination fee becomes payable, the Purchaser will be precluded from any other remedy against the Company or Overland, including expense reimbursement and specific performance. Further, if the Purchase Agreement is terminated such that the expense reimbursement becomes payable, the Purchaser will be precluded from any other remedy against the Company or Overland, including the Company termination fee and specific performance. Subject to certain exceptions and limitations, either party may terminate the Purchase Agreement if the Share Purchase is not consummated by August 19, 2018.
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Management has projected that cash on hand will not be sufficient to allow the Company to continue operations beyond May 31, 2018 if the Company is unable to amend, refinance, or pay off its debt and credit facilities. If the transactions contemplated by the Purchase Agreement are consummated, the Company expects that the proceeds to be received by the Company would be sufficient to pay off its outstanding debt and credit facilities. The Company will hold a special shareholder meeting on May 31, 2018 to seek shareholder approval for the Share Purchase and, subject to the receipt of requisite shareholder approval and meeting the other closing conditions contained therein (including Purchaser’s receipt of adequate funding to close the Share Purchase), anticipates the transaction will close shortly thereafter. There can be no guarantee that we will be able to raise additional funds or amend or refinance our debt and credit facilities on favorable terms or at all, nor can there be any guarantee that the Company’s shareholders will approve the Share Purchase or that the Share Purchase will ultimately be consummated. Significant changes from the Company’s current forecasts, including but not limited to: (i) any delay in the closing of the Share Purchase after May 31, 2018 (including as a result of a failure to receive the appropriate shareholder vote, the failure of the Purchaser to obtain funding adequate to fund the Purchase Price, or the failure to satisfy any closing conditions), (ii) failure to comply with the financial covenants in its credit facilities; (iii) shortfalls from projected sales levels; (iv) unexpected increases in product costs; (v) increases in operating costs; (vi) changes in the historical timing of collecting accounts receivable; and (vii) inability to maintain compliance with the requirements of the NASDAQ Capital Market and/or inability to maintain listing with the NASDAQ Capital Market could have a material adverse impact on the Company’s ability to access the level of funding necessary to continue its operations at current levels. If any of these events occurs or the Company is unable to generate sufficient cash from operations or financing sources, the Company may be forced to liquidate assets where possible and/or curtail, suspend or cease planned programs or operations generally or possibly seek bankruptcy protection, which would have a material adverse effect on the Company’s business, results of operations, financial position and liquidity.
The Company incurred losses from operations and negative cash flows from operating activities for the three months ended March 31, 2018, and such losses might continue for the foreseeable future. Based upon the Company's current expectations and projections for the next year, the Company believes that it may not have sufficient liquidity necessary to sustain operations beyond May 31, 2018 due to the maturity dates of the existing debt facilities. These factors, among others, raise substantial doubt that the Company will be able to continue as a going concern. The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
Reverse Stock Split
On July 5, 2017, the Board of Directors of the Company authorized a share consolidation (also known as a reverse stock split) of the Company’s issued and outstanding common shares at a ratio of 1-for-25, which became effective on July 11, 2017. All share and per share amounts in the accompanying consolidated financial statements and the notes thereto have been restated for all periods to reflect the share consolidation.
2. | Significant Accounting Policies |
Principles of Consolidation
The condensed consolidated financial statements of the Company have been prepared by management in accordance with accounting principles generally accepted in the United States of America (“GAAP”), applied on a basis consistent for all periods. These condensed consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All intercompany balances and transactions have been appropriately eliminated in consolidation.
Use of Estimates
The preparation of the condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Significant areas requiring the use of management estimates relate to the determination of provisions for impairment assessments of goodwill,
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other indefinite-lived intangible assets and long-lived assets; deferred revenue; allowance for doubtful receivables; inventory valuation; warranty provisions; deferred income taxes; and litigation claims. Actual results could differ from these estimates.
Foreign Currency Translation
The financial statements of foreign subsidiaries, for which the functional currency is the local currency, are translated into U.S. dollars using the exchange rate at the consolidated balance sheet date for assets and liabilities and a weighted-average exchange rate during the year for revenue, expenses, gains and losses. Translation adjustments are recorded as other comprehensive income (loss) within shareholders’ equity. Gains or losses from foreign currency transactions are recognized in the consolidated statements of operations. Such transactions resulted in a loss of $0.6 million in three months ended March 31, 2018 and a minimal gain in three months ended March 31, 2017.
Cash Equivalents
Highly liquid investments with insignificant interest rate risk and original maturities of three months or less, when purchased, are classified as cash equivalents. Cash equivalents are composed of money market funds. The carrying amounts approximate fair value due to the short maturities of these instruments.
Accounts Receivable
Accounts receivable is recorded at the invoiced amount and is non-interest bearing. We estimate our allowance for doubtful accounts based on an assessment of the collectability of specific accounts and the overall condition of the accounts receivable portfolio. When evaluating the adequacy of the allowance for doubtful accounts, we analyze specific trade and other receivables, historical bad debts, customer credits, customer concentrations, customer credit-worthiness, current economic trends and changes in customers’ payment terms and/or patterns. We review the allowance for doubtful accounts on a quarterly basis and record adjustments as considered necessary. Customer accounts are written-off against the allowance for doubtful accounts when an account is considered uncollectable.
Inventories
Inventories are stated at the lower of cost and net realizable value using the first-in-first-out method. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. We assess the value of inventories periodically based upon numerous factors including, among others, expected product or material demand, current market conditions, technological obsolescence, current cost, and net realizable value. If necessary, we write down its inventory for obsolete or unmarketable inventory by an amount equal to the difference between the cost of the inventory and the net realizable value.
Goodwill and Intangible Assets
Goodwill represents the excess of consideration paid over the value assigned to the net tangible and identifiable intangible assets acquired. For intangible assets purchased in a business combination, the estimated fair values of the assets received are used to establish their recorded values. For intangible assets acquired in a non-monetary exchange, the estimated fair values of the assets transferred (or the estimated fair values of the assets received, if more clearly evident) are used to establish their recorded values. Valuation techniques consistent with the market approach, income approach and/or cost approach are used to measure fair value.
Purchased intangible assets are amortized on a straight-line basis over their economic lives of six to 25 years for channel partner relationships, three to nine years for developed technology, three to eight years for capitalized development costs, and two to 25 years for customer relationships as this method most closely reflects the pattern in which the economic benefits of the assets will be consumed.
Impairment of Goodwill, Intangible Assets and Long-Lived Assets
Goodwill and intangible assets are tested for impairment on an annual basis at December 31, or more frequently if there are indicators of impairment. Triggering events for impairment reviews may be indicators such as adverse industry or economic trends, restructuring actions, lower projections of profitability, or a sustained decline in our market capitalization. Intangible assets
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are quantitatively assessed for impairment, if necessary, by comparing their estimated fair values to their carrying values. If the carrying value exceeds the fair value, the difference is recorded as an impairment.
Long-lived assets are reviewed for recoverability whenever events or changes in circumstances indicate the carrying value may not be recoverable. Our consideration includes, but is not limited to: (i) significant under-performance relative to historical or projected future operating results; (ii) significant changes in the manner of use of the assets or the strategy for the Company’s overall business; (iii) significant decrease in the market value of the assets; and (iv) significant negative industry or economic trends. When the carrying value is not considered recoverable, an impairment loss for the amount by which the carrying value of a long-lived asset exceeds its fair value is recognized, with an offsetting reduction in the carrying value of the related asset.
Revenue Recognition
The Company primarily generates revenue from solutions for standalone storage and long-term data archive products, as well as enterprise storage management solutions which are primarily grouped into three categories: (i) disk systems, (ii) tape automation systems, tape drive and media, and (iii) warranty and customer services.
Approximately 90% of the Company’s revenue is recognized when performance obligations under the terms of a contract with a customer are satisfied at a point in time. These contracts generally have a single performance obligation to transfer products. Accordingly, the Company recognizes revenue when change of control has been transferred to the customer, generally at the time of shipment of products. The Company sells its products both directly to customers and through distributors generally under agreements with payment terms typically less than 45 days. Revenue on direct product sales, excluding sales to distributors, are not entitled to any specific right of return or price protection, except for any defective product that may be returned under our standard product warranty. Product sales to distribution customers are subject to certain rights of return, stock rotation privileges and price protections, that create “variable considerations”. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products and is generally based upon a negotiated fixed price and is net of estimates for variable considerations.
For performance obligations related to warranty and customer services, such as extended product warranties, the Company transfers control and recognizes revenue over time on a ratable basis. The performance obligations are satisfied as services are rendered typically on a straight-line basis over the contract term, which is generally 12 months.
In limited circumstances where a customer is unable to accept shipment and requests products be delivered to, and stored on, the Company’s premises, also known as a “bill-and-hold” arrangements, revenue is recognized when: (i) the customer has requested delayed delivery and storage of the products, (ii) the goods are segregated from the inventory, (iii) the product is complete, ready for shipment and physical transfer to the customer, and (iv) the Company does not have the ability to use the product or direct it to another customer.
The Company enters into revenue arrangements that may consist of multiple performance obligations, of its product and service offerings, such as for sales of hardware devices and extended warranty services. The Company allocates revenue to the performance obligations in multiple element arrangements based on relative selling prices. The Company determines the transaction price based on its normal pricing and discounting practices for the specific product or service when sold separately. When the Company is not able to establish the individual transaction price for all performance obligations in an arrangement with multiple elements, the Company determines the selling price of each element based on third party evidence of selling price or based on the Company’s actual historical selling prices of similar items, whichever management believes provides the most reliable estimate of expected selling prices.
Warranty and Extended Warranty
The Company records a provision for standard warranties provided with all products. If future actual costs to repair were to differ significantly from estimates, the impact of these unforeseen costs or cost reductions would be recorded in subsequent periods.
Separately priced extended on-site warranties and service contracts are offered for sale to customers on all product lines. The Company contracts with third party service providers to provide service relating to on-site warranties and service contracts.
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Extended warranty and service contract revenue and amounts paid in advance to outside service organizations are deferred and recognized as service revenue and cost of service, respectively, over the period of the service agreement.
Shipping and Handling
Amounts billed to customers for shipping and handling are included in product revenue, and costs incurred related to shipping and handling are included in cost of product revenue.
Research and Development Costs
Research and development expenses include payroll, employee benefits, share-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to manufacturing. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products.
Segment Information
We report segment data based on the management approach. The management approach designates the internal reporting that is used by management for making operating and investment decisions and evaluating performance as the source of our reportable segments. We use one measurement of profitability and do not disaggregate our business for internal reporting. We operate in one segment providing data management, and desktop and application virtualization solutions for small and medium businesses and distributed enterprises. We disclose information about products and services, geographic areas, and major customers.
Comprehensive Loss
Comprehensive loss and its components encompasses all changes in equity other than those arising from transactions with shareholders, including net loss and foreign currency translation adjustments, and is disclosed in a separate consolidated statement of comprehensive loss.
Share-based Compensation
We account for share-based awards, and similar equity instruments, granted to employees, non-employee directors, and consultants under the fair value method. Share-based compensation award types include stock options and restricted stock. We use the Black-Scholes option pricing model to estimate the fair value of option awards on the measurement date, which generally is the date of grant. The expense is recognized over the requisite service period (usually the vesting period) for the estimated number of instruments for which service is expected to be rendered. The fair value of restricted stock units (“RSUs”) is estimated based on the market value of the Company’s common shares on the date of grant. The fair value of options granted to non-employees is estimated at the measurement date using the Black-Scholes option pricing model and the unvested options remeasured at each reporting date, with changes in fair value recognized in expense in the consolidated statement of operations.
Share-based compensation expense for options with graded vesting is recognized pursuant to an accelerated method. Share-based compensation expense for RSUs is recognized over the vesting period using the straight-line method. Share-based compensation expense for an award with performance conditions is recognized when the achievement of such performance conditions are determined to be probable. If the outcome of such performance condition is not determined to be probable or is not met, no compensation expense is recognized and any previously recognized compensation expense is reversed. Forfeitures are recognized in share-based compensation expense as they occur.
We have not recognized, and do not expect to recognize in the near future, any tax benefit related to share-based compensation cost as a result of the full valuation allowance of our net deferred tax assets and its net operating loss carryforward.
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Recently Issued Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) that are adopted by the Company as of the specified effective date. If not discussed, the Company believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company’s consolidated financial statements upon adoption.
In January 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-04, Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). The update simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. An entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, if applicable. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The same impairment test also applies to any reporting unit with a zero or negative carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update is effective for annual reporting periods, including interim periods, beginning after December 15, 2019, on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material effect on our consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). The update increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. The update is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. An entity will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. We are currently evaluating the effect that ASU 2016-02 will have on our consolidated financial statements and related disclosures.
Recently Adopted Accounting Pronouncements
On January 1, 2018, we adopted ASU 2014-09, Revenue from Contracts with Customers and all the related amendments, or Accounting Standards Codification (“ASC”) Topic 606. Under Topic 606, an entity is required to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Topic 606 defines a five-step process in order to achieve this core principle, which may require the use of judgment and estimates, and also requires expanded qualitative and quantitative disclosures relating to the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including significant judgments and estimates used. The adoption of the new standard requires the recognition of revenues generally upon shipment to our customers for both distributors and direct consumers also known as “sell-in basis” for sales of products to certain customers which had previously been recognized on a “sell-through basis” or when the product was ultimately shipped to the end consumer. We elected to adopt this guidance using the modified retrospective method and it resulted in a cumulative adjustment reducing our accumulated deficit by approximately $0.3 million. Comparative prior periods were not adjusted and continue to be reported under FASB ASC Topic 605, Revenue Recognition.
In connection with the adoption of Topic 606, we are required to capitalize certain contract acquisition costs consisting primarily of commissions paid when contracts are signed. The Company elected follow a Topic 606 practical expedient and expense the incremental costs of obtaining a contract (sales commissions) when incurred because the amortization period is generally one year or less and capitalized long-term contract costs are not significant. For certain performance obligations related to services, extended warranty and other service agreements that are settled over time, the Company has elected not to adjust the transaction price for the consideration of the effects of time value of money for prepaid services from customers as these services and warranty services are usually fully amortized in one year or less. The impact of the adoption of ASC 606 on our unaudited consolidated balance sheet at March 31, 2018 and our unaudited consolidated statements of comprehensive income, equity and cash flows for the three months ended March 31, 2018 was not material. We do not expect the adoption of this guidance to have a material effect on our results of operations in future periods.
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In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). The update addresses eight cash flow classification issues and how they should be reported in the statement of cash flows. The update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The adoption of the new standard on January 1, 2018 did not have a material effect on our financial position, results of operations or cash flows.
In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting (“ASU 2017-09”). The update provides clarity and is expected to reduce both diversity in practice and the cost and complexity when accounting for a change to the terms of a stock-based award. the update is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2017, on a prospective basis. The adoption of the new standard on January 1, 2018 did not have a material effect on our financial position, results of operations or cash flows.
In July 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815) (“ASU 2017-11”). The update changes the classification of certain equity-linked financial instruments (or embedded features) with down round features. The update also clarifies existing disclosure requirements for equity-classified instruments. The update is effective retrospectively for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. We early adopted the new standard effective January 1, 2018 and it did not have a material effect on our financial position, results of operations or cash flows.
3. | Business Combination |
UCX and HVE Acquisition
In December 2016, the Company acquired 19.9% of the outstanding equity interests of Unified ConneXions, Inc. (“UCX”) and HVE ConneXions, LLC (“HVE”) for the purchase price of $1.5 million. The Company issued 157,894 shares of its common shares in satisfaction of payment. In January 2017, the Company completed its acquisition of all of the remaining outstanding equity interests of UCX and HVE, for $1.1 million in cash and issued 88,235 common shares with an approximate value of $0.3 million. In 2017, the Company recognized a $1.1 million loss, included in other expense, as a result of the remeasurement to fair value the equity interest held immediately before the business combination. The valuation was based on the Company’s private placement completed as of January 26, 2017.
UCX and HVE provide information technology consulting services and hardware solutions around cloud computing, data storage and server virtualization to corporate, government, and educational institutions primarily in the southern central United States. By adding UCX’s technologies, professional services and engineering talent, and HVE’s products, engineering and virtualization expertise, the Company intends to expand its virtualization offerings as well as enhance its ability to accelerate the delivery of hybrid cloud solutions to customers. We incurred acquisition related expenses of $34,000 which consisted primarily of due diligence, legal and other one-time charges and are included in general and administrative expense in the consolidated statements of operations.
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A summary of the estimated fair values of the assets acquired and liabilities assumed as of the closing date were as follows (in thousands):
Cash | $ | 49 | ||
Accounts receivable | 582 | |||
Inventory | 206 | |||
Identifiable intangible assets | 1,260 | |||
Other assets | 45 | |||
Total identifiable assets acquired | 2,142 | |||
Accounts payable and accrued liabilities | (359 | ) | ||
Deferred revenue | (518 | ) | ||
Net identifiable assets acquired | 1,265 | |||
Goodwill | 522 | |||
Net assets acquired | $ | 1,787 | ||
Goodwill is primarily comprised of a trained and assembled workforce. The fair value estimates for the assets acquired and liabilities assumed for the acquisition were based on estimates and analysis, including work performed by third party valuation specialists. The goodwill recognized upon acquisition is not deductible for tax purposes.
The results of operations related to this acquisition have been included in our consolidated statements of operations from the acquisition date. Pro forma results of operations have not been presented because at this time it is impracticable to provide as the information is not available at the level of detail required.
The identified intangible assets as of the date of acquisition consisted of the following (in thousands):
Estimated Fair Value | Weighted- Average Useful Life (years) | |||||
Channel partner relationships | $ | 730 | 6.0 | |||
Customer relationships | 380 | 3.2 | ||||
Developed technology | 150 | 3.0 | ||||
Total identified intangible assets | $ | 1,260 | ||||
4. | Inventories |
The following table summarizes inventories (in thousands):
March 31, 2018 | December 31, 2017 | ||||||
Raw materials | $ | 1,601 | $ | 1,222 | |||
Work in process | 2,160 | 2,217 | |||||
Finished goods | 3,936 | 4,927 | |||||
$ | 7,697 | $ | 8,366 | ||||
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5. | Intangible Assets and Goodwill |
The following table summarizes intangible assets, net (in thousands):
March 31, 2018 | December 31, 2017 | ||||||
Developed technology | $ | 23,414 | $ | 23,414 | |||
Channel partner relationships(1) | 12,976 | 12,929 | |||||
Capitalized development costs(1) | 3,069 | 3,164 | |||||
Customer relationships(1) | 1,668 | 1,647 | |||||
41,127 | 41,154 | ||||||
Accumulated amortization: | |||||||
Developed technology | (16,299 | ) | (15,276 | ) | |||
Channel partner relationships(1) | (1,365 | ) | (1,201 | ) | |||
Capitalized development costs(1) | (1,461 | ) | (1,409 | ) | |||
Customer relationships(1) | (572 | ) | (495 | ) | |||
(19,697 | ) | (18,381 | ) | ||||
Total finite-lived assets, net | 21,430 | 22,773 | |||||
Indefinite-lived intangible assets - trade names | 18,700 | 18,700 | |||||
Total intangible assets, net | $ | 40,130 | $ | 41,473 | |||
________________
(1) | Includes the impact of foreign currency exchange rate fluctuations. |
Amortization expense of intangible assets was $1.3 million during each of the three months ended March 31, 2018 and 2017. Estimated amortization expense for intangible assets is expected to be approximately $2.4 million for the remainder of 2018 and $2.6 million, $2.5 million, $2.1 million, $1.9 million and $1.5 million in fiscal 2019, 2020, 2021, 2022 and 2023, respectively.
6. | Debt |
Related Party Convertible Note
In December 2014, in connection with the acquisition of Overland, the existing debt of Overland and the remaining debt of the Company were amended and restated into a $19.5 million convertible note held by FBC Holdings. In April 2016, the Company modified its convertible note with FBC Holdings, pursuant to which the holder made an additional advance and principal amount under the convertible note amount was increased to $24.5 million. The convertible note bears interest at an 8.0% simple annual interest rate, payable semi-annually. The obligations under the convertible note are secured by substantially all assets of the Company. At March 31, 2018, the Company had $23.8 million, net of unamortized debt costs of $0.7 million, outstanding on the convertible note.
The Company has the option to pay accrued and outstanding interest either entirely in cash or common shares. If the Company choses to pay the interest in common shares, the calculation is based upon the number of common shares that may be issued as payment of interest on the convertible note and will be determined by dividing the amount of interest due by the current market price as defined in the convertible note agreement. For the three months ended March 31, 2018 and 2017, the Company issued 344,959 and zero common shares, respectively, for the settlement of accrued interest expense.
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In March 2018, the Company and FBC Holdings entered into an amendment to the convertible note, under which the maturity date was extended from March 31, 2018 to May 31, 2018. The amendment also altered the schedule for interest payments under the FBC Debenture by providing for future accrued interest to be paid twice monthly rather than semi-annually. In partial consideration for the extension, the Company agreed to pay to FBC Holdings a fee, payable in cash or common shares of the Company at the Company’s option, of $735,000, payable in full by May 16, 2018. In April 2018, the Company issued in the aggregate 950,579 common shares to FBC Holdings for payment of accrued interest and partial payment of fees related to the March 2018 amendment to the convertible note.
In November 2015, the convertible note’s conversion price was adjusted to $75.00 per share. At the option of the Company, the convertible note is convertible into common shares at the conversion price at any time that the weighted average trading price for the common shares exceeds 150% of the conversion price (i.e. exceeds $112.50 per share), for ten consecutive trading days on its principal stock exchange that the common shares trade.
The convertible note contains customary covenants, including covenants that limit or restrict the Company’s ability to incur liens, incur indebtedness, or make certain restricted payments. Upon the occurrence of an event of default under the convertible note, the Holder may declare all amounts outstanding to be immediately due and payable. The convertible note specifies a number of events of default (some of which are subject to applicable grace or cure periods), including, among other things, non-payment defaults, covenant defaults, cross-defaults to other materials indebtedness, bankruptcy and insolvency defaults, and material judgment defaults. As of March 31, 2018, the Company was in compliance with all covenants of the convertible note.
For the three months ended March 31, 2018 and 2017, interest expense, including amortization of debt costs, on the convertible note was $0.6 million and $0.5 million, respectively.
Related Party Debt
In December 2017, the Company entered into a $2.0 million subordinated promissory note with MF Ventures, LLC, a related party. The promissory note is subordinate to the Company’s Opus Bank Credit Agreement and FBC Holdings indebtedness and has a maturity date of the earliest of: (i) December 11, 2020; (ii) immediately after repayment in full of the Opus Bank Credit Agreement and the FBC Holdings indebtedness; or (iii) immediately after the Company’s refinancing of both the Opus Bank Credit Agreement and the FBC Holdings indebtedness. The promissory note may be prepaid at any time by the Company; including any accrued and unpaid interest and a $0.3 million prepayment penalty. The promissory note bears interest at a 12.5% simple annual interest rate, payable quarterly in arrears. Interest shall be paid in kind by increasing the principal amount of the note on each quarterly interest payment date. At March 31, 2018, the Company had $2.1 million outstanding on the convertible note. For the three months ended March 31, 2018, interest expense, including amortization of debt costs, on the promissory note was $0.1 million.
In September 2016, the Company entered into a $2.5 million agreement with FBC Holdings. The term loan has a maturity date of January 31, 2018 and bears interest at a 20.0% simple annual interest rate, payable monthly in arrears. For the three months ended March 31, 2018 and 2017, interest expense, including amortization of debt costs, on the term loan was $5,000 and $119,000, respectively. In January 2018, the FBC Holdings term loan was repaid in full per the term loan agreement.
Credit Agreement
In April 2016, the Company entered into a Credit Agreement with Opus Bank for a term loan in the amount of $10.0 million and a credit facility in the amount of up to $10.0 million. A portion of the proceeds were used to pay off the Company’s then outstanding credit facilities with FBC Holdings and Silicon Valley Bank. The remainder of the proceeds were used for working capital and general business requirements. On December 30, 2016, the credit facility was reduced to $8.2 million. The obligations under the term loan and credit facility are secured by substantially all assets of the Company other than the stock of its subsidiaries organized outside of the U.S. and Canada that are pledged to secure the Company’s obligations under the Company’s convertible note. At March 31, 2018, the interest rate on the term loan and credit facility was 8.25%.
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In March 2018, the Company and Opus Bank entered into Amendment Number Eight to Credit Agreement (“Amendment Number Eight”). Under the terms of Amendment Number Eight the maturity date for the revolving and term loan credit facilities were extended from March 31, 2018 to May 31, 2018. In consideration for the extension, the Company agreed to pay to Opus Bank a fee of $0.1 million, payable in cash on the date the Credit Agreement is paid in full.
In March 2017, the Company and Opus Bank entered into Amendment Number Two to Credit Agreement, Amendment Number One to Amendment Number 1, Waiver and Reaffirmation (the “Second Amendment”). As a condition of the Second Amendment, the Company issued to Opus Bank (i) a warrant, exercisable for 15,957 shares at an exercise price of $0.25 per common share as the debt was not repaid by April 17, 2017 and (ii) a warrant, exercisable for 35,242 shares at an exercise price of $0.25 per common share as the debt was not repaid by May 31, 2017.
The term loan and credit facility contain customary covenants, including covenants that limit or restrict the Company’s ability to incur liens, incur indebtedness, or make certain restricted payments. Upon the occurrence of an event of default under the term loan, the holder may declare all amounts outstanding to be immediately due and payable. The term loan and credit facility specify a number of events of default (some of which are subject to applicable grace or cure periods), including, among other things, non-payment defaults, covenant defaults, cross-defaults to other materials indebtedness, bankruptcy and insolvency defaults, and material judgment defaults. As of March 31, 2018, the Company was in compliance with all covenants of the term loan and credit facility.
At March 31, 2018, the outstanding balances of the term loan and credit facility were $9.9 million, net of unamortized debt costs of $0.1 million, and $8.2 million, respectively. For the three months ended March 31, 2018 and 2017, interest expense, including amortization of debt costs, on the Opus facilities was $0.5 million and $1.2 million, respectively.
7. | Fair Value Measurements |
The authoritative guidance for fair value measurements establishes a three tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
Our financial instruments include cash equivalents, accounts receivable, prepaid expenses, accounts payable, accrued expenses, credit facility, debt and related party debt. Fair value estimates of these instruments are made at a specific point in time, based on relevant market information. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. The carrying amount of cash equivalents, accounts receivable, prepaid expenses, accounts payable and accrued expenses are generally considered to be representative of their respective fair values because of the short-term nature of those instruments. The carrying amount of the credit facility borrowings approximate their fair value as the interest rate of the credit facility is substantially comparable to rates offered for similar debt instruments. The carrying value of debt and related party debt approximates its fair value as the borrowing rates are substantially comparable to rates available for loans with similar terms.
The following table provides information by level for liabilities that are measured at fair value using significant unobservable inputs (Level 3) (in thousands):
Warrant liability as of December 31, 2017 | $ | 1,669 | ||
Adoption of accounting guidance | (46 | ) | ||
Change in fair value of warrants | (259 | ) | ||
Reclassification to equity resulting from warrant exchange agreement | (1,364 | ) | ||
Warrant liability as of March 31, 2018 | $ | — | ||
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Assets and Liabilities that are Measured at Fair Value on a Nonrecurring Basis
The Company's non-financial assets such as goodwill, intangible assets and property and equipment are recorded at fair value when an impairment is recognized or at the time acquired in a business combination.
8. | Share Capital |
Reverse Stock Split
On July 5, 2017, the Board of Directors of the Company authorized a share consolidation (also known as a reverse stock split) of the Company’s issued and outstanding common shares at a ratio of 1-for-25, which became effective on July 11, 2017. All share and per share amounts have been restated for all periods to reflect the share consolidation.
At March 31, 2018, the Company had the following outstanding warrants to purchase common shares:
Date issued | Contractual life (years) | Exercise price | Number outstanding | Expiration | |||||
May 2015 | 5 | $100.00 | 33,600 | May 31, 2020 | |||||
October 2015 | 5 | $58.25 | 16,077 | October 14, 2020 | |||||
December 2015 | 3 | $38.50 | 20,000 | December 21, 2018 | |||||
December 2015 | 5 | $62.50 | 41,100 | December 15, 2020 | |||||
December 2015 | 5 | $27.00 | 60,000 | (1) | December 4, 2020 | ||||
January 2016 | 3 | $51.50 | 3,539 | November 30, 2018 | |||||
February 2016 | 3 | $40.50 | 20,000 | February 26, 2019 | |||||
March 2016 | 5 | $62.50 | 1,200 | March 4, 2021 | |||||
November 2016 | 3 | $50.00 | 1,000 | November 8, 2019 | |||||
December 2016 | 6 | $0.25 | 34,483 | December 30, 2022 | |||||
March 2017 | 6 | $0.25 | 15,957 | April 18, 2023 | |||||
March 2017 | 6 | $0.25 | 35,242 | June 1, 2023 | |||||
August 2017 | 5 | $5.25 | 300,000 | August 11, 2022 | |||||
August 2017 | 5 | $5.25 | 95,000 | August 16, 2022 | |||||
August 2017 | 5 | $5.25 | 205,000 | August 22, 2022 | |||||
882,198 | (2) | ||||||||
_______________
(1) | If the Company or any subsidiary thereof, at any time while this warrant is outstanding, enters into a Variable Rate Transaction (“VRT”) (as defined in the purchase agreement) and the issue price, conversion price or exercise price per share applicable thereto is less than the warrant exercise price then in effect, the exercise price shall be reduced to equal the VRT price. |
(2) | Includes warrants to purchase up to 340,000 common shares, in the aggregate, outstanding to related parties at March 31, 2018. |
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Related Party Share Capital Transactions
In August 2017, the Company entered into a securities purchase agreement with certain investors pursuant to which the Company issued (i) 600,000 common shares, of which 395,000 common shares were issued to related parties, and (ii) warrants for the purchase of up to 600,000 common shares, of which warrants to purchase up to 395,000 common shares were issued to related parties, in a private placement in exchange for a cash payment of $3.0 million. The purchase price was $5.00 per common share and warrant to purchase one common share, and the exercise price of the warrants is $5.25 per warrant share. The warrants were subject to certain anti-dilution adjustments through December 2017.
In July 2017, the Company entered into amended and restated warrant agreements with certain holders of warrants previously issued in March 2016 (the “Amended March 2016 Warrant”) and between December 2016 and March 2017 (the “Amended March 2017 Warrants” and together with the Amended March 2016 Warrant, the “Amended and Restated Warrants”). Pursuant to the amended and restated warrant agreements, the Company issued an aggregate of 1,617,917 common shares, of which 1,315,385 common shares were issued to related parties, in exchange for the cancellation of such warrants. Immediately after the exchange, the amended and restated warrant agreements became null and void.
In March 2017, the Company entered into a securities purchase agreement with certain investors party thereto, pursuant to which the Company issued to the investors, in the aggregate, 818,182 of the Company’s common shares for gross proceeds of $4.5 million. The securities purchase agreement also provided for the concurrent private placement of warrants exercisable to purchase up to 867,272 common shares. Each warrant had an exercise price of $7.50 per warrant share. MF Ventures, LLC, a related party, participated in the offering by acquiring 181,818 common shares and warrants to purchase 181,818 shares. In August 2017, the Company issued additional common shares, which triggered a price adjustment for the March 2017 warrants from $7.50 to $5.00 and the Company issued, in the aggregate, additional warrants exercisable to purchase up to 433,638 common shares, of which MF Ventures, LLC received warrants exercisable to purchase 90,909 common shares. In March 2018, the Company entered into warrant exchange agreements, in a privately negotiated exchange under Section 4(a)(2) of the Securities Act of 1933, as amended, pursuant to which the Company issued 1,430,998 common shares in exchange for the surrender and cancellation of the Company’s outstanding March 24, 2017 warrants (the “Exchange”). Immediately after the Exchange, the previously issued warrants became null and void. MF Ventures, LLC, participated in the Exchange by acquiring 299,999 common shares in exchange for the cancellation of a warrant to purchase 272,727 common shares.
Between December 30, 2016 and March 16, 2017, the Company completed a private placement and issued a total of 725,599 “Units” at a purchase price of $7.50 per Unit. Each Unit consisted of one common share and one warrant from each of two series of warrants. The Company received gross proceeds of $5.4 million in connection with the sale of the Units. The warrants were exercisable to purchase 1,451,198 common shares in the aggregate. MF Ventures, LLC participated in the private placements by acquiring 333,333 common shares and warrants to purchase 666,666 common shares. Lynn Factor and Sheldon Inwentash, a married couple and related party to the Company, participated in the private placements by acquiring 213,000 common shares and warrants to purchase 426,000 common shares. An additional 28,000 common shares and warrants to purchase 56,000 common shares were acquired by ThreeD Capital Inc. Mr. Inwentash is the Chief Executive Officer of ThreeD Capital Inc. In July 2017, the warrants issued between December 30, 2016 and March 16, 2017 became null and void as a result of the amended and restated warrant agreements. As of December 31, 2017, Lynn Factor and Sheldon Inwentash no longer have a significant direct or indirect ownership of the Company and are no longer classified as a related party.
9. | Equity Incentive Plans |
During the three months ended March 31, 2018 and 2017, the Company granted awards of restricted stock units of 400 and 210,441, respectively, which 206,238 were granted outside of the 2015 Performance Incentive Plan. The restricted stock units were fair valued based on the date of grant. During the three months ended March 31, 2018 and 2017, the Company granted awards of stock options of none and 800, respectively. The stock options were fair valued using the Black-Scholes option pricing model. The restricted stock units and stock options typically vest over a period of approximately three years.
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During the three months ended March 31, 2018 and 2017, the Company granted restricted stock awards (“RSA”) in lieu of cash payment for services performed. The estimated fair value of the RSAs was based on the market value of the Company’s common shares on the date of grant. During the three months ended March 31, 2018 and 2017, the Company granted RSAs of 380,371 and 6,520, respectively, with a value of $787,000 and $52,000, respectively.
Stock Options
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model, which uses the weighted-average assumptions noted in the following table:
Three Months Ended March 31, | ||||
2018 | 2017 | |||
Expected volatility | n/a | 93.0 | % | |
Risk-free interest rate | n/a | 1.5 | % | |
Dividend yield | n/a | — | ||
Expected term (in years) | n/a | 4.7 | ||
The expected volatility was based on the Company’s historical share price. The risk-free interest rate is determined based upon a constant maturity U.S. Treasury security with a contractual life approximating the expected term of the option. The expected term of options granted is estimated based on a number of factors, including but not limited to the vesting term of the award, historical employee exercise behavior, the expected volatility of the Company’s common shares and an employee’s average length of service.
Share-Based Compensation Expense
The Company recorded the following compensation expense related to its share-based compensation awards (in thousands):
Three Months Ended March 31, | |||||||
2018 | 2017 | ||||||
Cost of sales | $ | 32 | $ | 84 | |||
Sales and marketing | 184 | 651 | |||||
Research and development | 96 | 370 | |||||
General and administrative | 509 | 1,064 | |||||
Total share-based compensation expense | $ | 821 | $ | 2,169 | |||
As of March 31, 2018, there was a total of $2.1 million of unrecognized compensation expense related to unvested equity-based compensation awards. The expense associated with non-vested restricted stock units and options awards granted as of March 31, 2018 is expected to be recognized over a weighted-average period of 1.6 years.
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10. | Net Loss per Share |
Basic net loss per share is computed by dividing net loss applicable to common shareholders by the weighted-average number of common shares outstanding during the period. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.
Anti-dilutive common share equivalents excluded from the computation of diluted net loss per share were as follows (in thousands):
Three Months Ended March 31, | |||||
2018 | 2017 | ||||
Common share purchase warrants | 882 | 2,744 | |||
Convertible notes | 327 | 327 | |||
Convertible notes interest | 328 | 452 | |||
Restricted stock not yet vested or released | 848 | 267 | |||
Options outstanding | 176 | 130 | |||
11. | Related Party Transactions |
Professional services provided by affiliates of the Company were $206,000 and $42,000 during the three months ended March 31, 2018 and 2017, respectively.
12. | Commitments and Contingencies |
Letters of credit
During the ordinary course of business, the Company provides standby letters of credit to third parties as required for certain transactions initiated by the Company. As of March 31, 2018, the Company’s had no outstanding standby letters of credit.
Warranty and Extended Warranty
The Company had $0.8 million in deferred costs included in other current and non-current assets related to deferred service revenue at both March 31, 2018 and December 31, 2017. Changes in the liability for product warranty and deferred revenue associated with extended warranties and service contracts were as follows (in thousands):
Product Warranty | Deferred Revenue | ||||||
Liability at December 31, 2017 | $ | 996 | $ | 5,672 | |||
Settlements made during the period | (156 | ) | (1,493 | ) | |||
Change in liability for warranties issued during the period | 180 | 1,339 | |||||
Change in liability for pre-existing warranties | 9 | — | |||||
Liability at March 31, 2018 | $ | 1,029 | $ | 5,518 | |||
Current liability | $ | 642 | $ | 4,260 | |||
Non-current liability | 387 | 1,258 | |||||
Liability at March 31, 2018 | $ | 1,029 | $ | 5,518 | |||
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Litigation
The Company is, from time to time, subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of such pending proceedings will not have a material effect on the Company’s results of operations, financial position or cash flows.
Patent Litigation Funding Agreement
In December 2010, Overland entered into a litigation funding agreement (the “Funding Agreement”) with Special Situations Fund III QP, L.P., Special Situations Private Equity Fund, L.P., Special Situations Technology Fund, L.P., and Special Situations Technology Fund II, L.P. (collectively, the “Special Situations Funds”) pursuant to which the Special Situations Funds agreed to fund certain patent litigation brought by Overland. In May 2014, the Special Situations Funds filed a complaint against Overland in the Supreme Court for New York County, alleging breach of the Funding Agreement. The Special Situations Funds alleged that Overland’s January 2014 acquisition of Tandberg Data entitled the Special Situation Funds to a $6.0 million payment under the Funding Agreement, and therefore Overland’s refusal to make the payment constituted a breach of the Funding Agreement by Overland. In November 2014, the Special Situations Funds amended their complaint to allege that Overland breached the Funding Agreement’s implied covenant of good faith and fair dealing by settling the patent litigation with BDT in bad faith to avoid a payment obligation under the Funding Agreement. The Special Situations Funds sought $6.0 million in contractual damages as well as costs and fees. On October 10, 2017, the Court entered an order granting Overland’s motion for summary judgment and dismissing the Special Situations Funds’ complaint in its entirety with prejudice, and in April 2018, the parties entered into a settlement agreement ending the litigation that did not require payment from either party.
Other
In January 2018, Mr. Vito Lupis filed a statement of claim in the Ontario Court of Justice alleging, among other things, breach of contracts, deceit and negligence against Mr. Giovanni J. Morelli, a former officer of the Company, and vicarious liability against the Company, in connection with stock purchase agreements and other related agreements that would have been entered into between Mr. Lupis and the Company in 2012. The Company believes the allegations are without merit and plans to vigorously defend itself against the allegations.
In April 2015, we filed a proof of claim in connection with bankruptcy proceedings of V3 Systems, Inc. (“V3”) based on breaches by V3 of the Asset Purchase Agreement entered into between V3 and the Company dated February 11, 2014 (the “APA”). On October 6, 2015, UD Dissolution Liquidating Trust (“UD Trust”), the apparent successor to V3, filed a complaint against us and certain of our current and former directors in the U.S. Bankruptcy Court for the District of Utah Central Division objecting to our proof of claim and asserting claims for affirmative relief against us and our directors. This complaint alleges, among other things, that Sphere 3D breached the APA and engaged in certain other actions and/or omissions that caused V3 to be unable to timely sell the Sphere 3D common shares received by V3 pursuant to the APA. The plaintiff seeks, among other things, monetary damages for the loss of the potential earn-out consideration, the value of the common shares held back by us pursuant to the APA and costs and fees. We believe the lawsuit to be without merit and intend to vigorously defend against the action.
On December 23, 2015, we filed a motion seeking to dismiss the majority of the claims asserted by the UD Trust. On January 13, 2016, we filed a counterclaim against the UD Trust in which we allege that V3 breached numerous provisions of the APA. On July 22, 2016, we filed a motion seeking to transfer venue of this action to the United States District Court for the District of Delaware. The Bankruptcy Court granted our motion to transfer venue on August 30, 2016, and the case was formally transferred to the Delaware Court on October 11, 2016. There is currently no hearing set on our motion to dismiss.
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In March 2018, UD Trust filed a complaint in U.S. District Court, Northern California District (“California Complaint”) asserting that two transactions involving the Company constitute fraudulent transfers under federal and state law. First, UD Trust alleges that the consolidation of the Company’s and its subsidiaries’ indebtedness to the Cyrus Group into a debenture between FBC and the Company in the principal amount of $19.5 million in December 2014 constitutes a fraudulent transfer. Second, UD Trust alleges that the Share Purchase Agreement constitutes a fraudulent transfer, and seeks to enjoin the Share Purchase or that the proceeds of the transaction be placed in escrow until the V3 litigation is resolved. The California Complaint also asserts a claim against the Company’s CEO for breach of fiduciary duty, and a claim against the Cyrus Group for aiding and abetting breach of fiduciary duty. We believe the lawsuit to be without merit and intend to vigorously defend against the action.
13. | Segmented Information |
The Company reports segment information as a single reportable business segment based upon the manner in which related information is organized, reviewed, and managed. The Company operates in one segment providing data storage and desktop virtualization solutions for small and medium businesses and distributed enterprises.
The following table summarizes net revenue (in thousands):
Three Months Ended March 31, | ||||||||
2018 | 2017 | |||||||
Disk systems | $ | 13,164 | $ | 14,965 | ||||
Tape automation systems | 2,064 | 2,398 | ||||||
Tape drives and media | 2,191 | 2,082 | ||||||
Service | 2,029 | 2,293 | ||||||
$ | 19,448 | $ | 21,738 | |||||
14. | Subsequent Events |
In April 2018, the Company closed an underwritten public offering of 3,300,000 common shares and warrants to purchase up to an aggregate of 990,000 common shares at an aggregate purchase price of $0.70 per common share and accompanying warrant, as well as a concurrent closing of warrants to purchase an additional 112,500 common shares pursuant to the partial exercise of the over-allotment option granted to the underwriter. Gross proceeds, before underwriting discounts and commissions and other offering expenses, were approximately $2.3 million.
On May 10, 2018, the Company issued 640,800 common shares to satisfy payment obligations incurred by the Company in the aggregate amount of $0.3 million. The obligations were related to the Purchase Agreement entered into in February 2018.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following quarterly management’s discussion and analysis (“MD&A”) should be read in conjunction with our unaudited condensed consolidated financial statements and the accompanying notes of Sphere 3D Corp. (the “Company”) for the three months ended March 31, 2018. The condensed consolidated financial statements have been presented in United States (“U.S.”) dollars and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Unless the context otherwise requires, any reference to the “Company,” “Sphere 3D,” “we,” “our,” “us” or similar terms refers to Sphere 3D Corp. and its subsidiaries. Unless otherwise indicated, all references to “$” and “dollars” in this discussion and analysis mean U.S. dollars.
This MD&A includes forward-looking statements that involve risks, uncertainties and assumptions that are difficult to predict. Words and expressions reflecting optimism, satisfaction or disappointment with current prospects, as well as words such as “believes,” “hopes,” “intends,” “estimates,” “expects,” “projects,” “plans,” “anticipates” and variations thereof, or the use of future tense, identify forward-looking statements, but their absence does not mean that a statement is not forward-looking. Forward-looking statements are based on information currently available to us and on estimates and assumptions made by us regarding, among other things, general economic conditions, in light of our experience and perception of historical trends, current conditions and expected future developments, as well as other factors that we believe are appropriate and reasonable in the circumstances, but there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results, performance or achievements or future events or developments to differ materially from those expressed or implied by the forward-looking statements, including, but not limited to: our entry into the Purchase Agreement dated February 20, 2018 with Silicon Valley Technology Partners LLC (“Purchaser”), an entity established and controlled by Eric Kelly, chairman and chief executive officer of the Company, pursuant to which Purchaser proposes to acquire Overland and the Data Protection and Archive business from Sphere 3D; Purchaser’s ability to obtain sufficient financing to fund such acquisition and our inability to meet the closing conditions and to close such acquisition on a timely basis; our ability to refinance our credit facilities and to raise additional debt or equity financing; the inability to maintain compliance with the requirements of the NASDAQ Capital Market and/or inability to maintain listing with the NASDAQ Capital Market; the limited operating history of Sphere 3D; the ability of Sphere 3D to manage growth and specifically, its recent acquisition of Unified ConneXions, Inc. (“UCX”) and HVE ConneXions, LLC (“HVE”); the impact of competition; the investment in technological innovation; any defects in components or design of Sphere 3D’s products; the retention or maintenance of key personnel; the possibility of significant fluctuations in operating results; currency fluctuations; the ability of Sphere 3D to maintain business relationships; financial, political or economic conditions; financing risks; future acquisitions; the ability of Sphere 3D to protect its intellectual property; third party intellectual property rights; volatility in the market price for the common shares of the Company; compliance by Sphere 3D with financial reporting and other requirements as a public company; conflicts of interests; future sales of common shares by Sphere 3D’s directors, officers and other shareholders; dilution and future sales of common shares. For more information on these risks, you should refer to the Company’s filings with the securities regulatory authorities, including the Company’s most recently filed Annual Report on Form 10-K, which is available on SEDAR at www.sedar.com and EDGAR at www.sec.gov. In evaluating such statements, we urge you to specifically consider various factors identified in this report, any of which could cause actual results to differ materially from those indicated by such forward-looking statements. Forward-looking statements speak only as of the date of this report and we undertake no obligation to publicly update any forward-looking statements to reflect new information, events or circumstances after the date of this report. Actual events or results may differ materially from such statements.
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Overview
Sphere 3D provides next-generation solutions for standalone storage and long-term data archive products, as well as technologies that converge the traditional silos of compute, storage and network into one integrated “hyper-converged” or converged solution. We provide enterprise storage management solutions, the archiving of the data created by these solutions, and the ability to connect to public cloud services such as Microsoft Azure for additional delivery options and hybrid cloud capabilities. Our solutions are tightly integrated and include a patented portfolio for operating systems for storage, proprietary virtual desktop orchestration software, and proprietary application container software. Our software, combined with commodity x86 servers, or its purpose built appliances, deliver solutions that provide application mobility, security, data integrity and simplified management. These solutions can be deployed through a public, private or hybrid cloud and are delivered through our global reseller network and professional services organization. We have a portfolio of brands including Overland-Tandberg™, HVE ConneXions and UCX ConneXions, dedicated to helping customers achieve their IT goals.
We have created our own platform, Glassware 2.0TM (“Glassware”) for the delivery of applications from a server-based computing architecture. This is accomplished through a number of unique approaches to virtualization utilized by Glassware including the use of software “containers” and “microvisors.” A container refers to software that takes an application and all the things required to run that application and encapsulates them with software. By doing so, users can run numerous applications from a single server and on a single copy of the operating system. A microvisor refers to the technology that allows non-Windows® based applications to run on the same servers as Windows software using a lightweight emulator. Glassware sales are not material.
First Quarter of 2018 and Recent Highlights
• | On April 17, 2018, the Company closed an underwritten public offering of 3,300,000 common shares and warrants to purchase up to an aggregate of 990,000 common shares at an aggregate purchase price of $0.70 per common share and accompanying warrant, as well as a concurrent closing of warrants to purchase an additional 112,500 common shares pursuant to the partial exercise of the over-allotment option granted to the underwriter. Gross proceeds, before underwriting discounts and commissions and other offering expenses, were approximately $2.3 million. |
• | On March 16, 2018, the Company entered into warrant exchange agreements, in a privately negotiated exchange under Section 4(a)(2) of the Securities Act of 1933, as amended, pursuant to which the Company issued 1,430,998 common shares in exchange for the surrender and cancellation of the Company’s outstanding March 24, 2017 warrants (the “Exchange”). Immediately after the Exchange, the previously issued warrants became null and void. MF Ventures, LLC, participated in the Exchange by acquiring 299,999 common shares in exchange for the cancellation of a warrant to purchase 272,727 common shares. |
• | On February 20, 2018, the Company, Overland Storage, Inc., a California corporation and a wholly owned subsidiary of the Company (“Overland”), and Silicon Valley Technology Partners LLC, a Delaware limited liability company established and controlled by Eric Kelly, the Company’s Chief Executive Officer and Chairman of the Board of Directors (the “Purchaser”) entered into a share purchase agreement (the “Purchase Agreement”), pursuant to which, among other things, and subject to certain closing conditions, the Company will sell to Purchaser all of the issued and outstanding shares of capital stock of Overland for $45.0 million (the “Purchase Price”), subject to a working capital adjustment (the “Share Purchase”). The net proceeds from the Share Purchase will be used to repay: (i) the Company’s outstanding obligations under its Credit Agreement with Opus Bank; (ii) its outstanding obligations under the related party convertible note with FBC Holdings S.a.r.l. (“FBC Holdings”); and (iii) its related party subordinated promissory note with MF Ventures, LLC. The Special Committee of the Board of Directors of the Company and the Board of Directors of the Company (with Eric Kelly recusing himself) unanimously approved the entry into the Purchase Agreement by the Company. The Company will hold a special shareholder meeting on May 31, 2018 to seek shareholder approval for the Share Purchase and, subject to the receipt of requisite shareholder approval and meeting the other closing conditions contained therein (including Purchaser’s receipt of adequate funding to close the Share Purchase), anticipates the transaction will close shortly thereafter. |
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Results of Operations
The following table sets forth certain financial data as a percentage of net revenue:
Three Months Ended March 31, | |||||
2018 | 2017 | ||||
Net revenue | 100.0 | % | 100.0 | % | |
Cost of revenue | 69.1 | 68.6 | |||
Gross profit | 30.9 | 31.4 | |||
Operating expenses: | |||||
Sales and marketing | 22.6 | 22.1 | |||
Research and development | 6.6 | 8.1 | |||
General and administrative | 27.9 | 23.0 | |||
57.1 | 53.2 | ||||
Loss from operations | (26.2 | ) | (21.8 | ) | |
Interest expense | (5.7 | ) | (8.5 | ) | |
Other expense, net | (1.5 | ) | (4.3 | ) | |
Loss before income taxes | (33.4 | ) | (34.6 | ) | |
Provision for income taxes | 1.7 | 1.4 | |||
Net loss | (35.1 | )% | (36.0 | )% | |
A summary of the sales mix by product follows (in thousands):
Three Months Ended March 31, | ||||||||||
2018 | 2017 | Change | ||||||||
Disk systems | $ | 13,164 | $ | 14,965 | (12.0 | )% | ||||
Tape automation systems | 2,064 | 2,398 | (13.9 | )% | ||||||
Tape drives and media | 2,191 | 2,082 | 5.2 | % | ||||||
Service | 2,029 | 2,293 | (11.5 | )% | ||||||
Total | $ | 19,448 | $ | 21,738 | (10.5 | )% | ||||
The First Quarter of 2018 Compared with The First Quarter of 2017
Net Revenue
We had revenue of $19.4 million during the first quarter of 2018 compared to $21.7 million during the first quarter of 2017. The decrease in net revenue is a result of a decrease in product revenue of $2.0 million primarily due a decrease of sales units for disk systems from our HVE product line, and a decrease in service revenue of $0.3 million. Original equipment manufacturer (“OEM”) net revenue accounted for 20.6% and 15.5% of net revenue during the first quarter of 2018 and 2017, respectively.
Product Revenue
Net product revenue decreased to $17.4 million during the first quarter of 2018 from $19.4 million during the first quarter of 2017, a decrease of $2.0 million. Revenue from disk systems decreased by $1.8 million primarily related to a $1.4 million decrease in our HVE product line related to a transaction in the first quarter of 2017 that did not recur in the first quarter of 2018. In addition, there was a $0.2 million decrease in tape automation, and tape drives and media revenue related to lower tape media sales volume.
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Service Revenue
Net service revenue decreased to $2.0 million during the first quarter of 2018 from $2.3 million during the first quarter of 2017. The decrease of approximately $0.3 million was due to a decrease in virtualization and extended service contracts related to tape automation product sales.
Gross Profit
Gross profit and margin were as follows (in thousands, unless otherwise noted):
Three Months Ended March 31, | |||||||||
2018 | 2017 | Change | |||||||
Gross profit | 6,010 | 6,831 | (12.0 | )% | |||||
Gross margin | 30.9 | % | 31.4 | % | (0.5 | )pt | |||
Gross profit - product | 4,884 | 5,360 | (8.9 | )% | |||||
Gross margin - product | 28.0 | % | 27.6 | % | 0.4 | pt | |||
Gross profit - service | 1,126 | 1,471 | (23.5 | )% | |||||
Gross margin - service | 55.5 | % | 64.2 | % | (8.7 | )pt | |||
In the first quarter of 2018, gross profit for product and service decreased primarily due to lower sales volume in our disk systems product line and a decrease in extended service contracts related to virtualization and tape automation product sales.
Operating Expenses
Sales and Marketing Expense
Sales and marketing expenses were $4.4 million and $4.8 million for the first quarter of 2018 and 2017, respectively. The decrease of $0.4 million was primarily due to a decrease of $0.4 million in employee and related expenses associated with a lower average headcount, and a $0.5 million decrease in share-based compensation, offset by a $0.5 million increase in strategic marketing and outside contractors’ fees.
Research and Development Expense
Research and development expenses were $1.3 million and $1.8 million for the first quarter of 2018 and 2017, respectively. The decrease of $0.5 million was primarily due to a decrease of $0.2 million in employee and related expenses and a $0.3 million decrease in share-based compensation.
General and Administrative Expense
General and administrative expenses were $5.4 million and $5.0 million for the first quarter of 2018 and 2017, respectively. The increase of $0.4 million was primarily due to a $1.1 million increase in transaction costs related to the share purchase agreement entered into in February 2018, offset by decreases of $0.6 million in share-based compensation expense, and $0.2 million in employee related expenses.
Non-Operating Expenses
Interest Expense
Interest expense was $1.1 million and $1.8 million for the first quarter of 2018 and 2017, respectively. The decrease was primarily related to a decrease in amortization of debt costs of $0.7 million.
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Other Expense, Net.
Other expense, net, in the first quarter of 2018 and 2017 was $0.3 million and $0.9 million, respectively. In the first quarter of 2018, other expense, net, primarily related to realized foreign currency loss of $0.6 million, offset by a gain on the revaluation of warrants of $0.3 million. In the first quarter of 2017, other expense, net, was primarily related to a $1.1 million loss from the revaluation of our investment in connection with our January 2017 acquisition, offset by a $0.2 million gain on revaluation of warrants.
Foreign Currency Risk
We conduct business on a global basis and a significant portion of our sales in international markets are not denominated in U.S. dollars. Our wholly-owned foreign subsidiaries incur costs that are denominated in local currencies. As exchange rates vary, these results may vary from expectations when translated into U.S. dollars, which could adversely impact overall expected results. The effect of exchange rate fluctuations on our results of operations resulted in a loss of $0.6 million in the first quarter of 2018 and a minimal gain in the first quarter of 2017.
Liquidity and Capital Resources
We have recurring losses from operations and a net working capital deficiency. Our primary source of cash flow is generated from sales of our disk and tape automation systems. We have financed our operations through gross proceeds from private sales of equity securities and with borrowings under our credit facilities. At March 31, 2018, we had cash of $2.3 million compared to cash of $4.6 million at December 31, 2017. As of March 31, 2018, we had a working capital deficit of $44.1 million, reflecting a decrease in current assets of $3.3 million and a decrease in current liabilities of $0.9 million compared to December 31, 2017. Cash management and preservation continue to be a top priority. We expect to incur negative operating cash flows as we continue to maintain and increase our sales volume, and maintain operational efficiencies.
In April 2018, the Company closed an underwritten public offering of 3,300,000 common shares and warrants to purchase up to an aggregate of 990,000 common shares at an aggregate purchase price of $0.70 per common share and accompanying warrant, as well as a concurrent closing of warrants to purchase an additional 112,500 common shares pursuant to the partial exercise of the over-allotment option granted to the underwriter. Gross proceeds, before underwriting discounts and commissions and other offering expenses, were approximately $2.3 million.
On February 20, 2018, the Company, Overland, and Silicon Valley Technology Partners LLC, a Delaware limited liability company established and controlled by Eric Kelly, the Company’s Chief Executive Officer and Chairman of the Board of Directors (the “Purchaser”) entered into a share purchase agreement (the “Purchase Agreement”), pursuant to which, among other things, and subject to certain closing conditions, the Company will sell to Purchaser all of the issued and outstanding shares of capital stock of Overland for $45.0 million (the “Purchase Price”), subject to working capital adjustments (the “Share Purchase”). The net proceeds from the Share Purchase will be used to repay: (i) the Company’s outstanding obligations under its Credit Agreement with Opus Bank; (ii) its outstanding obligations under the related party convertible note with FBC Holdings S.a.r.l. (“FBC Holdings”); and (iii) its related party subordinated promissory note with MF Ventures, LLC. The Special Committee of the Board of Directors of the Company and the Board of Directors of the Company (with Eric Kelly recusing) unanimously approved the entry into the Purchase Agreement by the Company. On May 10, 2018, the Company issued 640,800 common shares to satisfy payment obligations incurred by the Company in the aggregate amount of $0.3 million related to the Purchase Agreement. See Note 1 - Organization and Business for additional details.
Management has projected that cash on hand will not be sufficient to allow the Company to continue operations beyond May 31, 2018 if the Company is unable to amend, refinance, or pay off its debt and credit facilities. In February 2018, the Company entered into the Purchase Agreement. If the transactions contemplated by the Purchase Agreement are consummated, the Company expects that the proceeds to be received by the Company would be sufficient to pay off its outstanding debt and credit facilities. The Company will hold a special shareholder meeting on May 31, 2018 to seek shareholder approval for the Share Purchase and, subject to the receipt of requisite shareholder approval and meeting the other closing conditions contained therein (including Purchaser’s receipt of adequate funding to close the Share Purchase), anticipates the transaction will close shortly thereafter. There can be no guarantee that we will be able to raise additional funds or amend or refinance our debt and credit facilities on favorable
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terms or at all, nor can there be any guarantee that the Company’s shareholders will approve the Share Purchase or that the Share Purchase will ultimately be consummated. Significant changes from the Company’s current forecasts, including but not limited to: (i) any delay in the closing of the Share Purchase after May 31, 2018 (including as a result of a failure to receive the appropriate shareholder vote, the failure of the Purchaser to obtain funding adequate to fund the Purchase Price, or the failure to satisfy any closing conditions), (ii) failure to comply with the financial covenants in its credit facilities; (iii) shortfalls from projected sales levels; (iv) unexpected increases in product costs; (v) increases in operating costs; (vi) changes in the historical timing of collecting accounts receivable; and (vii) inability to maintain compliance with the requirements of the NASDAQ Capital Market and/or inability to maintain listing with the NASDAQ Capital Market could have a material adverse impact on the Company’s ability to access the level of funding necessary to continue its operations at current levels. If any of these events occurs or the Company is unable to generate sufficient cash from operations or financing sources, the Company may be forced to liquidate assets where possible and/or curtail, suspend or cease planned programs or operations generally or possibly seek bankruptcy protection, which would have a material adverse effect on the Company’s business, results of operations, financial position and liquidity.
As a result of our recurring losses from operations and negative cash flows, the report from our independent registered public accounting firm regarding our consolidated financial statements for the year ended December 31, 2017 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern.
As of March 31, 2018, our outstanding debt balance was as follows (in thousands):
Maturity Date | Interest Rate | Amount Outstanding | ||||||
Convertible note related party - net | 5/31/2018 | 8.0% | $ | 23,776 | ||||
Term loan - net | 5/31/2018 | 8.25% | $ | 9,914 | ||||
Revolving loan | 5/31/2018 | 8.25% | $ | 8,195 | ||||
Subordinated promissory note, related party | 5/31/2018 | 12.5% | $ | 2,078 | ||||
In March 2018, the Company and FBC Holdings entered into an amendment to the convertible note, under which the maturity date was extended from March 31, 2018 to May 31, 2018. The amendment also altered the schedule for interest payments under the FBC Debenture by providing for future accrued interest to be paid twice monthly rather than semi-annually. In partial consideration for the extension, the Company agreed to pay to FBC Holdings a fee, payable in cash or common shares of the Company at the Company’s option, of $735,000, payable in full by May 16, 2018. In April 2018, the Company issued in the aggregate 950,579 common shares to FBC Holdings for payment of accrued interest and partial payment of fees related to the March 2018 amendment to the convertible note.
In March 2018, the Company and Opus Bank entered into an Amendment Number Eight to Credit Agreement (“Amendment Number Eight”). Under the terms of Amendment Number Eight the maturity date for the revolving and term loan credit facilities were extended from March 31, 2018 to May 31, 2018. In consideration for the extension, the Company agreed to pay a fee of $0.1 million, payable in cash on the date the Credit Agreement is paid in full.
All debt and credit facilities are denominated in U.S. dollars. Our debt and credit facilities contain standard borrowing conditions and can be recalled by the lenders if certain conditions are not met.
The following table shows a summary of our cash flows (used in) provided by operating activities, investing activities and financing activities (in thousands):
Three Months Ended March 31, | ||||||||
2018 | 2017 | |||||||
Net cash used in operating activities | $ | (2,111 | ) | $ | (3,972 | ) | ||
Net cash used in investing activities | $ | (8 | ) | $ | (1,055 | ) | ||
Net cash (used in) provided by financing activities | $ | (192 | ) | $ | 6,852 | |||
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The use of cash during the first quarter of 2018 was primarily a result of our net loss of $6.8 million, offset by $2.3 million in non-cash items, which included share-based compensation, depreciation and amortization, amortization of debt issuance costs, and fair value adjustment of warrants.
During the first quarter of 2017, net cash used in investing activities were primarily related to our January 2017 acquisition.
During the first quarter of 2018, we made $0.2 million of payments on our related party debt. During the first quarter of 2017, we received $7.4 million in net proceeds from the issuance of common shares and warrants, offset by $0.6 million of payments on our related party debt.
Off-Balance Sheet Information
During the ordinary course of business, we may provide standby letters of credit to third parties as required for certain transactions initiated by us. As of March 31, 2018, we had no standby letters of credit outstanding.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial position and results of operations is based on our unaudited consolidated interim financial statements included elsewhere in this Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States. We believe certain of our accounting policies are critical to understanding our financial position and results of operations. Except for policy changes in accounting for revenues associated with our adoption of Topic 606 (see Note 2 “Revenue Recognition” in the Notes to Condensed Consolidated Financial Statements in Item 1), there have been no significant changes to our critical accounting judgments, policies and estimates as described in our Annual Report on Form 10-K for the year ended December 31, 2017.
Recent Accounting Pronouncements
See Note 2 - Significant Accounting Policies to our condensed consolidated financial statements for information about recent accounting pronouncements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact our financial position, results of operations, or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk from changes in foreign currency exchange rates as measured against the U.S. dollar. These exposures are directly related to our normal operating and funding activities. Historically, we have not used derivative instruments or engaged in hedging activities.
Foreign Currency Risk. We conduct business on a global basis and a significant portion of our sales in international markets are not denominated in U.S. dollars. Export sales represent a significant portion of our sales and are expected to continue to represent a significant portion of sales. Purchase contracts are typically in U.S. dollars. In addition, our wholly-owned foreign subsidiaries incur costs that are denominated in local currencies. As exchange rates vary, these results may vary from expectations when translated into U.S. dollars, which could adversely impact overall expected results. Such transactions resulted in a loss of $0.6 million for the three months ended March 31, 2018 and a minimal gain for the three months ended March 31, 2017.
Credit Risk. Credit risk is the risk that the counterparty to a financial instrument fails to meet its contractual obligations, resulting in a financial loss to us. We sell to a diverse customer base over a global geographic area. We evaluate collectability of specific customer receivables based on a variety of factors including currency risk, geopolitical risk, payment history, customer stability and other economic factors. Collectability of receivables is reviewed on an ongoing basis by management and the allowance for doubtful receivables is adjusted as required. Account balances are charged against the allowance for doubtful receivables when we determine that it is probable that the receivable will not be recovered. We believe that the geographic diversity of the customer base, combined with our established credit approval practices and ongoing monitoring of customer balances, mitigates this counterparty risk.
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Liquidity Risk. Liquidity risk is the risk that we will not be able to meet our financial obligations as they come due. We continually monitor our actual and projected cash flows and believe that our internally generated cash flows will not provide us with sufficient funding to meet all working capital and financing needs for at least the next 12 months.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) or 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective to give reasonable assurance that information required to be publicly disclosed is recorded, processed, summarized and reported on a timely basis as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the three months ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1. | Legal Proceedings. |
The Company is, from time to time, subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of such pending proceedings will not have a material effect on the Company’s results of operations, financial position or cash flows.
Patent Litigation Funding Agreement
In December 2010, Overland entered into a litigation funding agreement (the “Funding Agreement”) with Special Situations Fund III QP, L.P., Special Situations Private Equity Fund, L.P., Special Situations Technology Fund, L.P., and Special Situations Technology Fund II, L.P. (collectively, the “Special Situations Funds”) pursuant to which the Special Situations Funds agreed to fund certain patent litigation brought by Overland. In May 2014, the Special Situations Funds filed a complaint against Overland in the Supreme Court for New York County, alleging breach of the Funding Agreement. The Special Situations Funds alleged that Overland’s January 2014 acquisition of Tandberg Data entitled the Special Situation Funds to a $6.0 million payment under the Funding Agreement, and therefore Overland’s refusal to make the payment constituted a breach of the Funding Agreement by Overland. In November 2014, the Special Situations Funds amended their complaint to allege that Overland breached the Funding Agreement’s implied covenant of good faith and fair dealing by settling the patent litigation with BDT in bad faith to avoid a payment obligation under the Funding Agreement. The Special Situations Funds sought $6.0 million in contractual damages as well as costs and fees. On October 10, 2017, the Court entered an order granting Overland’s motion for summary judgment and dismissing the Special Situations Funds’ complaint in its entirety with prejudice, and in April 2018, the parties entered into a settlement agreement ending the litigation that did not require payment from either party.
Other
In January 2018, Mr. Vito Lupis filed a statement of claim in the Ontario Court of Justice alleging, among other things, breach of contracts, deceit and negligence against Mr. Giovanni J. Morelli, a former officer of the Company, and vicarious liability against the Company, in connection with stock purchase agreements and other related agreements that would have been entered into between Mr. Lupis and the Company in 2012. The Company believes the allegations are without merit and plans to vigorously defend itself against the allegations.
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In April 2015, we filed a proof of claim in connection with bankruptcy proceedings of V3 Systems, Inc. (“V3”) based on breaches by V3 of the Asset Purchase Agreement entered into between V3 and the Company dated February 11, 2014 (the “APA”). On October 6, 2015, UD Dissolution Liquidating Trust (“UD Trust”), the apparent successor to V3, filed a complaint against us and certain of our current and former directors in the U.S. Bankruptcy Court for the District of Utah Central Division objecting to our proof of claim and asserting claims for affirmative relief against us and our directors. This complaint alleges, among other things, that Sphere 3D breached the APA and engaged in certain other actions and/or omissions that caused V3 to be unable to timely sell the Sphere 3D common shares received by V3 pursuant to the APA. The plaintiff seeks, among other things, monetary damages for the loss of the potential earn-out consideration, the value of the common shares held back by us pursuant to the APA and costs and fees. We believe the lawsuit to be without merit and intend to vigorously defend against the action.
On December 23, 2015, we filed a motion seeking to dismiss the majority of the claims asserted by the UD Trust. On January 13, 2016, we filed a counterclaim against the UD Trust in which we allege that V3 breached numerous provisions of the APA. On July 22, 2016, we filed a motion seeking to transfer venue of this action to the United States District Court for the District of Delaware. The Bankruptcy Court granted our motion to transfer venue on August 30, 2016, and the case was formally transferred to the Delaware Court on October 11, 2016. There is currently no hearing set on our motion to dismiss.
In March 2018, UD Trust filed a complaint in U.S. District Court, Northern California District (“California Complaint”) asserting that two transactions involving the Company constitute fraudulent transfers under federal and state law. First, UD Trust alleges that the consolidation of the Company’s and its subsidiaries’ indebtedness to the Cyrus Group into a debenture between FBC and the Company in the principal amount of $19.5 million in December 2014 constitutes a fraudulent transfer. Second, UD Trust alleges that the Share Purchase Agreement constitutes a fraudulent transfer, and seeks to enjoin the Share Purchase or that the proceeds of the transaction be placed in escrow until the V3 litigation is resolved. The California Complaint also asserts a claim against the Company’s CEO for breach of fiduciary duty, and a claim against the Cyrus Group for aiding and abetting breach of fiduciary duty. We believe the lawsuit to be without merit and intend to vigorously defend against the action.
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Item 1A. Risk Factors.
An investment in our Company involves a high degree of risk. In addition to the risk factors and other information included or incorporated by reference to this report, you should carefully consider each of the risk factors described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, which is available on SEDAR at www.sedar.com and EDGAR at www.sec.gov. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the risks actually occur, our business and financial results could be harmed and the trading price of our common shares could decline.
Risks Related to the Share Purchase Agreement
Our agreement to sell Overland is subject to a number of conditions, some of which are outside of our control. If such conditions are not timely met, such sale may not occur, which would cause us to need immediate funding to pay our existing debt and other obligations and to continue our operations.
On February 20, 2018, we, Overland, and Silicon Valley Technology Partners LLC, a Delaware limited liability company established and controlled by Eric Kelly, our Chief Executive Officer and Chairman of the Board of Directors (the “Purchaser”) entered into a share purchase agreement (the “Purchase Agreement”), under which, subject to the terms and conditions of the Purchase Agreement, the Company will sell to Purchaser all of the issued and outstanding shares of capital stock of Overland for $45.0 million, subject to a working capital adjustment (the “Share Purchase”). The consummation of the Share Purchase is subject to certain customary conditions. A number of the conditions are not within the control of us, Overland, or Purchaser, and it is possible that such conditions may prevent, delay or otherwise materially adversely affect the completion of the Share Purchase. These conditions include, among others (i) the adoption of the Purchase Agreement by the affirmative vote of the holders of (a) at least 66 2/3% of the outstanding common shares of the Company cast in person or by proxy at the special meeting of shareholders and (b) a majority of the votes cast by certain “minority shareholders” in person or by proxy at the special meeting of shareholders, (ii) the Purchaser’s securing of adequate financing to fund the purchase price, (iii) the transfer by the Company of (a) the businesses of (x) Unified ConneXions, Inc. and (y) HVE ConneXions, LLC (including the provision of information technology consulting services and hardware solutions around cloud computing, data storage and server virtualization to corporate, government, and educational institutions), and (b) the SNAP network attached storage business to a subsidiary of the Company other than Overland or a subsidiary of Overland, and (iv) other customary closing conditions, including (among others) (a) the accuracy of each party’s representation and warrants, (b) each party’s performance in all material respects with its obligations under the Purchase Agreement, and (c) the absence of a material adverse effect on the Company (as defined in the Purchase Agreement).The Company cannot predict with certainty, whether and when any of the required closing conditions will be satisfied or if another uncertainty may arise. Currently, the Company’s special meeting of shareholders for the adoption of the Share Purchase is to be held on May 31, 2018, which is also the maturity date of our credit facility and convertible note. If the Share Purchase does not receive, or timely receive, the shareholder approval, or if another event occurs that delays or prevents the Share Purchase, such delay or failure to complete the Share Purchase may cause uncertainty or other negative consequences that may materially and adversely affect the Company’s business, financial condition and results of operations and, to the extent that the current price of the Company’s common stock reflects an assumption that the Share Purchase will be completed, the price per share for the Company’s common stock.
If we fail to complete the Share Purchase, we will be required to seek financing to pay off our existing secured debt, satisfy our other liabilities, pay our transaction expenses and continue our operations as a going concern.
If we do not complete the Share Purchase, we will continue to face challenges and uncertainties in our ability to repay the outstanding obligations due under the Credit Agreement with Opus Bank and the outstanding obligations under the $24.5 million convertible note with FBC Holdings, which are both scheduled to mature May 31, 2018. As discussed above, it is possible that the net proceeds will not be sufficient to pay all of the above debts, liabilities and expenses or that there will be enough cash or working capital in the Company to fund its continuing operations. Accordingly, the Company may need to raise additional capital through debt or equity financings before, at or around the time of the closing of the Share Purchase, failing which the Company may not be able to continue to operate as a going concern.
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Further, if the Share Purchase is not consummated, our directors, executive officers and other employees will have expended extensive time and effort and will have experienced significant distractions from their work during the period the transaction was pending and we will have incurred significant third party transaction costs, in each case, without any commensurate benefit, which may have a material and adverse effect on our common share price and results of operations.
Risks Related to our Business
Our Opus Bank debt facilities mature on the earlier of the maturity date in the 8% Senior Secured Convertible Debenture (“Convertible Note”), dated December 1, 2014, issued to FBC Holdings, or May 31, 2018, and our Convertible Note with FBC Holdings matures on May 31, 2018. If we are unable to refinance or amend our debt and credit facilities before their maturity date, we may be forced to liquidate assets and/or curtail or cease operations.
We have obtained external funding for our business through a credit agreement with Opus Bank. Pursuant to the terms of Amendment Number Eight, the debt facilities mature on the earliest of (a) the maturity date in the Convertible Note, (b) May 31, 2018 or (c) such earlier date upon which the obligations may be accelerated in accordance with terms of the credit agreement. We will need to raise additional funds and/or amend or refinance our credit facility in order to satisfy our obligations under our credit agreement with Opus Bank. In addition, upon the occurrence of certain events of default under our current credit facility, including failure to meet certain monthly revenue and EBITDA targets, our lender may elect to declare all amounts outstanding to be immediately due and payable and terminate all commitments to extend further credit. A default under the agreement could result in default and cross-acceleration under other indebtedness. In February 2018, the Company entered into a Purchase Agreement. If the transactions contemplated by the Purchase Agreement are consummated, the Company expects that the proceeds to be received by the Company would be sufficient to pay off its outstanding debt and credit facilities. The Company will hold a special shareholder meeting on May 31, 2018 to seek shareholder approval for the Share Purchase and, subject to the receipt of requisite shareholder approval and meeting the other closing conditions contained therein (including Purchaser’s receipt of adequate funding to close the Share Purchase), anticipates the transaction will close shortly thereafter. There can be no guarantee that we will be able to raise additional funds or amend or refinance our debt and credit facilities on favorable terms or at all, nor can there be any guarantee that the Company’s shareholders will approve the Share Purchase.
If any of these events occurs or the Company is unable to generate sufficient cash from operations or financing sources, the Company may be forced to liquidate assets where possible and/or curtail, suspend or cease planned programs or operations generally or possibly seek bankruptcy protection, which would have a material adverse effect on the Company’s business, results of operations, financial position and liquidity.
Our cash and other sources of liquidity will not be sufficient to fund our operations beyond May 31, 2018. If we raise additional funding through sales of equity or equity-based securities, your shares will be diluted. If we need additional funding for operations and we are unable to raise it, we may be forced to liquidate assets and/or curtail or cease operations.
Management has projected that cash on hand will not be sufficient to allow the Company to continue operations beyond May 31, 2018 if the Company is unable to amend, refinance, or pay off its debt and credit facilities. In February 2018, the Company entered into the Purchase Agreement. If the transactions contemplated by the Purchase Agreement are consummated, the Company expects that the proceeds to be received by the Company would be sufficient to pay off its outstanding debt and credit facilities. The Company will hold a special shareholder meeting on May 31, 2018 to seek shareholder approval for the Share Purchase and, subject to the receipt of requisite shareholder approval and meeting the other closing conditions contained therein (including Purchaser’s receipt of adequate funding to close the Share Purchase), anticipates the transaction will close shortly thereafter. There can be no guarantee that we will be able to raise additional funds or amend or refinance our debt and credit facilities on favorable terms or at all, nor can there be any guarantee that the Company’s shareholders will approve the Share Purchase or that the Share Purchase will ultimately be consummated. Significant changes from the Company’s current forecasts, including but not limited to: (i) any delay in the closing of the Share Purchase after May 31, 2018 (including as a result of a failure to receive the appropriate shareholder vote, the failure of the Purchaser to obtain funding adequate to fund the Purchase Price, or the failure to satisfy any closing conditions), (ii) failure to comply with the financial covenants in its credit facilities; (iii) shortfalls from projected sales levels; (iv) unexpected increases in product costs; (v) increases in operating costs; (vi) changes in the historical timing of collecting accounts receivable; and (vii) inability to maintain compliance with the requirements of the NASDAQ Capital Market and/or
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inability to maintain listing with the NASDAQ Capital Market could have a material adverse impact on the Company’s ability to access the level of funding necessary to continue its operations at current levels. If any of these events occurs or the Company is unable to generate sufficient cash from operations or financing sources, the Company may be forced to liquidate assets where possible and/or curtail, suspend or cease planned programs or operations generally or possibly seek bankruptcy protection, which would have a material adverse effect on the Company’s business, results of operations, financial position and liquidity.
If we raise additional funds by selling additional shares of our capital stock, or securities convertible into shares of our capital stock, the ownership interest of our existing shareholders will be diluted. The amount of dilution could be increased by the issuance of warrants or securities with other dilutive characteristics, such as anti-dilution clauses or price resets.
We urge you to review the additional information about our liquidity and capital resources in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this report. If our business ceases to continue as a going concern due to lack of available capital or otherwise, it could have a material adverse effect on our business, results of operations, financial position, and liquidity.
Risks Related to Our Public Company Status and Our Common Shares
If our common shares are delisted from the NASDAQ Capital Market, our business, financial condition, results of operations and share price could be adversely affected, and the liquidity of our common shares and our ability to obtain financing could be impaired.
We have in the past and may in the future fail to comply with the minimum $1.00 per share closing bid price requirement for continued listing on the NASDAQ Capital Market.
Maintaining the listing of our common shares on the NASDAQ Capital Market requires that we comply with the closing bid price requirement, amongst other certain listing requirements. If our common shares cease to be listed for trading on NASDAQ for any reason, it may harm our share price, increase the volatility of our share price, decrease the level of trading activity and make it more difficult for investors to buy or sell shares of our common shares. Our failure to maintain a listing on NASDAQ may constitute an event of default under our outstanding indebtedness as well as any future indebtedness, which would accelerate the maturity date of such debt or trigger other obligations. In addition, certain institutional investors that are not permitted to own securities of non-listed companies may be required to sell their shares, which would adversely affect the trading price of our common shares. If we are not listed on NASDAQ, we will be limited in our ability to raise additional capital we may need.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On March 29, 2018, the Company issued 344,959 common shares under Section 4(a)(2) of the Securities Act of 1933, as amended, for the settlement of accrued interest expense.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
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Item 6. Exhibits.
Exhibit | Filed | Incorporated by Reference | |||
Number | Description | Herewith | Form | File No. | Date Filed |
2.2 | 8-K | 001-36532 | 2/21/2018 | ||
3.1 | 6-K | 001-36532 | 3/25/2015 | ||
3.2 | 6-K | 001-36532 | 7/17/2017 | ||
3.3 | 6-K | 001-36532 | 7/17/2017 | ||
3.4 | 6-K | 001-36532 | 5/12/2017 | ||
10.1 | S-8 | 333-214605 | 1/29/2018 | ||
10.2 | S-8 | 333-205236 | 1/29/2018 | ||
10.3 | 8-K | 001-36532 | 3/19/2018 | ||
10.4 | X | ||||
10.5 | X | ||||
31.1 | X | ||||
31.2 | X | ||||
32 | X | ||||
101.INS | XBRL Instance Document | X | |||
101.SCH | XBRL Taxonomy Extension Schema | X | |||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | X | |||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | X | |||
101.LAB | XBRL Taxonomy Extension Label Linkbase | X | |||
101.PRE | XBRL Taxonomy Presentation Linkbase | X | |||
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SIGNATURE
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.
Sphere 3D Corp. | ||||
Date: | May 10, 2018 | By: | /s/ Kurt L. Kalbfleisch | |
Kurt L. Kalbfleisch Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) | ||||
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